Rigging oil prices

Factual Questions
1

I don’t know much about the oil market except for the threads that I read here about whether or not speculators are driving the price of oil significantly beyond the fundamentals. I was just reading an article in Time that argues that it is certainly possible that suppliers are able to push up prices anonymously and that more participant transparency is needed in the market. They don’t claim that they have any evidence of wrongdoing, but state that suppliers have the motive and the opportunity and nothing to stop them. How plausible is the scenario they describe? I put this in GQ because I don’t want this to turn in to a rantfest.

Thanks for your help,
Rob

2

Suppose that your premise is correct. Speculators are buying up oil futures in the hopes of selling them for more money than they paid for them and this drives up the price of oil.

What business is it of yours? If I buy a bond or an acre of land or a house or a baseball card or a barrel of oil because I believe that in the future someone will pay me more money for it than what I paid for it why should it be of interest to anyone other than myself and the eventual purchaser?

Americans have decided that they enjoy a lifestyle that requires large quantities of gasoline. They like to drive long distances in fuel inefficient vehicles. They have chosen to put their balls in the oil companies vise. To decide at this point that the oil companies should not squeeze is disingenuous. Change your lifestyle, buy less gasoline, or pay the price.

3

Just so we understand each other, it is not my premise. It is that of the article’s authors. If you buy a bond or an acre of land and then sell it back to yourself or to a confederate and then repeat to inflate the price, I might want to know, and I definitely do if we are talking about something that I have to buy, like food or oil. Also, oil prices affect more than just SUV drivers (for the record, I drive a Chevy Prism). As I heard it put, everything you buy got to you on a truck.

If oil suppliers are making money off their investments, more power to them, but if they are manipulating prices based on their advantageous position, I don’t see that as being very different from insider trading.

That is neither here nor there. I just want to know if the author’s premise is plausible or not.

Thanks for your help,
Rob

4

The article seems a bit sensational to me. Are the authors even graduates? The article has a whole of speculation but not a lot of facts in it. They fail to make a correlation between the futures market price and the spot price. They say that it influences the market, but not exactly how. The truth is that the futures market and spot market are too completely different prices. The last time I specifically studied the futures market was in my price theory class, so my knowledge is a little hazy. However, I distinctly remember my professor telling us that the futures market is like everyone betting on the super bowl, however, all those bets do not have an affect on the outcome of the actual game.

But suppose it is true? Where is the money coming from? How are they hiding their purchases? Hedge funds aren’t big enough. It would need to be a hugely orchestrated event (well many of them) all with high transaction costs through the various brokerage houses. But, I’ll let that go for now, as I don’t want to get into an argument of efficient personal trading.

Next, these super-rich with all their billions of dollars are going to have to compete against all the industries of the world (airline, car manufacturing, transport, etc.) who want the price of oil to drop. Do these handful of ultra-rich have enough money to counter the markets of India and China who desperately want to drive the price down, who already subsidize their oil?

Speculators can take physical delivery of the oil, and keep the game going, assuming they survive the margin call. Where are they going to store it? I haven’t heard any where that there is an excess supply of oil. These are millions of barrels. Even oil producers don’t have that much storage capacity. The oil producer operations are set to bring oil out to market. Producers who don’t sell, or worse, play the speculation game and lose (i.e. can’t sell their over-priced contracts) are just making their operations more expensive. That cost is reported and audited, and affects their profit margin, which affects their stock price. Is it worth the risk at that point?

Lastly, here is an article from the CFTC that shows that no oil producers have taken a long futures position and pretty much debunks the whole theory that speculation increases the oil prices. (warning .pdf)

http://www.cftc.gov/stellent/groups/public/@newsroom/documents/file/itfinterimreportoncrudeoil0708.pdf

5

Thank goodness you didn’t work for California back in 2001 when electricity rates shot up triple digits because of market manipulation.

Interestingly enough, the CFTC released data that showed a single small firm held 11% of the oil traded in NYME in July.

It’s one thing to make a sound investment, buying for a dollar and selling for two. It’s entirely another to take advantage of a position not open to retail investors and open Pandor’s Box of Regulation.

6

Can you elaborate a little bit? How big would hedge funds need to be?

What techniques would a major consumer use to fight them?

Could a supplier who owned a futures contract simply not produce the oil? Does the supplier have to take physical delivery and then store the oil?
Thanks for your help,
Rob

7

There’s no set size. It’s just that one rich guy can’t command one hedge fund to do the buying for him because it would look highly suspicious, if not illegal. Some of my doctor friends in hedge funds would likely pull out because the fund isn’t doing what they want it to do (they don’t like the idea of one person controlling what is supposed to be a diversified fund, or doing what the fund manager is supposed to be doing). The last thing a hedge fund wants is an investigation from the CFTC. So, the rich person has to diversify his purchases. This becomes logistically difficult, something like trying to buy all the lottery tickets for all possible combinations at one convenience store. On top of that, who is coordinating all these purchases? Where is the money coming from? This becomes all very easy to trace. So the market manipulator would have to employ a team of people to do this, thus cutting into his profits.

For every long position, generally, there is a short. Whoever is in the imbalance is left holding the bag. In this case, longs outweigh the shorts, and last I heard, that was 170 contracts. That’s 170 deliveries of oil that someone has to take. If that person is not going to take the oil, he has to put it somewhere. The oil supplier doesn’t know who is going to buy his future contract, but I suppose, he could choose not to sell any (assuming he is able to get into the futures market in the first place, and that is being in the long position without a shorter) but that’s an awful lot of risk, which I’ll address below.

However, you must understand that consumers don’t fight for lower oil costs or lower speculation at this point in the market. Consumers need the oil now. Consumer compete on the spot price of oil now, which is not influenced by the futures market.

I suppose it is possible, but the logistics of coordinating such events is massively improbable. Assuming that there is a consortium of players, and assuming they can all agree to divide the spoils somehow, one person can undercut them all and expose the rest of the consortium’s positions. A more simple way of understanding that is how member of OPEC routinely break their agreements and sell oil anyway.

For your second question, if the future contract holder can’t zero out his position (find a shorter), then at the expiration of the contract, he must take delivery or sell (he’ll often just sell at a lower price). The oil supplier won’t know this (plus he would have to be able to sell to himself on the futures market, also a logistically hard thing to do) in the future. How will he know how to ramp up production? Hopefully, I’ve demonstrated how much risk there is in all this. If a new supply of oil is found and the price drops, the long holder will be very exposed and crushed from the forthcoming margin call.

8

One problem I have always had with the notion of speculators pushing up prices is – how long could that go on, given that oil trades in futures contracts?

In other words, if I buy the December crude contract, I have to unload it before December unless I want a truckload of oil showing up at my house. Speculators could only play chicken in hoarding bunches of contracts on which they of course never plan to take delivery for so long – eventually, they need to sell, the price would collapse, etc.

Have any of the CTs found a way to explain how such “speculation” could be sustainable? At the end of the day, the contract will be sold to a refinery; nobody is literally hoarding oil (the way you might hoard gold or even stocks).

9

Perhaps someone with better knowledge than I can point out the flaw in my thinking: There is no need to go through shady futures speculation; if producers want to raise the price of oil they can just lower production.

As a confirmed capitalist I want speculators. If speculators think that oil will become scarce or expensive they’ll buy oil now, raise the price, and get us moving in a different direction before a complete shut-off arrives.