- The price of crude oil today is not made according to
any traditional relation of supply to demand. It's controlled by an elaborate
financial market system as well as by the four major Anglo-American oil
companies. As much as 60% of today's crude oil price is pure speculation
driven by large trader banks and hedge funds. It has nothing to do with
the convenient myths of Peak Oil. It has to do with control of oil and
its price. How?
- First, the crucial role of the international oil exchanges
in London and New York is crucial to the game. Nymex in New York and the
ICE Futures in London today control global benchmark oil prices which in
turn set most of the freely traded oil cargo. They do so via oil futures
contracts on two grades of crude oil-West Texas Intermediate and North
- A third rather new oil exchange, the Dubai Mercantile
Exchange (DME), trading Dubai crude, is more or less a daughter of Nymex,
with Nymex President, James Newsome, sitting on the board of DME and most
key personnel British or American citizens.
- Brent is used in spot and long-term contracts to value
as much of crude oil produced in global oil markets each day. The Brent
price is published by a private oil industry publication, Platt's. Major
oil producers including Russia and Nigeria use Brent as a benchmark for
pricing the crude they produce. Brent is a key crude blend for the European
market and, to some extent, for Asia.
- WTI has historically been more of a US crude oil basket.
Not only is it used as the basis for US-traded oil futures, but it's also
a key benchmark for US production.
- 'The tail that wags the dog'
- All this is well and official. But how today's oil prices
are really determined is done by a process so opaque only a handful of
major oil trading banks such as Goldman Sachs or Morgan Stanley have any
idea who is buying and who selling oil futures or derivative contracts
that set physical oil prices in this strange new world of "paper oil."
- With the development of unregulated international derivatives
trading in oil futures over the past decade or more, the way has opened
for the present speculative bubble in oil prices.
- Since the advent of oil futures trading and the two major
London and New York oil futures contracts, control of oil prices has left
OPEC and gone to Wall Street. It is a classic case of the "tail that
wags the dog."
- A June 2006 US Senate Permanent Subcommittee on Investigations
report on "The Role of Market Speculation in rising oil and gas prices,"
noted, "there is substantial evidence supporting the conclusion that
the large amount of speculation in the current market has significantly
- What the Senate committee staff documented in the report
was a gaping loophole in US Government regulation of oil derivatives trading
so huge a herd of elephants could walk through it. That seems precisely
what they have been doing in ramping oil prices through the roof in recent
- The Senate report was ignored in the media and in the
- The report pointed out that the Commodity Futures Trading
Trading Commission, a financial futures regulator, had been mandated by
Congress to ensure that prices on the futures market reflect the laws of
supply and demand rather than manipulative practices or excessive speculation.
The US Commodity Exchange Act (CEA) states, "Excessive speculation
in any commodity under contracts of sale of such commodity for future delivery
. . . causing sudden or unreasonable fluctuations or unwarranted changes
in the price of such commodity, is an undue and unnecessary burden on interstate
commerce in such commodity."
- Further, the CEA directs the CFTC to establish such trading
limits "as the Commission finds are necessary to diminish, eliminate,
or prevent such burden." Where is the CFTC now that we need such limits?
- They seem to have deliberately walked away from their
mandated oversight responsibilities in the world's most important traded
- Enron has the last laugh
- As that US Senate report noted:
- "Until recently, US energy futures were traded exclusively
on regulated exchanges within the United States, like the NYMEX, which
are subject to extensive oversight by the CFTC, including ongoing
monitoring to detect and prevent price manipulation or fraud. In recent
years, however, there has been a tremendous growth in the trading of contracts
that look and are structured just like futures contracts, but which are
traded on unregulated OTC electronic markets. Because of their similarity
to futures contracts they are often called "futures look-alikes."
- The only practical difference between futures look-alike
contracts and futures contracts is that the look-alikes are traded
in unregulated markets whereas futures are traded on regulated exchanges.
The trading of energy commodities by large firms on OTC electronic exchanges
was exempted from CFTC oversight by a provision inserted at the behest
of Enron and other large energy traders into the Commodity Futures Modernization
Act of 2000 in the waning hours of the 106th Congress.
- The impact on market oversight has been substantial.
NYMEX traders, for example, are required to keep records of all trades
and report large trades to the CFTC. These Large Trader Reports, together
with daily trading data providing price and volume information, are the
CFTC's primary tools to gauge the extent of speculation in the markets
and to detect, prevent, and prosecute price manipulation. CFTC Chairman
Reuben Jeffrey recently stated: "The Commission's Large Trader information
system is one of the cornerstones of our surveillance program and enables
detection of concentrated and coordinated positions that might be used
by one or more traders to attempt manipulation."
- In contrast to trades conducted on the NYMEX, traders
on unregulated OTC electronic exchanges are not required to keep records
or file Large Trader Reports with the CFTC, and these trades are exempt
from routine CFTC oversight. In contrast to trades conducted on regulated
futures exchanges, there is no limit on the number of contracts a speculator
may hold on an unregulated OTC electronic exchange, no monitoring of trading
by the exchange itself, and no reporting of the amount of outstanding contracts
("open interest") at the end of each day."
- Then, apparently to make sure the way was opened really
wide to potential market oil price manipulation, in January 2006, the Bush
Administration's CFTC permitted the Intercontinental Exchange (ICE), the
leading operator of electronic energy exchanges, to use its trading terminals
in the United States for the trading of US crude oil futures on the ICE
futures exchange in London called "ICE Futures."
- Previously, the ICE Futures exchange in London had traded
only in European energy commodities Brent crude oil and United Kingdom
natural gas. As a United Kingdom futures market, the ICE Futures exchange
is regulated solely by the UK Financial Services Authority. In 1999, the
London exchange obtained the CFTC's permission to install computer terminals
in the United States to permit traders in New York and other US cities
to trade European energy commodities through the ICE exchange.
- The CFTC opens the door
- Then, in January 2006, ICE Futures in London began trading
a futures contract for
- West Texas Intermediate (WTI) crude oil, a type of crude
oil that is produced and delivered in the United States. ICE Futures also
notified the CFTC that it would be permitting traders in the United States
to use ICE terminals in the United States to trade its new WTI contract
on the ICE Futures London exchange. ICE Futures as well allowed traders
in the United States to trade US gasoline and heating oil futures on the
ICE Futures exchange in London.
- Despite the use by US traders of trading terminals within
the United States to trade US oil, gasoline, and heating oil futures contracts,
the CFTC has until today refused to assert any jurisdiction over the trading
of these contracts.
- Persons within the United States seeking to trade key
US energy commodities US crude oil, gasoline, and heating oil futures
are able to avoid all US market oversight or reporting requirements
by routing their trades through the ICE Futures exchange in London instead
of the NYMEX in New York.
- Is that not elegant? The US Government energy futures
regulator, CFTC opened the way to the present unregulated and highly opaque
oil futures speculation. It may just be coincidence that the present CEO
of NYMEX, James Newsome, who also sits on the Dubai Exchange, is a former
chairman of the US CFTC. In Washington doors revolve quite smoothly between
private and public posts.
- A glance at the price for Brent and WTI futures prices
since January 2006 indicates the remarkable correlation between skyrocketing
oil prices and the unregulated trade in ICE oil futures in US markets.
Keep in mind that ICE Futures in London is owned and controlled by a USA
company based in Atlanta Georgia.
- In January 2006 when the CFTC allowed the ICE Futures
the gaping exception, oil prices were trading in the range of $59-60 a
barrel. Today some two years later we see prices tapping $120 and trend
upwards. This is not an OPEC problem, it is a US Government regulatory
problem of malign neglect.
- By not requiring the ICE to file daily reports of large
trades of energy commodities, it is not able to detect and deter price
manipulation. As the Senate report noted, "The CFTC's ability to detect
and deter energy price manipulation is suffering from critical information
gaps, because traders on OTC electronic exchanges and the London ICE Futures
are currently exempt from CFTC reporting requirements. Large trader reporting
is also essential to analyze the effect of speculation on energy prices."
- The report added, "ICE's filings with the Securities
and Exchange Commission and other evidence indicate that its over-the-counter
electronic exchange performs a price discovery function -- and thereby
affects US energy prices -- in the cash market for the energy commodities
traded on that exchange."
- Hedge Funds and Banks driving oil prices
- In the most recent sustained run-up in energy prices,
large financial institutions, hedge funds, pension funds, and other investors
have been pouring billions of dollars into the energy commodities markets
to try to take advantage of price changes or hedge against them. Most of
this additional investment has not come from producers or consumers of
these commodities, but from speculators seeking to take advantage of these
price changes. The CFTC defines a speculator as a person who "does
not produce or use the commodity, but risks his or her own capital trading
futures in that commodity in hopes of making a profit on price changes."
- The large purchases of crude oil futures contracts by
speculators have, in effect, created an
- additional demand for oil, driving up the price of oil
for future delivery in the same manner that additional demand for contracts
for the delivery of a physical barrel today drives up the price for oil
on the spot market. As far as the market is concerned, the demand for a
barrel of oil that results from the purchase of a futures contract by a
speculator is just as real as the demand for a barrel that results from
the purchase of a futures contract by a refiner or other user of petroleum.
- Perhaps 60% of oil prices today pure speculation
- Goldman Sachs and Morgan Stanley today are the two leading
energy trading firms in the United States. Citigroup and JP Morgan Chase
are major players and fund numerous hedge funds as well who speculate.
- In June 2006, oil traded in futures markets at some $60
a barrel and the Senate investigation estimated that some $25 of that was
due to pure financial speculation. One analyst estimated in August 2005
that US oil inventory levels suggested WTI crude prices should be around
$25 a barrel, and not $60.
- That would mean today that at least $50 to $60 or more
of today's $115 a barrel price is due to pure hedge fund and financial
institution speculation. However, given the unchanged equilibrium in global
oil supply and demand over recent months amid the explosive rise in oil
futures prices traded on Nymex and ICE exchanges in New York and London
it is more likely that as much as 60% of the today oil price is pure speculation.
No one knows officially except the tiny handful of energy trading banks
in New York and London and they certainly aren't talking.
- By purchasing large numbers of futures contracts, and
thereby pushing up futures
- prices to even higher levels than current prices, speculators
have provided a financial incentive for oil companies to buy even more
oil and place it in storage. A refiner will purchase extra oil today, even
if it costs $115 per barrel, if the futures price is even higher.
- As a result, over the past two years crude oil inventories
have been steadily growing, resulting in US crude oil inventories that
are now higher than at any time in the previous eight years. The large
influx of speculative investment into oil futures has led to a situation
where we have both high supplies of crude oil and high crude oil prices.
- Compelling evidence also suggests that the oft-cited
geopolitical, economic, and natural factors do not explain the recent rise
in energy prices can be seen in the actual data on crude oil supply and
demand. Although demand has significantly increased over the past few years,
so have supplies.
- Over the past couple of years global crude oil production
has increased along with the increases in demand; in fact, during this
period global supplies have exceeded demand, according to the US Department
of Energy. The US Department of Energy's Energy Information Administration
(EIA) recently forecast that in the next few years global surplus production
capacity will continue to grow to between 3 and 5 million barrels per day
by 2010, thereby "substantially thickening the surplus capacity cushion."
- Dollar and oil link
- A common speculation strategy amid a declining USA economy
and a falling US dollar is for speculators and ordinary investment funds
desperate for more profitable investments amid the US securitization disaster,
to take futures positions selling the dollar "short" and oil
- For huge US or EU pension funds or banks desperate to
get profits following the collapse in earnings since August 2007 and the
US real estate crisis, oil is one of the best ways to get huge speculative
gains. The backdrop that supports the current oil price bubble is continued
unrest in the Middle East, in Sudan, in Venezuela and Pakistan and firm
oil demand in China and most of the world outside the US. Speculators trade
on rumor, not fact.
- In turn, once major oil companies and refiners in North
America and EU countries begin to hoard oil, supplies appear even tighter
lending background support to present prices.
- Because the over-the-counter (OTC) and London ICE Futures
energy markets are unregulated, there are no precise or reliable figures
as to the total dollar value of recent spending on investments in energy
commodities, but the estimates are consistently in the range of tens of
billions of dollars.
- The increased speculative interest in commodities is
also seen in the increasing popularity of commodity index funds, which
are funds whose price is tied to the price of a basket of various commodity
futures. Goldman Sachs estimates that pension funds and mutual funds have
invested a total of approximately $85 billion in commodity index funds,
and that investments in its own index, the Goldman Sachs Commodity Index
(GSCI), has tripled over the past few years. Notable is the fact that the
US Treasury Secretary, Henry Paulson, is former Chairman of Goldman Sachs.
- F. William Engdahl is an Associate of the Centre for
Research on Globalization (CRG) and author of A Century of War: Anglo-American
Oil Politics and the New World Order. He may be contacted at email@example.com
- 1 United States Senate Premanent Subcommittee on
Investigations, 109th Congress 2nd Session, The Role of Market speculation
in Rising Oil and Gas Prices: A Need to Put the Cop Back on the Beat; Staff
Report, prepared by the Permanent Subcommittee on Investigations of the
Committee on Homeland Security and Governmental Affairs, United States
Senate, Washington D.C., June 27, 2006. p. 3.