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Paper oil


Oil futures closed over $139 a barrel on the NYMEX yesterday, a new record. Last night, I received two viral emails from friends blaming Democrats and radical environmentalists for creating a shortage of oil, which in turn has created the spike in prices.

It’s a simple explanation, and it’s wrong.

The price of oil has increased faster over the last two years than at any time in American history, including the 1973-74 OPEC oil embargo. But this time, there are no lines at the gas pumps. Supplies on hand in the U.S. are at the highest level since the early 1990s.

Furthermore, there is no global shortage. Worldwide production of oil rose 2.5% in the first quarter, while worldwide demand grew by only 2%.

The problem of skyrocketing oil prices is bipartisan, and it involves culprits who aren’t even on the public’s radar. And none of the major party presidential candidates have called them out.

F. William Engdahl explains the convoluted workings oil futures trading:

[H]ow 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.
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.

It may also just be coincidence that two of the most prominent voices warning of future supply/price problems are Secretary Treasury Henry Paulson (former CEO of Goldman Sachs) and analyst Ole Slorer of Morgan Stanley, who said yesterday that oil could hit $150 a barrel by the 4th of July.

Remember, Goldman Sachs and Morgan Stanley are the two largest energy trading firms in the United States (Goldman Sachs is the largest in the world). This gives them some expertise in analyzing price trends. Their predictions of tighter supplies and higher prices may well be self-fulfilling prophecies as they motivate more speculators to trade on those expectations.

Goldman Sachs and Morgan Stanley are also positioned to profit from price fluctuations — it is, after all, what they do — that may result from such dire price/supply forecasts.

Others in the game include JP Morgan Chase and Citigroup, companies highly leveraged in subprime mortgage speculation. Is it such a stretch to speculate that the same bubblemetrics that pushed real estate prices to record levels in the U.S. is now at work in oil markets? Consider this: in 2000, approximately $9 billion was invested in oil futures. Today that number is $250 billion.

So maybe it is a problem of supply and demand after all. When the supply of dollars in the market relative to a barrel of oil increases, demand for those dollars declines. Thus, the number of dollars it takes to buy a barrel of oil increases. Econ 101.

Isn’t it interesting that none of the candidates for president have mentioned institutional investors as the possible culprits behind ballooning oil prices? Maybe it has something to do with donations the commercial bankers and hedge funds have kicked into campaign coffers — most of it, interestingly, to Democrats.

So progressives are in for a rude surprise if they expect any relief from high energy costs from President Obama. Unless and until the United States Congress clamps down on unregulated speculation in oil futures, we’ll continue to participate in a huge involuntary wealth transfer from those of us who rely on oil and its derivative products to those who control the trade in oil-based financial derivatives.

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