Grappling with rising prices of crude oil
Atul Aneja
The exact role played by speculators in pushing up oil prices has
come under greater scrutiny after the Jeddah conference.
The Jeddah conference of oil producers and consumers, which concluded
on June 22, brought into sharp focus the role of speculators behind the
recent surge in oil prices. The conference exposed deep divisions
between oil producers and leading industrialised nations over the causes
behind what has been described as the third oil shock. King Abdullah bin
Abdul al Aziz of Saudi Arabia was outspoken in his criticism of oil
speculators at the conference. Following the lead of the world's largest
oil producer, the rest of the members of the Organisation of Petroleum
Exporting Countries (OPEC) amplified its line of argument.
The United States aggressively countered the assertion by oil
producers. Ahead of the meeting, U.S. Energy Secretary Samuel Bodman
stressed that it was not speculation, but the supply shortages in the
wake of surging demand that had pushed up the prices to their present
highs. Key western allies such as Germany backed Washington's position.
It was evident that the industrialised world wanted to steer the global
energy debate on soaring prices from the role that speculators had
played to expansion of output, from which western oil companies could
stand to benefit.
Without adopting a confrontational stance, India's position on the
price increase stood out for its clarity, forthrightness and pragmatism.
Finance Minister P. Chidambaram targeted speculators for causing the
recent spurt in prices. "Respectfully, we reject the suggestion that
rising demand is the cause of spiralling oil prices. Surely, demand and
supply dynamics cannot explain what has happened over the last 12
months.
How is it that the oil prices were $70 a barrel in August 2007 and
how is it that they have doubled when there has been no dramatic change
in demand?" Mr. Chidambaram added that the current pandemonium in oil
prices lay in "unregulated over-the-counter (OTC) markets and futures
trading in oil."
Notwithstanding the rift between the OPEC and buyers in the West, the
exact role played by speculators in pushing up prices has come under
greater scrutiny after the Jeddah conference. While the entire picture
on the modus operandi of speculators is still being pieced together,
there is sufficient information to conclude that they have played a key
role in escalating prices dramatically in just over a year.
Leading players
Speculators neither own nor use oil. Instead they provide capital
which is used for trading in oil futures in the hope of making a profit
at a later date. The speculator enters into a contract in the "futures
market" for the purchase of oil on a specified future date.
The implications of this practice over the last one year have been
enormous.
Billions of dollars have been pouring into the commodity futures
markets lately. Large financial institutions, hedge funds and pension
funds have pumped huge volumes of capital in these markets. Goldman
Sachs, Citigroup, J.P. Morgan Chase, and Morgan Stanley are some leading
firms in the U.S. that have been involved in the oil trade.
It is estimated that speculation is behind nearly 60 per cent
increase in the price of oil. A U.S. Senate subcommittee report of June
2006, "The role of market speculation in rising oil and gas prices,"
observed that "there is substantial evidence supporting the conclusion
that large amount of speculation in the current market has significantly
increased prices."
In the past, U.S. energy futures were traded exclusively through
regulated exchanges such as the New York Mercantile Exchange. The
Commodity Futures Trading Commission (CFTC) - a regulatory authority
established by Congress on financial futures - monitored the
transactions to prevent excessive speculation and other manipulative
practices.
Exclusive authority
It allowed U.S. crude oil futures to be traded on the
Intercontinental Exchange futures. A leading operator of electronic
energy exchanges, ICE is based in London. Consequently, it is not CFTC,
but the U.K. Financial Services Authority which, so far, has exercised
exclusive authority over the functioning of the ICE Futures exchange. As
a result, speculators in the U.S. trading in crude oil, gasoline and
heating oil futures can bypass the U.S. regulatory mechanisms, by
avoiding trading through NYMEX. Instead, they can route their
transactions through the ICE Futures exchange.
Tensions
It is evident that geopolitical tensions in West Asia have been
overplayed as a factor behind the recent surge in prices. The fear of a
possible war in the world's energy heartland has coincided with
excessive speculation, causing prices to gallop.
The prospects of a war in the region, and the possible disruption it
would cause to global oil supplies, have been used for expanding
production capacity significantly.
It has been said that already the gap between the total current
supply potential, including the spare production capacity that countries
like Saudi Arabia possess, and the growing energy demand in the world
has been narrowing down alarmingly.
However, at the Jeddah conference, Saudi Arabia's Oil Minister Ali Al
Naimi emphasised that the expansion of supplies was not a problem. He
pointed out that from July, the Kingdom would produce 9.7 million
barrels a day. Production capacity would be raised to 12.5 million
barrels by the end of 2009. A further 2.5 million barrels could be added
through production in some of the new giant fields, raising capacity to
a mammoth 15 million barrels a day.
As the role of unbridled speculation in the surge in oil prices
becomes more evident, the international energy community has begun to
consider ways to tackle it. At the Jeddah conference, Mr. Chidambaram
called upon "producers - especially OPEC - and consumers to wrest
control over oil trading from the hands of speculators." He advocated
the adoption of a "price band mechanism" that would work with the direct
involvement of producers and consumers. OPEC, however, rejected the call
on Monday saying the market is the best judge.
The pernicious impact of speculation on oil has also become part of
the U.S. domestic debate. Members of the campaign team of U.S.
Presidential hopeful Barack Obama have criticised the law which prevents
the CFTC from fully overseeing the oil futures market and investigating
cases of excessive speculation.
Despite some glimmer of hope, achieving lasting success will not be
easy as powerful vested interests are involved in keeping alive
speculative trading in oil.
The Hindu |