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Should trading in crude be tempered?

Adapted from newspaper

Plug the loopholes that help speculation

It is common knowledge now that since a long time prices


of the physical barrel are determined more by the oil
futures market and less by demand-supply considerations.

As the price is moving towards $150 barrel, a conservative


calculation shows at least 60% of the price comes from
unregulated future speculation by hedge funds, ‘gambling’
desks of banks and financial groups.
T N R Rao
Former Union They play in the London ICE futures and New York Nymex
Petroleum futures exchanges and the uncontrolled inter bank or over-
Secretary ,India the-counter trading to escape scrutiny. In fact, they have
since long replaced Opec as price makers in the oil market.

This is because margin rules of US Commodity Futures Trading Commission allow


speculators to buy oil futures with only 6% of its value for payment, giving an
extreme leverage of 16:1 and this drives prices to wildly unrealistic levels and
makes good bank losses in disasters like subprime at the expense of the common
consumers.

The hoax of peak oil, that the era of cheap oil has peaked and is on a downward
slide, has also helped perpetuate these uncontrolled price manipulations. However,
the US government’s latest Energy Information Administration (EIA) report shows
a drop in US demand along with a very modest increase in that of China.

This would hardly dent the current oil production of the world of some 86 mbpd.
Prices have thus become detached from market fundamentals. By no account is
there a shortage of oil and every demand is being met. In other words, there are low
buyers for the physical barrel at today’s prices, but there are plenty of buyers for
pieces of papers (futures) linked to the price of oil next month or next year.

So a major step required by the US, UK and European regulators is to reduce the
artificial demand for long-term oil hoarding created by such investors who are
piling into commodities the same way they did into technology shares in the late
’90s and the subprimes during 2003-06.
Regulators should tighten tax rules and plug loopholes that enable long-term
investors to accumulate immense positions far larger than those permitted to
ordinary commodity speculators. And these should help reverse the recent oil price
spikes.

It’s time to correct speculation in oil trade


Market fundamentals show that production has not kept pace with growing
demand for oil, resulting in increasing, and increasingly volatile, prices.

World oil consumption growth has averaged 1.8% per year, but for the past three
years global oil production has remained constant at roughly 85 mbpd. If there are
no additional supplies of oil, for every per cent increase in demand, we should
expect double digit percentage increase in price to balance the market.

The prices have unreasonably risen because of speculation. The free market of
crude oil is getting to be awfully expensive. It can hardly be termed ‘free’ when
speculators are ruling the roost and producers are in turn further incentivised by
returns to create a play for the speculators. Even reasonable inventory levels are
not able to hold the levels.

The NYMEX is the pre-eminent energy futures market in the world and has
become the price-setting mechanism for oil. Opec also refers to NYMEX when it
sets its price targets. The margin requirements on NYMEX and such markets are
considered by many as too low for the control it potentially has of large volume and
value of trade.

Analysts believe that many other parameters prominently demonstrate the play of
speculators. It is time the speculative element in trade is studied and corrected.
Opec producers have consistently argued that speculation and the weak dollar were
largely responsible for record breaking prices, while western consuming nations, led
by the US, contend that more output is needed.

Surprisingly much against the expectations created due to the pre-meet diffidence to
accept role of speculation, the statement issued by 36 countries in last week’s Jeddah
Energy Meet said, “The transparency and regulation of financial markets should be
improved through measures to capture more data on index fund activity and to
examine cross-exchange interactions in the crude market.”

Let us all hope that world oil markets take actions to have rational trade while
concurrently the producers assisted by major consumers create “the existence of
spare capacity throughout the chain for the stability of the global oil market”, as the
statement also stated.