The real reason gas prices are soaring
An oil-trading pro blames a flood of new investors buying oil ETFs for the recent pain at the pump.
By Charles Wallace, DailyFinance
Have you ever wondered why when you go to the gas station to fill up the family car, the price of gas at the pump has just jumped 25 cents a gallon over the past three days? Perhaps you thought the oil companies were just being greedy. Or you believed the nightly news pundit who said that gas prices went up because the crisis in Libya was affecting supplies of oil. One professional oil trader says that you'd be wrong on both counts.
Dan Dicker, who has spent nearly three decades in the oil market, has a profoundly disturbing explanation of why the price of oil, and the gasoline that comes from the crude product, has risen so dramatically in recent months. It turns out, Dicker says, that the price has nothing to do with supply and demand for oil. It's the financial market for oil, filled with both professional speculators and amateur investors betting on poorly understood oil exchange-traded funds, who have ratcheted up the price of gas to such sky high levels.
"There is no supply issue going on here -- what you have is the perception of the possibility of a supply issue," Dicker says. "A whole bunch of people are pouring money into an oil market trying to take advantage of what they perceive to be a real risk in supply. It's a marketplace that I argue should not be allowed to be wagered on like a stock or bond."
Dicker notes that Libya produces only 1.3 million barrels of oil a day, just a tiny fraction of the world oil market. Even if Libyan crude were lost to the world market in the current turmoil, and there is no sign that it is, Saudi Arabia has 5 million barrels a day to use in case of an emergency.
Dicker, who has just published a book called Oil's Endless Bid: Taming The Price of Oil To Secure Our Economy, makes a strong case that if the government stepped in and regulated oil trading so that only investors with a genuine interest in the physical product, such as airlines and heating oil companies, could buy and sell oil futures, then the price of oil would fall by 50% overnight and our economy would be much better off.
Why Greater Regulation Is Needed
"You have to make it so the original intent of commodity markets, to be used almost exclusively as hedging tools, is returned," he says.
Though Dicker acknowledges that is not likely to happen, he points out that when the 2008 economic crisis froze all financial markets and investors stampeded to the sidelines, the true price of a barrel of crude oil became known: $32. It's now hovering at around $110 thanks entirely to investor demand, he says.
One of the reasons Dicker is calling for greater regulation of the oil market is that no one really knows how large it is or what is going on it on a day-to-day basis. In fact, it reminds Dicker of the market for credit default swaps, which brought down the insurance giant AIG and forced the government into a $180 billion bailout.
The market for oil traded financial instruments has been estimated at between $8 trillion and $30 trillion, but there are no concrete numbers because traders don't have to tell anyone how much they are betting either for or against the oil price. Dicker says if the government minimally required oil trading to be conducted in a transparent manner on exchanges instead of the current over-the-counter system, a large number of speculators would leave the market and the price of would fall sharply.
He also notes that the major shift in oil trading has been relatively recent. First, financial firms such as asset managers and pension funds realized they needed to diversify their holdings of stocks and bonds, which had performed badly over the previous few years.
The move was made easier by the arrival in 2006 of electronic trading of oil futures. The formerly cumbersome process of trading oil with a floor trader at the New York Mercantile Exchange was suddenly replaced by a streamlined process requiring only a few keystrokes on Chicago Mercantile Exchange's Globex computer platform.
From a few thousand trades an hour at the old NYMEX, traders now process millions of trades an hour by computer. Dicker estimates the financial market for oil is 15 times greater than the amount of actual oil being traded, with 75 types of futures being sold on exchanges. That doesn't even include all the private, over the counter transactions that take place.
"The amount of money pouring into hard assets, particularly oil, is outsized because it's new and fresh, so you get these outsized moves from $68 a barrel in the summer of 2010 to $100 now," Dicker says.
Why does all this trading drive up the price, when buyers and sellers should theoretically cancel each other out? Dicker says that is primarily because almost all oil investments being sold by the big investment banks are long trades -- bets that the price will go up. While it's also possible to short oil ETFs, no one does. So the price heads ever skyward.
"There is no shorting of the market and the commodity market is not like a stock market," he says. "It is not designed to have only one half of a trade. It is designed to inspire both halves, that's how you arrive at a correct price." Dicker gives the following example: Let's say you live in a neighborhood where all the homes are priced at $200,000. Suddenly an army of buyers arrives who want desperately to move into the neighborhood. You were not really interested in selling before, but now a buyer offers you $400,000 for your $200,000 house. What are you going to say?
"That's what's going on in oil," Dicker says. "You have this army of people who have been flooding into a brand new neighborhood and they've had to inspire somebody to sell and the only way you can do that is pay an outrageous price for it."
The Biggest Winners
Among the biggest winners of the new oil markets are investment banks like Goldman Sachs (GS) and Morgan Stanley (MS), which create new products for clients and then use that information to trade on the products. In 2004 and 2005, Goldman Sachs made $1.5 billion a year trading oil, Dicker says. In the first half of 2009 alone, the firm made $3.4 billion oil trading profits. Firms like Goldman are not taking bets that oil will move lower or higher. Trading simply means naming a spread of buy and sell prices from which they can eke out tiny but regular profits, a business without risk.
Dicker is particularly contemptuous of oil ETFs of the kind that many small investors have used as vehicles to diversify their holdings. "In these markets, the way they are set up, with all the edges with investment banks, the regular investor is just fodder," Dicker says. "The ETFs are the world's worst investment. They've only lasted this long because oil prices continue to rally."
So if gas prices would come down sharply with minimal regulation, why doesn't the government step in and impose limitations as it has done recently for other derivatives, forcing most firms to conduct their trading on exchanges? Dicker believes it is largely because large financial firms with a direct interest in oil trading have made so much money with oil that they can afford to lobby Congress to block any significant reforms.
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This article is right on. If the speculators were removed from this equation the true price of crude would reveal itself to under $ 40.00 bucks a barrel. Now I see no reason to hold the worlds economies hostage to Goldman Sacks and MorganStanley. Hey let them speculate with mortgage financing. Oh they already sucked our wallets dry already on that scam.
Democrats have been in control of Congress for years, even during the $140 oil spike in 2008. I didn't see them giving back their Goldman Sachs lobby money, did you? And...GS is a Democrat leaning company. They always have been.
I agree with article... It used to be only end user could contract oil, fuel, etc. In mid 90's I could buy diesel for around $0.45 /gallon or less per tanker load ( 8,000- 10,000 gallons). Once they open it up to anyone to buy or invest in ( big banks, mutual funds) it sykrocketed. Today can not even buy a tanker for under $3.40 here..
If outside money was cutoff it, the market price would fall....
Actually we should tax every stock market trade to help pay for the national debt and big bank bailout. My solution would be to put a 3-5 % tax on every stock sold, make every one in commondity market ( wheat ,corn, oil, etc) either pay for the storage or take delivery of the product... As a farmer if I haul grain to town I have to sell or pay storage ($0.06 / bushel up front per month)
Basically take out spectulation, make these markets a long term investment..
Speculators helped bring down the housing market and now oil is what they've chased over to...its sickening and Washington stands idle with their thumbs up their collective asses!
you folks who blamed people for forclosing because they bought too much house conveniently 'forgot' all the speculators who bought investment homes then just dumped them when they either could not rent them or, in a lot of cases, bought in areas where umemployment soared and the values dropped...IT WASN'T JUST REGULAR FOLKS WHO GOT IN OVER THEIR HEADS!
Speculation is damaging the ability to sustain a healthy economy.
We as a nation have become so complacent...does anyone remember that we went through this same scenario back in 1970 (s)...the "Alaskan Pipeline" ring a bell?
Plain and simple it is a matter of greed...how many of us have been witness to our local stations inch up the price every weekend or even several times within a day...it is called price gouging and as long as we put up with it...it will happen.
Our government will do what we allow them to do...as my father would say, "on the back's of the middle class."
again we see the politicians are in the pockets of big business, their employers! We all better think twice who we vote for in the next election.
The oil companies make billions in net profit every QUARTER, not for the whole year. You would think they can afford to lower the price of gas.
And yet no politicians has ever brought out this matter and face the facts of price fixing.
For the people in position , It has come to be for my pocket not for the good of the people.
Dicker says. "A whole bunch of people are pouring money into an oil market trying to take advantage of what they perceive to be a real risk in supply. It's a marketplace that I argue should not be allowed to be wagered on like a stock or bond."
....Well don't even think of regulating it lest Boehner, McConnell, Bachmann, Beck, Limbaugh and Palin turn purple with rage. I used to support the GOP, now I don't support anyone, except Thomas Jefferson, but unfortunately, he's dead now (any chance he could be cloned?).
so Dirtygirl2 & roadhouse blues,
I think you must have forgotten how the Bush administration made several attempts to regulate Fannie Mae & Freddie Mac and were denied by Barney Frank & Chris Dodd.
Barney's own words:
"Hearing from September 2003 on an administration proposal to alter the regulation of GSEs like Fannie Mae and Freddie Mac. See Congressman Barney Frank's opening statement, which begins at 4:40. It's rather amusing. Here's an excerpt of his opening statement:
"I want to begin by saying that I am glad to consider the legislation, but I do not think we are facing any kind of a crisis. That is, in my view, the two government sponsored enterprises we are talking about here, Fannie Mae and Freddie Mac, are not in a crisis. We have recently had an accounting problem with Freddie Mac that has led to people being dismissed, as appears to be appropriate. I do not think at this point there is a problem with a threat to the Treasury.
The more people, in my judgment, exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see. I think we see entities that are fundamentally sound financially and withstand some of the disastrous scenarios. And even if there were a problem, the Federal Government doesn't bail them out. But the more pressure there is there, then the less I think we see in terms of affordable housing."
Quite interesting, I'd say.
Here is some information about Mr. Dodd,
"As Banking Chairman, Mr. Dodd was declaiming on the Senate floor that the toxic twins absolutely, positively, no doubt about it, need to be reformed—just not yet. He thus opposed Arizona Senator John McCain's amendment to his financial regulatory-reform bill to shrink the mortgage giants, raise their underwriting and capital standards, cap the taxpayer losses (now $145 billion and counting) and eventually shut down the failed enterprises.......For much of yesterday's debate, Mr. Dodd was visibly angry. Perhaps that is because he was left alone on the floor to defend the most expensive of all federal bailouts. Thanks to his own sweetheart mortgage from Countrywide Financial—a leading Fannie business partner—Mr. Dodd isn't running for re-election. But other Democrats chose to spend yesterday's debate in undisclosed locations. They were no doubt thrilled to enjoy federal witness protection from C-SPAN's cameras as Fan and Fred's longtime opponent, Alabama Senator Richard Shelby, described the various reform efforts they had blocked over the years. "
So, who is opposed to regulation and reform?
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