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Is Wall Street to blame for the 2008 'Oil Bubble'?

I didn't get a chance to write about this when I first spotted it last week (h/t The Moderate Voice):

CBS News "60 Minutes": Did Speculation Fuel Oil Price Swings?

As the president of the Petroleum Marketers Association, [Dan Gilligan] represents more than 8,000 retail and wholesale suppliers, everyone from home heating oil companies to gas station owners.

When 60 Minutes talked to him last summer, his members were getting blamed for gouging the public, even though their costs had also gone through the roof. He told Kroft the problem was in the commodities markets, which had been invaded by a new breed of investor.

"Approximately 60 to 70 percent of the oil contracts in the futures markets are now held by speculative entities. Not by companies that need oil, not by the airlines, not by the oil companies. But by investors that are looking to make money from their speculative positions," Gilligan explained.

Gilligan said these investors don't actually take delivery of the oil. "All they do is buy the paper, and hope that they can sell it for more than they paid for it. Before they have to take delivery."

"They're trying to make money on the market for oil?" Kroft asked.

"Absolutely," Gilligan replied. "On the volatility that exists in the market. They make it going up and down."

In market-speak that's called "arbitrage"; essentially it's the art of finding bargains and buying into them early, before the market catches on. When other investors discover the same opportunity and try to buy, the increased demand causes the price to rise. Then the early buyers can sell their investments (shares, option, or futures) at a profit. Much of the arbitrage trading business involves intraday bargain-hunting and short-term buy and sell trading between the stock and futures markets. Because the profit on individual trades is small, arbitrage traders make up for it by buying and selling large numbers of shares. When a lot of high-volume activity occurs in the markets, prices can go up or down erratically.

About the same time, hedge fund manager Michael Masters reached the same conclusion. Masters' expertise is in tracking the flow of investments into and out of financial markets and he noticed huge amounts of money leaving stocks for commodities and oil futures, most of it going into index funds, betting the price of oil was going to go up.

Asked who was buying this "paper oil," Masters told Kroft, "The California pension fund. Harvard Endowment. Lots of large institutional investors. And, by the way, other investors, hedge funds, Wall Street trading desks were following right behind them, putting money - sovereign wealth funds were putting money in the futures markets as well. So you had all these investors putting money in the futures markets. And that was driving the price up."

In a five year period, Masters said the amount of money institutional investors, hedge funds, and the big Wall Street banks had placed in the commodities markets went from $13 billion to $300 billion. Last year, 27 barrels of crude were being traded every day on the New York Mercantile Exchange for every one barrel of oil that was actually being consumed in the United States.

So who was responsible for convincing investors to put their money in futures-based index funds?

Surprise, surprise ...

Masters believes the investor demand for commodities, and oil futures in particular, was created on Wall Street by hedge funds and the big Wall Street investment banks like Morgan Stanley, Goldman Sachs, Barclays, and J.P. Morgan, who made billions investing hundreds of billions of dollars of their clients' money.

"The investment banks facilitated it," Masters said. "You know, they found folks to write papers espousing the benefits of investing in commodities. And then they promoted commodities as a, quote/unquote, 'asset class.' Like, you could invest in commodities just like you could in stocks or bonds or anything else, like they were suitable for long-term investment."

Dan Gilligan of the Petroleum Marketers Association agreed.

"Are you saying that companies like Goldman Sachs and Morgan Stanley and Barclays have as much to do with the price of oil going up as Exxon? Or...Shell?" Kroft asked.

"Yes," Gilligan said. "I tease people sometimes that, you know, people say, 'Well, who's the largest oil company in America?' And they'll always say, 'Well, Exxon Mobil or Chevron, or BP.' But I'll say, 'No. Morgan Stanley.'"

Morgan Stanley isn't an oil company in the traditional sense of the word - it doesn't own or control oil wells or refineries, or gas stations. But according to documents filed with the Securities and Exchange Commission, Morgan Stanley is a significant player in the wholesale market through various entities controlled by the corporation.

It not only buys and sells the physical product through subsidiaries and companies that it controls, Morgan Stanley has the capacity to store and hold 20 million barrels. For example, some storage tanks in New Haven, Conn. hold Morgan Stanley heating oil bound for homes in New England, where it controls nearly 15 percent of the market.

The Wall Street bank Goldman Sachs also has huge stakes in companies that own a refinery in Coffeyville, Kan., and control 43,000 miles of pipeline and more than 150 storage terminals.

Yikes. Now we probably know why President Bush, a former oil man, was so eager to put the TARP bailout program together. Poorly managed though it was, it probably provided a lifeline that kept the US oil industry from tanking along with the mortgage and banking sectors. On top of the current recession I can't imagine how disastrous an oil market collapse would have been.

Asked if there is price manipulation going on, Dan Gilligan told Kroft, "I can't say. And the reason I can't say it, is because nobody knows. Our federal regulators don't have access to the data. They don't know who holds what positions."

[...]

It's impossible to tell exactly who was buying and selling all those oil contracts because most of the trading is now conducted in secret, with no public scrutiny or government oversight. Over time, the big Wall Street banks were allowed to buy and sell as many oil contracts as they wanted for their clients, circumventing regulations intended to limit speculation. And in 2000, Congress effectively deregulated the futures market, granting exemptions for complicated derivative investments called oil swaps, as well as electronic trading on private exchanges.

"Who was responsible for deregulating the oil future market?" Kroft asked Michael Greenberger.

"You'd have to say Enron," he replied. "This was something they desperately wanted, and they got."

Greenberger, who wanted more regulation while he was at the Commodity Futures Trading Commission, not less, says it all happened when Enron was the seventh largest corporation in the United States. "This was when Enron was riding high. And what Enron wanted, Enron got."

Asked why they wanted a deregulated market in oil futures, Greenberger said, "Because they wanted to establish their own little energy futures exchange through computerized trading. They knew that if they could get this trading engine established without the controls that had been placed on speculators, they would have the ability to drive the price of energy products in any way they wanted to take it."

"When Enron failed, we learned that Enron, and its conspirators who used their trading engine, were able to drive the price of electricity up, some say, by as much as 300 percent on the West Coast," he added.

"Is the same thing going on right now in the oil business?" Kroft asked.

"Every Enron trader, who knew how to do these manipulations, became the most valuable employee on Wall Street," Greenberger said.

So there was really more to it than just arbitrage trading. It appears that the big investment banks were actually trying to corner the US oil market, taking advantage of Clinton-era deregulation to control the lion's share of domestic oil trading, then using commodities swapping to lock in low to moderate oil delivery prices while encouraging investor enthusiasm that pumped billions of dollars into the oil futures market and allowed speculators to wildly increase futures prices. If you're sitting on reserves swapped at $65/bbl that could sell in six months for $145/bbl, that's some serious money.

The whole thing fell apart, it seems, when the real estate meltdown robbed the banks of their cash supply and they could no longer afford to engage in large-scale oil futures trading. When their futures-indexed investment funds started failing, investors yanked their cash, and normal supply/demand economics pulled the price of oil back down to a level that more accurately reflected the abundant supply on the market and the reduced demand brought on by the unreasonably high prices.

So who is to blame politically? Some of the responsibility certainly rests on the Clinton administration, which repeatedly ignored Enron's financial irregularities while enlisting its Commerce and Energy Departments to aid Enron in one sweetheart energy deal after another. But we should also ask why the Bush Administration, which repeatedly expressed concerns about the runaway subprime mortgage market, seemed either ill-informed or indifferent about the runaway price of crude oil.

The long-term sustainability of the free market is based in part on its ability to shake out irrational trends. The market did indeed work in this case, because the rapid spike in crude oil futures pricing was unsustainable and not based on true supply and demand. But the price that we all paid -- and will keep paying in the form of long-term debt -- for that brief period of market irrationality was very high. Let's hope that next time the market can dampen irrational price increases before they do so much collateral damage.

____________________

ADDED: Here is a good write-up on the subject of "cornering the market," specifically about why it is usually a bad idea. The Hunt Brothers tried to corner the silver market in the late 1970's. Originally they intended to invest in silver as a hedge against inflation. But they got greedy and began to buy more and more silver on leveraged (that is, borrowed) money until they owned more silver on paper than could be physically delivered. The result was a huge spike in the price of silver, since the market supply was virtually depleted. The banks that loaned money to the Hunt brothers suddenly found themselves with debt liabilities that could have ruined them. The article explains, in depth, how the banks, commodity markets, and the Federal Reserve conspired to change the rules for silver trading so that they bailed themselves out, recovered all of their debts, and in the process, bankrupted the Hunt brothers.

Fast-forward to 2008. In the case of oil speculation, it was the banks who were reaping enormous profits (as opposed to holding debts). Their profits were paid by all of us on everything tied to the price of oil, which is ... well ... virtually everything. But the banks had no way to absorb the enormous losses triggered by the simultaneous collapse of their mortgage and oil derivatives. They bankrupted themselves. This time, they couldn't "change the rules." The government had to bail them out. So we the people, through the US Treasury, have become the debt holders for the financial damaged created by oil speculators. Thanks a lot, guys.


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Comments (11)

Of course they're not. Some... (Below threshold)
JFO:

Of course they're not. Somehow, someway Obama is.

Wall Street and Obama are j... (Below threshold)
LaMedusa:

Wall Street and Obama are just two of many players for the Puppetmasters. No one notices that China threatened to cave in the economy if they didn't receive some kind of collateral, thus we began the circulation of the Amero. Those non-existent FEMA camps will be ready for occupants, as well:

"Janet Napolitano, Obama's new Homeland Security pick is another rip-roaring, opinionated "Madeline Albright." Loaded with her own prejudices she will use FEMA camps to house anti-immigrant protestors. She is a raging feminist who appeared on the cover of CURVE, the best selling Lesbian Magazine. Early on, before her appointment, Napolitano stated that her sympathy for illegal aliens reduces her enthusiasm for border security. She is also a strong advocate for abortion rights.

Next, he intends to socialize medical care although every country that has adopted that solution found it to be a poor substitute when people must wait a year to obtain a hip operation and many die waiting to receive an appointment to have heart surgery.

His next item on the agenda is to make sure that this country's borders will remain open just as the Bush Administration did and the merging of the New American Union of Canada, the U.S. and Mexico will proceed with a creation of a new currency called the amero. Here he supports the Bush agreement that was made in a secret meeting in Texas with the Prime Minister of Canada and the President of Mexico to sell out the sovereignty of the U.S.

Tons of ameros have already been shipped to China this month. The amero is meant to cut the value of the dollar as a means to solve the debt problem. All criminal administrations in charge of countries use this method of deflating their currencies to rob those who accumulate savings. As a result, goods will cost more, MUCH MORE to the point where inflation will parallel another Weymar Republic where it took a wheelbarrow loaded with thousand mark notes to buy a loaf of bread."
http://www.newswithviews.com/Kress/joe136.htm

What open borders? What FEMA camps? And what the hell is an amero? I'm sure if we play "just don't look" long enough, it will all go away, right?

So Big Oil was a victim of ... (Below threshold)
GianiD:

So Big Oil was a victim of Wall St, yet, somehow, they'll always be guilty in the eyes of the left(cept when they pay those BILLIONS in taxes).

Speculators stabilize price... (Below threshold)

Speculators stabilize prices. Punish speculators--expect more market instability.
http://www.rightklik.net/

I have posted commen... (Below threshold)
Larry:


I have posted comment on this subject many times here. The guiding light on speculative oil price increases has been Ed Wallace, a radio personality in Dallas, who has a Saturday program styled Inside Automotive along with commentary for Business Week and the Ft. Worth Star Telegram.

According to Wallace, there were two sides to the run up, namely inside industry speculations led by British Petroleum and investment bank activity led by Goldman Sachs. He has never published the names of those two, but he did so say in a private email to me a few months ago.

A ton of money was made and lost on speculating in oil.

Masters' guesses were oblit... (Below threshold)

Masters' guesses were obliterated by an Institute for Energy Research debunking, as pointed out by Newt's American Solutions. (before anyone whines about an energy research group being the ones doing the debunking, I suggest reviewing their figures and then try to explain why it would be more relevant if, say, PETA or Greenpeace provided the debunking) That said, everything that follows that is based on his incorrect guessing is pretty much a waste of time. And Gilligan is as biased for his side of the argument as they come, he spent most of 2008 desperately appearing all over the place saying they weren't to blame and pointing the finger at anyone else that he could. I always got a laugh out of him whenever I heard him on the radio trying to explain something that even someone as amateurish as me knew to be impossible.

I don't have a link, but I ... (Below threshold)
Mac Lorry:

I don't have a link, but I head a news piece on this and it seems there was a rule change that allowed this speculation to drive up the price of oil. Under the old rule you had to be able to take delivery of the oil in order to bid on it. That rule kept the trading within a limited group that actually use oil. I think we should go back to that rule and maybe expand that anti-parasite rule to other commodities.

of course there is manipula... (Below threshold)
milt tomkins:

of course there is manipulation in the markets...It is even more prevelent than you think.,, just read these 2 books,..Hedge Fund Trading Secrets Revealed by Robert Dorfman... and Confessions of a Street Addict by Jim Cramer....both these books take you on a great ride about hedge funds and how they make money. I learned about this secret society than I ever would have imagined. Dorfman actually teaches traders his strategies.

Sorry Folks but markets wil... (Below threshold)
Rich k:

Sorry Folks but markets will always move at a speed that outpaces regulations that try to control them. Do the research and its pretty clear. DC is always one step behind and always will be considering how slow they are in every aspect of predicting ANYTHING.So bitch all you want but get used to these events happening for all time in the future because not one of you or any of those you elect will ever be able to tame the market or predict where the next trough of profit comes from.Legal or otherwise.

They did, but not the domes... (Below threshold)
Vasos Panagiotopoulos:

They did, but not the domestic ones. Economics is efficient if unhampered by politics. The sovereign wealth speculators probably had political motives. Unless those countries are willing to reciprocate in openness and fairness, we should keep a tighter eye on sovereign wealth funds. The only thing that worked in our favor is the foreigners competed with each other and the economic balance of terror burned them as well. The Cold War was fought by infinitely more rational actors than today's terrorist lunatics.

SAVE ENERGY - Make a change... (Below threshold)

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Resist the urge to override the pre-programmed settings. Every time you do, you use more energy and may end up paying more on your energy bill.
Set the “hold” button at a constant energy-saving temperature when going away for the weekend or on vacation.
Install your thermostat away from heating or cooling registers, appliances, lighting, doorways, skylights, and windows, and areas that receive direct sunlight or drafts. Interior walls are best.
If you have a heat pump, you may require a special programmable thermostat to maximize your energy savings year-round. Talk to your retailer or contractor for the details before selecting your thermostat.
Programmable Thermostats
Furnaces are the most commonly used residential heating system in the United States, running most often on gas, but sometimes on fuel oil or electricity, and deliver their heat through a duct system. One in four furnaces in U.S. homes today is more than 20 years old. ENERGY STAR qualified furnaces use advanced technology to deliver higher efficiency than standard new furnaces available today.
A programmable thermostat is recommended for individuals and families who are away from home during set periods of time throughout the week, allowing them to use less energy without sacrificing comfort. Programmable thermostats that have earned the ENERGY STAR offer the most energy-saving potential for your home and, unlike older manual thermostats, contain no mercury. Through proper use of your
ENERGY STAR qualified thermostat, you can save about $150 every year in energy costs.
In order to increase your energy savings, it’s important that you:
Keep the thermostat set at energy-saving temperatures for long periods of time, such as during the day when no one is home and through the night. ENERGY STAR qualified thermostats come with four pre-programmed temperature settings for typical weekday and weekend routines.
Resist the urge to override the pre-programmed settings. Every time you do, you use more energy and may end up paying more on your energy bill.
Set the “hold” button at a constant energy-saving temperature when going away for the weekend or on vacation.
Install your thermostat away from heating or cooling registers, appliances, lighting, doorways, skylights, and windows, and areas that receive direct sunlight or drafts. Interior walls are best.
If you have a heat pump, you may require a special programmable thermostat to maximize your energy savings year-round. Talk to your retailer or contractor for the details before selecting your thermostat.
Furnaces
ENERGY STAR qualified central air conditioners have a higher SEER than today’s standard models. SEER, the Seasonal Energy Efficiency Ratio, measures energy efficiency. The higher the SEER, the greater the level of efficiency. Since sizing and proper installation of a central air conditioning system are critical to energy efficiency and home comfort, it is important to hire a qualified technician.
Central Air Conditioners
Electric Air-Source Heat Pumps (ASHPs): ASHPs, often used in moderate climates, use the difference between outdoor and indoor air temperatures to cool and heat your home. For example, they work in cold weather because the air is warmer than the refrigerant in the system and causes it to boil into a gas. This gas is then compressed which drives the temperature up to 120 degrees or more. This hot gas transfers heat to your home. High efficiency ASHPs use less energy than conventional models. They also come with higher HSPF ratings. HSPF, the Heating and Seasonal Performance Factor, measures the heating efficiency of heat pumps.
Geothermal Heat Pumps (GHPs): By using stable temperature conditions in the ground, GHPs cool and heat your home. In addition to providing much lower energy bills, high efficiency GHPs are quieter and include water-heating capabilities. Although initially expensive, they quickly pay back the homeowner with significant cost savings. GHPs are most often installed in new homes and require a duct system.
Heat Pumps
A boiler heats your home by burning gas or fuel oil to heat water or steam that circulates through radiators, baseboards, or radiant floor systems. Boilers do not use a duct system. Boilers that have earned the ENERGY STAR have higher AFUE ratings. AFUE, the Annual Fuel Utilization Efficiency, is a measure of heating equipment efficiency.
How much energy you save will vary based on your use and climate, with colder regions likely saving more. Features that improve boiler efficiency include electronic ignition, which eliminates the need to have the pilot light burning all the time, and technologies that extract more heat from the same amount of fuel.
Boilers
A boiler heats your home by burning gas or fuel oil to heat water or steam that circulates through radiators, baseboards, or radiant floor systems. Boilers do not use a duct system. Boilers that have earned the ENERGY STAR have higher AFUE ratings. AFUE, the Annual Fuel Utilization Efficiency, is a measure of heating equipment efficiency.
How much energy you save will vary based on your use and climate, with colder regions likely saving more. Features that improve boiler efficiency include electronic ignition, which eliminates the need to have the pilot light burning all the time, and technologies that extract more heat from the same amount of fuel.

Getting Properly Sized Equipment and a Quality Installation
When purchasing heating and cooling equipment, choosing energy-efficient products is a step in the right direction. However, asking the right questions of your contractor and making sure your equipment is properly sized and installed are also important elements to ensure that your new system performs at optimal efficiency.
When it comes to heating and cooling equipment, bigger doesn’t always mean better. Larger capacity systems are intended to meet the needs of a larger heating or cooling load. However, if the unit is too large for your home, you will experience less comfort and increased costs. Oversized equipment will operate in short run times or cycles, not allowing the unit to reach efficient operation. In addition, oversized equipment will not run long enough to remove humidity from the air. This can leave you feeling cool but not comfortable.
Don’t assume that the size of your new system will be the same as your old equipment. Changes, such as additions or insulation improvements, may have been made to the house since the original equipment was installed; or, the equipment may have been too large from the start. Expect the contractor to gather information about your house such as the level of insulation, type and size of the windows, and floor area. Your contractor can determine the right size for your heating and cooling equipment by using ACCA/ANSI Manual J®, or an equivalent sizing calculation tool that takes these and other factors into consideration.
When installing your new heating and cooling equipment, your contractor should do the following to ensure a quality installation:
Quality Heating Installation Checklist:
Provide adequate room around the equipment for service and maintenance.
Test and verify proper airflow (if a furnace or heat pump).
Verify that your furnace or boiler has been tested for proper burner operation and proper venting of flue gases. The vent piping should be inspected for leaks or deterioration and repaired or replaced as necessary.
Quality Cooling Installation Checklist:
Provide adequate room around the equipment for service and maintenance.
Replace the indoor coil of the equipment when replacing the outdoor unit. To get the expected level of efficiency, you should have a matched set. An old coil will not work efficiently with a new outdoor unit.
Confirm that the level of refrigerant charge and the airflow across the indoor coil meets the manufacturer’s recommendation. It’s estimated that more than 60% of central air conditioners are incorrectly charged during installation.
Place the condenser in an area that can be protected from rain, snow, or vegetation, as specified by the manufacturer. If you have a central air conditioning unit, cover your outside equipment during the winter to protect it from snow and ice. Heat pumps need to be left uncovered to properly operate during the winter.
Protecting Our Environment Starts at Home.
The average household can be responsible for nearly twice the greenhouse gas emissions as the average car. The leading source of greenhouse gas emissions is energy production; whenever you operate any product in your home that runs on electricity, a power plant is most likely generating that electricity by burning fossil fuels (such as coal and oil), which produces greenhouse gases. Here are 5 ways you can help reduce the risks of global warming!
5 Steps You Can Take to Reduce Air Pollution:
Change five lights. Change a light and you help change the world. If every American home replaced their 5 most frequently used light fixtures or the bulbs in them with ones that have earned the ENERGY STAR, we would save close to $9 billion each year in energy costs, and together we'd prevent the greenhouse gases equivalent to the emissions from nearly 10 million cars.
Look for products that have earned the ENERGY STAR. Ask for us by name. You’ll get the features and performance you want AND help reduce air pollution. Look for ENERGY STAR qualified products in more than 50 product categories, including lighting, home electronics, heating and cooling equipment, and appliances. If you are building or buying a newly constructed home, ask about ENERGY STAR –we qualify those too.
Heat and cool smartly. Improve the performance of your heating and cooling system. Have it serviced annually by a licensed contractor, and remember to clean or replace air filters regularly. To avoid heating or
cooling an empty house, use an ENERGY STAR qualified programmable thermostat. And when it’s time to replace old equipment, choose an ENERGY STAR qualified model, and make sure it’s sized and installed
properly. If just one household in 10 did this, the change would prevent more than 17 billion pounds of greenhouse gases.
Seal up your home. Drafty windows and doors, cold walls or ceilings, and high energy bills are all symptoms of air leaks (usually in the attic and basement) and poor insulation. Seal air leaks, add insulation, and choose ENERGY STAR qualified windows when replacing old windows.
That way you’ll improve the comfort and durability of your home, save energy and help protect our environment.
Tell family and friends. Slip it into a conversation with a friend or family member. Talk about it at a neighbor’s barbecue. Pass it on at a PTA meeting or at work. We’re asking you to help spread the word that
energy efficiency is good for your home and good for our environment.
Tell five people and together we can help our homes help us all.
ENERGY STAR - It’s a good sign.
The ENERGY STAR program is a voluntary partnership between consumers, their families, and many of the most respected brand names. All of us are working together to achieve a common goal: to protect our environment for future generations by changing to more energy-efficient practices today.
Since the fossil fuel-based energy used in a typical home can cause twice as many greenhouse gas emissions as the average car, the U.S.
Environmental Protection Agency encourages homeowners to make their homes more energy-efficient. The government awards the ENERGY STAR to those products, companies and organizations, homes, and services that meet specifications established by EPA and DOE. It’s our future.
Together, we can make a change for the better.

YJ Draiman




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