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Deflating the oil bubble

Michael Greenberger

TEXT OF INTERVIEW

Kai Ryssdal: Alright, so let's see.... Yesterday, we had Saudi Arabia saying it's going to boost production by 2 percent. Next week, the Saudis are hosting a meeting aimed at bringing some sanity to crude prices. And yet at one point today, oil was trading within 11 cents of $140 a barrel.

That's probably why tomorrow morning will find the head of the Commodity Futures Trading Commission on Capitol Hill.

The CFTC's in charge of regulating oil markets in this country and Congress has been after the agency to do something -- to do anything -- about oil and gas prices, what lawmakers perceive to be speculation, in particular.

Michael Greenberger used to run the Trading division of the CFTC.

Mr. Greenberger, good to have you here.

Michael Greenberger: Nice to be here.

Ryssdal: Why is it so hard to figure out what's going on in commodities markets -- oil specifically?

Greenberger: Well, the reason it's hard to figure out is about 30 percent of our crude oil energy futures are traded in what is called a dark market -- that is a market that was deregulated in December of 2000 at the behest of Enron. Prior to that legislation being passed, all energy futures traded in the United States or affecting the United States in a significant fashion were regulated by United States regulators under a very careful regime that had been perfected over about 78 years and many observers believe that because those markets are not being policed, malpractices are being committed and traders are able to boost the price virtually at their will.

Ryssdal: You're not really telling me that seven years on, we're still paying the price for Enron, are you?

Greenberger: Well, this has been called the "Enron Loophole" and there are many legislators working very hard to close that loophole. There is tremendous concern about this on Capitol Hill and on a bipartisan basis, people are drafting legislation to try and get a handle on this and not eliminate speculation, but bring the speculation under the kind of time-tested controls that were used until Enron had its way and amended the law to escape traditional tested regulation on speculative activities.

Ryssdal: So what's Congress going to do? Congress is going to get together, they're going to pass a law and it's going to say, "CFTC, fix this?"

Greenberger: Well, there are several proposals suggesting or proposing that light shine on these dark markets and some of the legislation goes further than others, but the bottom line is the speculators will, in the end, be policed. We will know who they are, what they're doing, what their controls are, what effect they're having on the market. Maybe we'll find out that there's nothing there.

Ryssdal: So just to be clear, you do think that we're in a bubble, then?

Greenberger: I believe it and I'm certainly not alone in my belief. If you talk to anybody who trades in these markets on a regular basis, they will tell you that the markets are completely dysfunctional and out of control because of speculative activity.

Ryssdal: How long is it going to take then if we are, as you say, in a bubble, for it to work its way through and us to get back to something more realistic for the price of a barrel of oil, whether its 50 bucks or 80 bucks?

Greenberger: From my own experience as a commodity regulator, I believe that if the Bush Administration were serious about its regulation, we could begin seeing prices drop within a month. If we don't get the kind of regulation that has been done for decades and the market proceeds along the pace its proceeding, we will have to go through a very, very serious recession. The question is do you want to deflate the bubble by that kind of suffering or do you want to deflate the bubble by applying tight U.S. regulatory controls?

Ryssdal: Michael Greenberger used to run the Division of Trading and Markets for the Commodities Futures Trading Commission. He teaches law at the University of Maryland now. Mr. Greenberger, thanks a lot for your time.

Greenberger: You're welcome.

About the author

Kai Ryssdal is the host and senior editor of Marketplace, public radio’s program on business and the economy.
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All speculators need to take delivery. Senator Tom Coburn, MD is the champion of transparency.

Please pardon my ignorance here. How, exactly, is this a sane money-making scheme? From what I've read so far, the speculative gains arise when the price for longer-term contracts exceeds the price for near-term contracts sufficiently that would-be near-term sellers withhold their oil from the near-term (or current) market based on a higher, promised long-term price. This exacerbates whatever near-term supply-demand issues arise -- because no one wants to release the oil in the near-term -- thus pushing up the price for the oil needed to fill the near-term supply-demand disparities.

These higher prices accelerate further price increases, so the longer-term contracts that the speculators bought in prior periods represent "bargains" for actual oil consumers when they come due. (I'm assuming that as the market price accelerates, the last year's "future" price is lower than today's "market" price.) The gains made by the speculators allow the speculators to buy new long-term contracts, and the cycle spirals upward. As more speculators sense an opportunity, more speculators get into the oil market, competing as much with each other, as with actual oil consumers. Other articles have suggested that at some point -- whether the speculative actions are intentional or not -- the speculators wind up in control of the market.

And this is, as I understand it, the cause for calls on the CFTC to take what limited action it can, and for calls on Congress to repeal the Enron Loophole so that CFTC has clear authority to examine the oil futures market on so-far unregulated exchanges.

But what happens next, if regulators don't step in? While the speculators are not oil consumers themselves, they have, at the very least, a desire to continue making profits from their contracts. Presumably, they do not want to release the oil below their contract price. But just as reasonably, they don't want to accept delivery of the actual oil. (They own capital, not oil tankers, storage tanks, or refineries.)

Already airlines (large consumers of distilled petroleum products) are desparate to cut costs so they can pay for jet fuel. American consumers are driving less. Does the entire system collapse on itself, with the last round of speculators officially holding the bag (and likely petitioning the US Government or the Federal Reserve for an emergency bailout)? Do the speculators wind up owning the oil companies and the industries dependent on oil and petroleum products? Ultimately, how long can the price sprial upward? Even if speculators can temporarily plow their profits into oil, transportation, or energy industries, with the expectation that they can pass their overpriced contracts onto captive consumers, how long does the system work before the consumer collapses?

Gambling, speculation, simply profiting from market fluctuations provides no value to other economic system participants. There is no economic contribution made so any value extracted creates an imbalance in the system for those that did make a genuine value contribution. It has been decided by the majority of economic system participants that this will no longer be a feature allowing a few to benefit to the detriment of the many.

The "Enron Loophole" allows oil traders to set their own prices in advance of delivery of product. Mr. Greenberger made the point in Senate testimony that the largest owner of of heating oil in Mew England is Morgan Stanley. That should be one large clue that speculation is a very large factor. Yes, demand is increasing; yes, supply is diminishing. But not at the rates that would justify these price gains without rampant speculation. Countdown with Keith Olberman had a piece on 06/18/08 on this very subject. (It is still available on msnbc.com) I suspect it was spurred by the Observer piece mentioned in these comments. Everyone should be writing or calling their Senators and Congressmen to complain about this "loophole".

If, as Mr. Jolly states, inventories of oil have remained stable throughout the current oil price run-up, then what could have led to the high prices but wild speculation? It's certainly not supply and demand.

Manipulation of markets is a time-honored way to make a fortune. The only thing is that it used to be illegal. There was a reason that the big banks and other companies were broken up years ago. Those reasons have not disappeared, and our government has failed us miserably by not reigning this in.

From Paul Krugman, NY Times, 13 May 2008, "The Oil Nonbubble":
(http://tinyurl.com/67mufs)

"...The only way speculation can have a persistent effect on oil prices, then, is if it leads to physical hoarding -- an increase in private inventories of black gunk. This actually happened in the late 1970s, when the effects of disrupted Iranian supply were amplified by widespread panic stockpiling.

But it hasn't happened this time: all through the period of the alleged bubble, inventories have remained at more or less normal levels. This tells us that the rise in oil prices isn't the result of runaway speculation; it's the result of fundamental factors, mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China. The rise in oil prices these past few years had to happen to keep demand growth from exceeding supply growth.

Saying that high-priced oil isn't a bubble doesn't mean that oil prices will never decline. I wouldn't be shocked if a pullback in demand, driven by delayed effects of high prices, sends the price of crude back below $100 for a while. But it does mean that speculators aren't at the heart of the story.

Why, then, do we keep hearing assertions that they are?..."

Wow, this discussion proceeds as if speculation is the be-all and end-all to this whole story, and if we would just regulate those speculators...

Let’s slow down a minute. There is considerable dispute whether high oil prices are caused by a bubble, or whether they're due to supply just barely meeting demand (and not meeting future demand).

Kai covered this topic in an unscientific way -- he didn't test the "alternative hypothesis" that supply/demand imbalance is causing oil price increases. None of the many who have researched this, and believe it's the cause, were interviewed by Kai.

The two most recent market bubbles in America in the last decade -- dot-com stocks, and the housing bubble -- were clearly explained by factors that were visible to anyone watching, but overlooked by the mainstream (P/E ratios of hi-tech stocks, housing cost increases racing well ahead of personal income increases). The same cannot be said (at least based on present evidence) of a “gas bubble.” Until recent weeks, the idea that rising oil demand in India/China, coupled with strong evidence of global peak oil production (or near peak oil production) being at hand, were well accepted as the causes of rising oil prices. Now, poof -- it's become speculation. But I’ve not seen evidence that the supply/demand factors have gone away.

On speculation, a final note: Isn't the extreme price volatility due to the fact that no one can safely speculate what oil is going to be worth in the future?

For more, I encourage folks interested in this topic to read Paul Krugman’s Op-Ed piece (in NY Times), “The Oil Nonbubble” (see http://tinyurl.com/67mufs)

It has come to my attention that the oil bubble is going to pop very soon. Information has come to light that demand has been significantly over stated, and has droped further than has been reported. These things will be brought to light at the confrence in Saudi Arabia. Rumor has it the price of oil could drop 40 to 60% iin the next week. The time to sell is now, and you might not lose all your investment.

An immediate Federal speed limit of 55 miles per hour would reduce gas used by 20% nationwide. Every Automotive Engineer knows this. Why hasen't Congress imposed this law? It will not be popular but it's time we Americans imposed some discipline on ourselvs.

This is the short range fix. Meantime we should impose a Horsepower Limit on Automobile manufacturers. This will also decrease fuel consumption. We no longer need 550 HP Cadallics and 200 mile an hour Corvets along with thirsty SUV's. Our nation got along on 100 horsepower or less for years in the past. With low horsepower and all the existing auto technology,60 or more miles per gallon is only a couple of years away, if you don't let the manufacturers mislead you. Where has Common Sense been hiding in Washington? Then lets develop an Energy Plan for our people that will phase out oil dependency completely at some time in the future. Last, get off producing fuel from corn. Fund resurces to develop fuel from water. We seem to be part way on this concept already. Bring back Critical Thinking and Common Sense!

Sincerely, Retired Automotive Teacher

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