Understanding Speculation in the Oil Market

May 24, 2011

The constant and erratic rise and fall of gas prices over the last few years has always bothered me. During this time, we have never experienced gas shortages like we saw in the 1970s, yet “supply and demand” has always been blamed for the rise and fall of oil prices. I find it hard to believe that simple “supply and demand” can cause oil prices to change so quickly and dramatically, especially when the available supply of gasoline has remained steady.

Common sense suggests there is more to this than just supply and demand. It is my belief that speculation in the oil futures market is what has caused the dramatic rise and fall of gas prices over the last few years.

An oil “future” is a contract between a buyer and a seller. The buyer agrees to pay a fixed price for a barrel of oil at a certain time. When that date rolls around, the buyer will pay the agreed-upon price for the oil, even if market value has risen (or fallen) by that time.

The Commodity Future Trading Commission (CFTC) was established by Congress in 1974 to prevent speculation from artificially raising the price of commodities traded on the futures exchange. Among the items traded are crude oil, gasoline, and home heating oil, all of which are essential to the everyday life of most Americans. The CFTC regulates trading via the New York Mercantile Exchange (NYMX). Unfortunately, over the last few years, loopholes have allowed speculators to bypass the NYMX to make their trades, severally eroding the power of the Trading Commission.

The first loophole was created in 2000 and get ready for this—it is commonly referred to as the Enron Loophole. Thanks again, Enron! This loophole allows for “over the counter” (OTC) trading of oil futures outside of the Mercantile Exchange, which bypasses Trading Commission oversight. Enron developed, and our government approved, the software that made this type of trading possible. Strike one against the consumer.

In that same year, a consortium of financial institutions and oil companies created the International Exchange (ICE) in London to trade European oil futures. This exchange was based in Atlanta, GA, but since they are trading European futures, the Trading Commission has no jurisdiction over it. Now fast forward to 2006 when the Trading Commission began allowing U.S. oil futures to be traded on ICE, where previously they could only be traded on the NYMX. This allowed speculators to buy and sell oil futures with no oversight at all from the Trading Commission. Strike two against the consumer.

Despite reports that speculators are not affecting the price of oil, it’s just about impossible to believe they are not. We saw the price of oil more than quadruple in the years from 2003 to 2008. Not surprisingly, there was a corresponding influx of money into the oil futures market, rising from 13 billion to 260 billion dollars over the same time period. Some members of Congress agreed that speculation was behind the increase in oil prices and introduced a bill in May 2008 that would have extended Trade Commission oversight to foreign oil markets such as ICE. This bill died on the Senate floor—strike three!

Now we are again seeing the effects of speculation in the oil futures market and will continue to see them until something is done to close the loopholes the speculators have been using—or better yet, get them out of the market altogether. It is my opinion that speculators should not be allowed in the commodity markets at all. I would like to see a requirement in place where if you purchase a commodity future, you must then take delivery of the product before you can resell it.

If you feel as strongly as I do about this matter please write your representative in Washington or forward this blog. They will only act if we ask them to!


About the Author

Jim Taddei has been in the automotive field since 1975 and has over 25 years of experience with General Motors products, achieving the designation of GM Master Technician. He is also currently certified as an ASE Master Technician, and holds an Advanced California Smog Check License. He has been the lead technician and team leader at a multi-line dealership. After leaving the dealership he spent a couple of years working in an independent shop and now uses his experience and expertise to help verify the quality of RepairPal Certified shops.

3 User Comments

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By , May 27, 2011
As long as corporate america controls our government the people will be at risk. We need a government that can look ahead and make decisions that work for the majority. The rich will always get richer and the poor will get poorer until it gets so out of whack that we start a revolution and then the rich may lose it all. Roland
By , June 03, 2011
It is not Corporate America that is the culprit, it is the greed of the individual that is the root cause. A free market enterprise system is what has made America the greatest nation in the history of mankind. It a the free market that allows the price of goods and services to be determined, not through government control, but by individual desire. Greed will always be a factor in our lives and it will always be a struggle to determine how best to control that greed. Judicious application of government control may be warranted but only after electing men of integrity with the moral conviction to enact laws that control the greed of individuals without trampling upon the free market and the prosperity it has brought us.
By , June 03, 2011
Forgot to sign off on last comment ... Bob Franks - God Bless America