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Thursday, June 12, 2008

John McCain Vs. Oil Speculators

Gasoline prices may emerge as the most important issue in the election in November. Right now, it probably favors the Democrats who can paint the Republicans as too close to the oil companies. Of course, this is a fluid situation and their is just as much room for the Republicans and especially John McCain have just as much room for opportunity on this issue. In my opinion, neither party has done much of anything on this issue, and both spend far more time with mindless rhetoric than any real solutions. Thus, it will be a race to see which party, or candidate, comes up with a tangible solution first. Here is what John McCain said today.

Presidential candidate John McCain said that while demand is the main reason for rising oil prices, speculators have contributed to the increase.

``There's a certain speculator effect here; how big that is is impossible for me to judge,'' McCain said in an interview on Bloomberg television today. ``There should be a thorough investigation.''

Last night on the Factor, Bill discussed the issue of oil speculators with both Dick Morris and Dennis Kucinich. Morris agreed that whichever candidate took the more aggressive stance against the oil speculators would have a huge political advantage on this issue.

This issue seems tailor made for Barack Obama because he is so in love with regulations. That said, attacking oil speculators can be done with one simple regulation. In fact, the problem of oil speculation is very similar to the problem we had with speculation in stocks in 1929. Speculators can buy oil futures with only ten percent of the money down. In order to control the speculation, politicians need only to regulate a higher margin.

Of course, this plan is fraught with unintended consequences. For instance, it isn't merely oil futures that have ten percent margin but just about all futures work as such. In fact, the low margins create speculation, and frankly, what is a futures market if not a market for speculators. There is no doubt that such a plan would irk many a conservative. In fact, it didn't take long for conservative blog, Red State, to get irked.

Crude oil is a commodity that combines very large size (trillions of dollars per year) with excellent liquidity on futures markets, and is in demand.

Global demand for crude oil is at least stable (it’s falling in the developed countries, but rising like a rocket in Asia and the Middle East). That puts a floor under the crude price in the near term.As a result, crude oil has taken on many of the characteristics of an asset class (the kind of thing that investors buy) in addition to an industrial commodity. And as an asset, oil is very attractive because it acts as a hedge against inflation.

Why are investors buying an industrial commodity instead of the fixed-income securities they usually buy? Simple. Because there’s still a huge amount of sovereign money in the world (what Ben Bernanke calls the “savings glut”) and it tends to migrate into US Treasury debt. That raises the price and lowers the yield.

Far be it from me to disagree with this very tedious if not financially sound explanation of the oil market. Still, there is no doubt that speculators drive up the price of oil far beyond what any measures of supply and demand call for. There is varying degrees of speculation in all markets, however there are few markets as vital to our economy as oil. It is still up for debate whether or not more regulation on oil futures would be good for our society. What is not open for debate is that taking on the speculators is good for the political standing of whatever politician decides to do it. Of course, simply calling for investigations is not nearly enough. For now, John McCain has taken a baby step in this confrontation. If he is to make this a political issue, he will have to do a lot more than calling for investigations.


kmorrison said...

I've heard that making speculators take delivery of their product would also stop rampant speculation. Does that make sense? (I'm no commodities expert)

Anonymous said...

Of course it would, where would you put X barrels of oil? (or a thousand pork bellies) It would also suck liquidity out of the market, and leave it in the hands of a very small shipping cartel. Pure nonsense with unintended consequences coming out of it's ears.

Anonymous said...

Anonymous said...

I do not think that is impossible that there is a speculative bubble underlying SOME of the increase in oil prices. However, I think that it would be unwise to attempt to burst that (possible) bubble, for fear of further undermining liquidity in the energy markets.

Unknown said...

I disagree that it is pure nonsense as anonymous said. Who cares if it sucks liquidity out of the market. As far as I'm concerned, they should take it off the market. Let businesses set the prices. We don't trade everything on commodities exchanges. No dairy, no honey, no green beans, no get the picture. Somehow, competitive prices still get set for these products whether there is a commodity exchange or not.

mike volpe said...

Travis, after some thought, I have to agree with you. What would suck more liquidity out is raising the margin on being able to buy futures from where it is now, I believe 10%, to something higher like 50%, which is one of the things I suggested in my piece on bringing down oil prices.

Forcing delivery would mean that only those with sincere interest in hedging on oil for future delivery would be in the market. That is an interesting idea.

Anonymous said...

U.S. regulations used to limit only industries involved in the oil industries (suppliers, airlines, etc.) to investing in oil futures. The oil commodity market moved to London to escape U.S. regulators, and speculation in the oil markets has exploded. The U.S. can and should once again find a way to limit these non-industry speculators.