Too many interests embedded into higher petroleum prices? President Obama announced a multi-agency investigation into causes for such rapidly rising and volatile crude oil prices. Besides long overdue, will the investigation get lost in the forest? Speculation does not stand as a lone redwood but is part of a much broader system that includes varying degrees of connectivity to valid industry and hedging techniques. Does the US Government (and other states) have vested interests, including in higher prices? Further, manipulation and speculation is not the same thing although they may appear synonymous. Is there Speculation in Oil Markets? Of course, but it is part of a natural hedging market. In order for true industry participants to be able to hedge future production costs and revenues, speculators have frequently been the counter-party. However, when purely financial participants come to dominate the market volume, then by definition their participation exceeds any potential hedging activity. According to Professor Ed Yardeni (President of Yardeni Research, Head of Research at Prudential Bache, Oppenheimer and one of my professors at Columbia Graduate Business School) has estimated that around ¾ of all activity in the petroleum futures market is not industry but financial participants. Oil as an Investment Instrument Prices of at least certain energy products are not being driven by supply and demand fundamentals for the product of producers and consumers. Rather, now the price is substantively also influenced by financial market participants' activity. Commodities, and particularly petroleum have become “investment vehicles.” The evolution of “Exchange Trade Funds” or ETF’s has facilitated the trading of such investments as stocks in the equity markets. It has eased entry into the commodities markets of smaller investors along with the bigger players who have been there for longer. In effect, all of these investors, bigger and smaller, have become the speculators by definition. Perhaps this can be seen as making the commodities markets more egalitarian. Nonetheless, it is speculation. Most actual consumers of such commodities though do not have the financial capacity to engage or adequately protect/hedge themselves against spiking prices and volatility. It also has been too frequently the case that smaller players who jump into the market tend to become the prey, the biggest losers, in these highly predatory markets where financial heft and knowledge (insider information or not) are key. Also, the big players usually lead the trend and are the first out. "Too Crowded" on Buy Side & Bubbles Bursting Goldman Sachs recently changed its course 180%, going from big bull to divesting its position in the oil markets. Their stated reason was that too many people were piling into these commodity investments creating a real likelihood for a bubble bursting. While the market immediately reacted with a slide of several dollars, there has been little incentive/risk for most of those who hold petroleum on paper as an investment instrument to sell. While speculation can drive prices unnaturally too low, it is a general rule in financial markets idiom that it is easier for all all to make profits on rising prices. That is one reason why "bubble formation" has become a more common consideration. And, markets tend to rise until they reach "exhaustion" or to put it into more common language, it all keeps going up until the prices become so high as to cause an economic crash, the kind that we just experienced in 2007-2008. In meantime, Goldman may have gotten out early or perhaps just in time. Regardless, a profit of almost 50% was pocketed on a "bet" of billions of dollars. Real Risks on Supply & Demand What we have not yet discussed is the various considerations that could be contributing to the rise in price and volatility: · Political/conflict risk as the Middle East and Nigeria are undergoing a tumultuous period · Rising demand in developing economies, especially China and India · Potential shrinking supply not meeting demand, at least 3-5 years out · Falling US$ as people seek out commodities as a hedge against inflation and the eroding value of paper currencies · To what extent are low interest rates responsible (presumably because such are simultaneously facilitating speculative investments with cheap money and driving inflationary pressures?) “Wall Street” Premium We will address the above considerations, and undoubtedly each has at least the possibility of effecting perceptions of risk and prices. However, the question is not whether speculation is the only source for volatility, but how much and is it an inordinate impact. Recent estimates by industry and financial market participants estimate the Wall Street premium to be anywhere from $15 to $50 per barrel (today around around $112 for NYMEX and $125 for Brent per barrel.) That is a broad “guess” as it is impossible to fine tune such a figure. (It is noteworthy though that production costs per barrel are anywhere from $60 or slightly above to down into single figures for mature producing wells.) Regardless, under current prices, there is more than plenty of profit/premium in the price. Convergence of Interests to Push Prices Higher There are also other less overt considerations for oil prices rising dramatically. · OPEC gouging, (although some OPEC states as Saudi Arabia are concerned about too high prices/volatility accelerating demand destruction, thus undermining value of their huge oil reserves for medium to longer term. Also, many/most OPEC states would be concerned about overall global economic wealth, as they are invested in such developed economies through various sovereign funds and individual accounts.) · How about states as the Russian Federation, Iran or Venezuela seeking to translate oil into political leverage? · Rather than tax and anger consumers, how about even US government policy discouraging consumption in order to diminish “dependence on foreign oil?” · Green/Alternative as well as “domestic” energy sources (in the US) are frequently not cost-efficient at lower price ranges for petroleum on global markets. Lower prices for petroleum during the recent financial crisis caused many "alternative" ventures to end up no longer economically viable and many ended up flushed down the financial toilet In other words, there are many interests that have converged to push oil prices higher, including your “pension account” perhaps. Nonetheless, it is the ordinary citizen consumer that will bear the highest proportion of the higher prices, and not only at the gas pump. Every day concerns from food affordability to employment availability are impacted by such prices. "Manipulation" Does not Even Have to be Factor We have not yet even mentioned “manipulation.” However, speculation without overt manipulation may have the same impact. Also, with so many financial interests vested, from political/military on global level to financial, the current volatility and speculation reasoned markets can only invite manipulation. Of course, we also have to define manipulation, at least for legal purposes and potential criminal civil liability in view of the current US investigation just launched by the Obama Administration, and even leave the possibility open that such has contributed to perceptions/interests pushing prices higher. We will look to follow up on all of these consideration in future Reports. By Ambassador Muhamed Sacirbey Face Book at “Diplomatically Incorrect” Twitter – DiplomaticallyX Related Reports Including: “Oil Prices Why & Where?” - diplomaticallyincorrect.org/films/movie/oil-prices-whywhere/26314 Go to our “INTERNATIONAL FINANCIAL CRISIS” channel at: diplomaticallyincorrect.org/c/international-financial-crisis