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A Closer Look at Oil Speculators
by Hazel Henderson, President, Ethical Markets Media, USA



Ever since the 1980s when Britain's Margaret Thatcher and US President Ronald Reagan spurred de-regulation of global finance and privatization, market fundamentalism became the main game.
At last, the world is seeing the difference between money and real wealth, between "demand" in markets and the real needs of people without money. We cringe at the tragic pictures of poor people eyeing abundant, tempting supplies of food in the local markets around the world but who are forced to go away hungry or make their children patties made of mud, spices and whatever scraps of vegetation they can find.

The games of traders, speculators, hedge funds, private equity and even pension funds and charitable foundation and university portfolio managers, driving up prices of oil and food, invoke increasing outrage and demands for reform. The recent FAO Summit in Rome called for $10 billion more to pay these higher food prices. Yet, without financial reforms, this money will fatten players in the global casino.

The flaws of laissez-faire economics are again evident in the latest set of financial debacles, with $100 billion written down from faulty risk models and collapsed hedge funds to speculation in oil and commodities. Despite the efforts of socially-responsible investors and asset managers to impose transparency, better corporate governance and true-cost pricing, little progress has been made to internalize social and environmental costs into risk-analyses, company balance sheets and national GDP accounting. These huge, mounting costs: from pollution to global climate change, ignored for decades by financiers, accountants and most official statistics, now feed the suspicions of millions that global finance is indeed a casino with rules rigged by the insiders.

In the ceaseless, now computerized, trading between all market players (recently measured in London's exchanges by the elevated testosterone levels of the mostly-male traders), the games of money, power and ego are changing again - for the worse.

  • Market players unwilling to submit to enhanced scrutiny of shareholders, analysts and the rigors of public stock ownership retreat into private equity deals - buy companies, saddle them with debt and often strip their assets and re-sell them.
  • Companies try to boost their stock prices with share buy-backs - limiting the supply, e.g., oil companies "banking" huge oil price increases rather than investing in new supplies or facilities.
  • Hedge funds (630 speculating in energy) total $2.9 trillion with their top 10 managers earning $14 billion in 2007. They still proliferate even after their many risk-analyses failures, as greedier investors seek ever-higher returns. The game, as with private equity, is also to buy companies with borrowed money. Speculating in commodities ($8 trillion of futures contracts in oil in 2007) drives up the prices of other necessities.
  • The game of "enhancing shareholder value" (versus other stakeholders' interests), played by private equity and hedge fund players, has led many asset managers of employee pension funds, foundations and university endowments to join these new greed sweepstakes. Many employees are shocked to find their pension fund managers investing their retirement funds in all these efforts to try to beat each others' market performance - contributing to the problems of plant closures, rising gas and food prices and carbon emissions.
  • The newest game is the rise of sovereign wealth funds, swelled with oil revenues and trade surpluses. Norway has the oldest and most responsibly managed of these funds. Others are in Singapore, China, Kuwait and the United Arab Emirates. Here the game is not just money but power and influence as well as buying real assets instead of holding slumping US dollars. The USA, the world's largest debtor, must court these funds, sending Treasure Secretary Henry Paulson, hat in hand, while President Bush pleads with Saudi Arabia's King Abdullah for more oil.
  • Banks, hurt by reckless investments in the alphabet soup of esoteric derivatives: CDOs, SIVs, CDSs (at $62 trillion), also look to sovereign wealth funds to bail them out, joining hedge funds and private equity supplicants. Taxpayers baulk at the bail out of Wall Street investment bank Bear Stearns, while central banks are exhausting their reserves, tools and remedies. US Fed interest rate cuts have weakened the dollar, feeding inflation and speculative bubbles in oil and commodities.

What are the likely outcomes of all these new games in the global casino - still unregulated since the Asian meltdowns of the late 1990s? Firstly, we are seeing the effects of the massive credit creation by central banks which fed the dot.com bubble, the housing bubble, the oil, food and commodities bubbles - a worldwide expansion of fiat currencies. The globalization of unregulated financial markets led to the rapid "contagion" - accelerated by computerized and algorithm-based automated trading. The "rocket-scientist" academic mathematicians, lured by the hedge funds, turned out faulty models which failed to see risks from these new conditions and how their own trading strategies were creating new systemic risks to their own financial markets.

Financial sectors of the US, UK and other market economies metastasized - just as they had done prior to the Wall Street Crash of 1929. In Britain, finance represents 25% of GDP and over 20% in the USA. Too many people are employed in trading, borrowing and financial engineering - rather than in producing real goods and services.

Money was an important invention in human societies, but it only retains its value if it is a good tracking and scoring system of the products and exchanges of the real economy. Pyramiding of paper and now electronic "assets" inevitably leads to write-downs, dislocating both the speculating players and the rest of the economy. We see now how the changing theories of central bankers distort real economies, from Alan Greenspan's belief that the dot.coms had created a "New Economy" to his urging US borrowers to try adjustable rate mortgages and hailing all the new derivatives as "financial innovations" that spread risk to those able to bear it.

Reforms of these excesses in the global financial casino include:

  • taxing the 90% of speculation in today's $2 trillion of daily currency trading;
  • curbing the $260 billion in index funds tied to oil and other commodities;
  • reducing the 16 to 1 leverage allowed in oil and commodity trading by raising margin requirements;
  • repealing the "ENRON loophole" passed in 2001 that de-regulated energy trading;
  • repealing of US and EU subsidies and mandates for ethanol;
  • greater transparency and oversight of hedge funds, private equity and sovereign wealth funds.

Many more fundamental reforms are necessary: requiring central banks to use their more targeted tools beyond manipulating interest rates, e.g., increasing the capital reserves banks must hold and raising margin requirements on stock purchases. Reforming tax policies is urgent: taxing carbon emissions, pollution, waste, planned obsolescence and resource-depletion while reducing income and payroll taxes.

Shifting the still-massive subsidies showered on the oil, coal, gas and nuclear industries to production tax credits can accelerate the growth of renewable energy. Solar, wind, geothermal, tidal, fuel cells, hydrogen, mass transit, smart DC electric grids as well as capturing the 40% of energy currently wasted in the US fossil fuel economy can shift human societies to the Solar Age.

And as we change the financial games and fix accounting errors in the global casino, we can also change the obsolete scorecards. There is widespread public recognition in global surveys of the errors of money-measured GDP growth, and correcting its omissions of social and environmental costs has begun (www.beyond-gdp.eu). Including all these factors and indicators of health, education, poverty gaps, environment and quality of life can help shrink the global casino and restore finance to its proper function.

Debate is now raging in policy circles about the role of speculators in sky high oil prices, now in the $140 per barrel range. Yes, supply is tight and world demand is rising. In addition, 77% of the world's proven oil reserves are now controlled by national governments. Political risks abound in the Mid-East, Nigeria and elsewhere. Peak oil is approaching and global warming is bringing a slow end to the Fossil Fuel Age. We are entering the next industrial stage, the Solar Age, based on renewable "green" technologies, solar, wind, geothermal and ocean energy.

But the fights between the incumbent fossil fuel and nuclear sectors and the rising solar and renewable resource sectors are heating up, as I predicted in my The Politics of the Solar Age (1981). The US Congress passed House Bill HR. 6377 in June to limit speculators in oil. Expert witnesses to Congress claim that enforcing higher margin payments on oil futures and other tighter rules by the Commodity Futures Trading Commission (CFTC) could cut oil prices in half in 30 days. Mainstream media are hesitant to fully cover this, fearful of repercussions from this powerful industry and big financial players. Meanwhile, the International Energy Agency (IEA), a powerful voice for the fossil fuel industry, insists that speculators are not a problem and that demand will be reduced by the high prices.

The first thing we need to know is the difference between speculators and hedgers. Hedging is buying future contracts for oil to be delivered, hopefully at a lower price. Hedging is a vital activity performed by participants in the commodity futures trading markets such as Chicago's CME, New York's NYMEX and London-owned, Atlanta-based ICE (Intercontinental Commodities Exchange). Hedging, for example, by US-based Southwest Airlines still allows them to continue operating for another year without facing bankruptcy now plaguing other airlines. The key in hedging is that hedgers need real oil to operate their businesses and plan to take delivery of the oil when their futures contract comes due. Thus, these commodities markets performed a vital function but were rarely overseen properly in the past 7 years by the CFTC.

Speculating is buying futures oil contracts, purely betting that oil will rise in price. Huge sums have poured into this from pension funds, hedge funds, exchange traded funds (ETFs), as well as university endowments and other large institutional investment managers, all competing for "alpha," i.e. higher than average returns. Such huge flows of money into commodities and their futures markets have disrupted their normal functioning. They were never intended for the purposes of such large investment pools just buying futures contracts and then rolling them over when their delivery dates come due. These speculators are buying paper or electronic barrels of oil, while hedgers continue buying real barrels for their legitimate business proposes

All this was revealed in the explosive hearings of June 26th ,chaired by Congressman Bart Stupak, with experts in financial markets including Michael Masters, CEO of Masters Capital Management; Fadel Gheit, Oppenheimer & Company; Roger Diwan, Partner, PFC Consultants; Edward Krapel and others. All urged immediate enforcement by the CFTC of higher margins, up to 50%, full disclosure of buying by large investment funds, limiting the size of such purchasers and fuller disclosure. The Bill, HR 6377, which passed in late June, called for these reforms and stated that speculation in oil futures had risen from 37% of energy trading in April 2000 to 71% by April 2008. All witnesses agreed that this "bubble" in oil must be popped as soon as possible because it was wrecking the price discovery function and normal operations of vital futures markets. The speculative bets by the big new players with their "long only" positions had helped push up prices beyond the true supply-demand price of between $60 to $80 per barrel. Usually, where traders are hedging for buyers of real oil, there are just as many "short" positions to balance out the market. One witness said that the oil "bubble" was fast becoming a "tumor," metastasizing every day.

In my earlier editorial for InterPressService, "Changing Games in the Global Casino," I called for similar measures now in the House Bill HR 6377. The damage I cited to real people and real companies is growing daily, as food prices lead to hunger and oil prices lead to bankruptcies in trucking, fishing, airlines and other industries. In the USA, the towns of Gary and Terre Haute, both in Indiana, have lost all air service due to airlines going bust. Mass transit is still crumbling and often non-existent for people trying to find other means than driving to work. Infrastructure, mass transit and energy conservation have been ignored for decades in the USA in favor of continued subsidies of some $230 billion per year to oil, gas and nuclear energy, all big political contributors and sponsors of ad campaigns to deny the realities of global warming.

The key questions raised by those defending current policies and speculation are :

· If the CFTC imposed these new rules to curb speculators, would trading move from the NYMEX and ICE to other new exchanges with less regulation (the usual threat whenever such regulating of markets is proposed). The answer from the experts is that this is an empty threat and that any such new, unregulated markets would be little more than "casinos in the sky."

· If oil prices could be brought down by 50% in 30 days, how would this compare with more drilling for new oil supplies in the USA off the coasts and in the Arctic Natural Wildlife Refuge (ANWR)? The answer was no comparison! Exploring and drilling would take many years, billions of new investment and hardly affect the world price of oil.

The US Congress Committee on Natural Resources reported in June 2008 that the USA cannot drill its way to cheaper oil prices. The oil companies in the past 4 years have already stockpiled another 10,000 permits to drill on public lands, on top of the 28,776 permits they have already, only 18,954 of which have been activated. The US Department of the Interior reported in May 2008 that the US public "had been deluded into believing that large tracts of oil and gas are off-limits, whereas only 38% of oil and 16% of gas areas are excluded from leasing."

What would be the risks to markets and economic stability if these reforms were suddenly enacted? The answers the witnesses gave were that these reforms would be bullish: for stocks, bonds, the US dollar, all the companies now stressed and facing bankruptcy, and all the consumers trying to afford higher food and gasoline prices. The pension funds and other big speculators would have to unwind their positions quickly, but they represent a small percentage of most portfolios and their other assets would rise .

Another bigger question is why anyone thinks that oil companies would want to invest billions to find new oil supplies, which would only decrease the price of their product? The business decisions oil companies have been making are what Wall Street demands: to deliver the most profits to their shareholders, not to reduce the price of oil. Sitting on the leases they hold without exploring or drilling them both keeps oil prices high and increases the value of their leases as "proven reserves" to beef up their balance sheets. And lobbying Congress for more leases would add more "proven reserves" to their bottom lines. Thus we see this market logic at work as oil companies continue to bank their huge profits and use the cash to buy back their own stock.

The public interest, however, demands the passage of HR 6377. If oil prices tumble as a result, the retail price of gasoline should stay above $ 4 a gallon (closer to the real world price of up to $9), even if additional taxes are imposed. Fifteen percent of the speculation in oil is related to the US dollar's decline. So the US needs to kick its addiction to oil - not by demanding more at lower prices, but by shifting that $230 billion of subsidies to fossil fuels and nukes to ramp up wind, solar, geothermal and ocean sources. Cars will soon be run on electricity, as the CEO of Nissan Motors, USA testified at another hearing chaired by Congressman Edward Markey on Global Warming in June. Nissan will start delivering all electric cars in 2010. Meanwhile high oil prices, even at their real levels of $60-$80 per barrel are rapidly shifting societies toward the Solar Age, where gasoline will not be needed in cars or other transport. The world's remaining oil is too valuable to continue burning in inefficient cars, but can be saved for chemicals, plastics and other higher-value uses.

Meanwhile, the public interest also demands that oil companies use their piles of cash to invest directly in the most cost-effective new energy sources now growing at double digit rates around the world. These include wind power, solar photovoltaics sprouting on rooftops in many countries, solar thermal concentrator power plants now dotting the desert Southwest in the USA, Spain and other countries. Together with unexploited geothermal and ocean energy, these Solar Age energy sources are already delivering electricity to homes and businesses worldwide. And all those pension funds should also be investing in all these new energy sources to assure the future financial security of their beneficiaries, rather than playing as short-term speculators. Socially concerned investors, employees and citizens should hold the managers of their pension funds to higher standards to foster the transition to the Solar Age.

Hazel Henderson is author of Ethical Markets: Growing The Green Economy (2007) and co-creator with the Calvert group of the Calvert-Henderson-Quality of Life Indicators regularly updated at www.Calvert-Henderson.com. She can be reached at www.EthicalMarkets.com and her TV shows are at www.EthicalMarkets.tv.