Why the Oil Market Needs More Instead of Less Speculators

Less than 3% of the world’s oil consumption is traded in futures at the New York Mercantile Exchange (NYMEX). This is an alarming small percentage, considering the enormous impact these futures have on the world economy. Not only do they provide direction for stock markets, they also affect millions of consumers every day at the gas station, and influence the price of every airline ticket sold.

Do we want a market with such a huge responsibility to the world economy be determined by only a few players? At the moment the market is so small, that it takes only one big financial institution to determine the direction of oil prices. During the summer of 2008 the energy trading company Vitol controlled almost 11% of the futures traded. Imagine the price action when this company decides to sell off its positions, shaking up markets all around the world. A simple calculation shows us that using the leverage offered at the futures market will enable you to control the entire oil futures market with only $4 billion in cash. That’s a very cheap price for practically buying the world economy.

The US government believes that it is the oil speculators who let oil prices soar to around $145 a barrel in 2008. The funny thing is that in reality most of the price hike is accounted for by the companies who dislike it the most, the airline companies. Hedging is a common strategy to manage risk by limiting the influence of fluctuating prices on business profitability. By taking long positions, the airlines make sure that an increased cost for kerosene is compensated by a profit on their positions. However, their increasing demand for long positions leads to rising prices, creating opportunities for speculators to gain a profit.

A good example of the reason why there should be more oil speculators happened on June 30, 2009 at the ICE Futures Exchange Europe. This little brother of the NYMEX experienced a sudden price hike of almost $2 a barrel because of rogue trading by London oil broker PVM Oil Futures. This unauthorized trading cost the broker around $10 million, and painfully shows that with a limited amount of money the market can be influenced significantly. Imagine what happens if the really big financial institutions want to move the price a bit.

What if the US government decides to regulate the oil futures market and close trading for speculators? Not only will the market loose its natural price mechanism, it will also become a play bal for the boys who profit the most from rising oil prices: the oil companies. It will make it even easier for them to control the market and artificially drive prices up. They can afford it to take huge risks because they will always hold the Joker card. Whenever their long positions are threatened by declining oil prices, they have the possibility to cut supply, therefore driving prices up, until their positions are covered again. Is that what we want?

What the market needs is an increased participation by individual speculators who do not have any physical ties to the oil market itself. These are the people that are trading for only one reason: profit. They do not benefit from higher or lower oil prices in any other way than the positions they own. Traders are trading facts, therefore contributing to the natural price mechanism. When demand surpasses supply, prices will increase, if not, the other way around. They do not posses the opportunity to influence prices in an artificial way. When their trading volumes become the bigger part of the market, the true oil price is on its way.