Via commentor Alex S., Lee Fan at ThinkProgress has a Special Report on “How Koch Became An Oil Speculation Powerhouse, From Inventing Oil Derivatives To Deregulating The Market“:
In April, ThinkProgress caused a stir when we uncovered a series of Koch Industries corporate documents revealing the company’s role as an oil speculator. Like many oil companies, Koch uses legitimate hedging products to create price stability. However, the documents reveal that Koch is also participating in the unregulated derivatives markets as a financial player, buying and selling speculative products that are increasingly contributing to the skyrocketing price of oil. Excessive energy speculation today is at its highest levels ever, and even Goldman Sachs now admits that at least $27 of the price of crude oil is a result from reckless speculation rather than market fundamentals of supply and demand. Many experts interviewed by ThinkProgress argue that the figure is far higher, and out of control speculation has doubled the current price of crude oil…
Charles Koch, the CEO of Koch Industries who is worth a reported $22 billion, likes to call his business an example of something he describes as the “Science of Liberty.” In reality, his company’s deregulation crusade has contributed to rolling blackouts, consolidation and monopolies in financial markets, and economy-wrecking oil price spikes. In comments to the CFTC, the reform-minded nonprofit Better Markets noted that, “the history of these markets is a history of anti-competitive, self-interested, predatory conduct that serves the interest of the exclusive few at the expense of the many and the system as a whole.”
After working furiously to unleash oil speculators like Koch and Enron, the Gramm family was rewarded with plum jobs, including spots on corporate boards and placements at speculator-funded think tanks. Wendy Gramm still holds a position at the Koch-funded Mercatus Center at George Mason University, although she hasn’t authored a paper in years. While the Gramm family has faded somewhat from the public eye, their actions have radically changed the global economy. Since the Koch-Gramm-Enron deregulation bonanza, non-commercial oil speculators have flooded the market and increased the price volatility of oil in leaps and bounds, hurting consumers and businesses across the globe while making a small set of oil barons and financial giants very rich…
Phil and Wendy Gramm! Another phun Republican couple, two busy legacies of the Reagan era, still hard at work (under the radar) stealing money from the 90% of us at the broad end of the income pyramid in service to their Robber Baron masters. Go read the whole report, for a timeline of the Koch’s very successful quarter-century campaign to destroy the American economy, and possibly the global biosphere, in pursuit of their insane ideology.
That explains why uber lobbyist Haley Blubber has been hitting the airwaves blaming President Obama for jacking up oil prices.
It’s projection with these asswipes, always.
That’s nearly $1 dollar a gallon just to pad their wallets from yours. Not a bad scheme to make money out of thin air.
I’d gladly trade that in for a 75c per gallon tax to pay for alternative energy research and energy infrastructure upgrades.
@evinfuilt: There was a study a few years back that estimated the cost of providing no-fault car insurance to all motorists at $.50 per gallon.
J. Michael Neal
Guh. This is going to be one of those threads where I get stressed out. The ThinkProgress stuff is ridiculous. It starts with the fact that they misrepresent their source. Here’s TP:
In the two sources they cite, Goldman said no such thing. Maybe they did and it’s quoted somewhere else, but they need to cite that, then. What Goldman did say is that they put a trade on in December, long a basket of commodities and that it has gone up 25% since then. That’s correlation; nowhere did they claim causation.
In the same way, they never claimed causation between closing the position and the drop in oil prices last week. all sorts of things happened that could have caused the drop.
Once again, I really wish that credulous people wouldn’t start screaming about a subject they don’t understand. As I’ve said before, until someone can posit a mechanism by which speculation in oil futures can produce any sustained artificial increase in the spot price without taking delivery and keeping the oil off the market, I’ll remain extremely skeptical. No such mechanism is posited here.
Also, there’s this, which demonstrates that someone has no idea what they are talking about:
Maybe. Hell, I don’t have any trouble believing that Koch is engaged in speculation. However, trading in financial products with no intention of taking delivery does not constitute evidence that they aren’t hedging. People hedge with products they intend to close out before they mature all the time. There are all sorts of reasons to do it. Either the writer is ignorant of how hedging is done, or they are misleading the reader by drawing a connection that they know doesn’t exist.
So, we have an outright lie and a misleading implication. The stories at ThinkProgress score a big, fat zero on the educational scale.
@J. Michael Neal: Yes, and the Koch brothers’ documented activities are sufficient to make one’s blood curdle, so why bother making things like this up?
J. Michael Neal
@jwb: Yeah. I don’t want to imply that I’m defending the Kochs here. Referring to the last thread, Mark Knopfler really should do a song about them like he did Ray Kroc. Or Imelda Marcos, though I have a harder time seeing the Kochs as ridiculous like that.
@J. Michael Neal: Uh, how bout this?
scroll down below the photo and over to the farthest column to what Mr. Chang of Koch Indus, sez. They’re taking delivery with what they call “contango.” Kinda appropriate name . . . .
I’m with Neal on this one. The Koch’s activities make me angry. And I am intrigued by the idea that speculation can drive up prices. I see estimates that 20 or 30 percent of the price at a certain time is due to speculative activity, but I don’t see clear explanations of how this is done through futures trading, or how long speculation, and only speculation, can raise prices that much.
Seems to me that there are two ways that speculation can raise prices: physical storage of produced oil, or decision to produce. Some one who controls a significant amount of storage in ships or in the ground, and has the cash to manipulate poorly regulated futures markets (like an OTC futures market).
So I was intrigued by the links.
But the only numbers I found that I could put into context of world production was the 20 year high amount of oil stored offshore in tankers:
“Frontline Ltd., the world’s biggest owner of supertankers, said Jan. 14 about 80 million barrels of crude oil are being stored in tankers, the most in 20 years. A purchaser could buy oil now, keep it for months at sea and fetch better prices by selling futures that are higher than the spot price.”
(from the links in the post)
But if I read the reports correctly, 80 million barrels of oil is about one days worth of production.
Is that enough storage capacity to influence the prices significantly for months on end? I don’t know.
The numbers of takers rented by individual companies in the links, was in the fives and low tens, but there are almost 5000 registered oil tankers in the world.
I did not find a detailed explanation of how speculation could raise prices above what future demand for productive use for oil would justify.
Am i wasting my time hoping they are actually going to go Galt?
@jimbob: ‘contango’ is a standard futures strategy. You can read about it in intro textbooks. Can an individual firm like the Koch’s cantango their way to manipulating world oil prices for months on end? Can they do it without the cooperation from major oil companies and producers?
Maybe Galt’s Gulch is too tacky. We could all chip in and get them a rainbow unicorn gumdrop land Galt’s Gulch, and maybe they would take the offer.
Gordon, The Big Express Engine
@jimbob: Contango means that the spot price of oil (the price today) is lower than the forward strip of futures prices (strip meaning the series of future dates – 1 month out, 3 months out, 6 months out etc. – that constitute a forward curve of pricing). The opposite is called “backwardation” (spot prices are lower than the forward strip).
Oil hedgers that have the ability to take physical delivery of crude oil (meaning they own or lease storage capacity – google Cushing Oklahoma storage capacity to see what I mean) will often put on contango oil trades, where they buy spot crude for physical delivery and immediately sell forward at the futures price to lock in the gain. In the interim between the spot date (today ) and the futures date of their forward trade (say 3 months from today), they simply store the oil and hold it before making the future delivery.
J. Michael Neal
@jimbob: Uhm, yeah. Do you know what “contango” means? It means that the futures price is higher than the spot price at the time the trade is made. Note that you have to adjust the spot price by the global interest rate and the amount of time into the future to properly compare the prices. With oil, you also have to figure in storage costs.
It’s a rare event when the futures price is enough higher than the spot price for this to work. It sure as hell isn’t the case right now, or at any time since 2008. Beyond that, the analyses I’ve seen suggest that most of the people who tried this trade in 2008 lost money on it. Some probably made money, but not many. Your timing has to be exquisite to make it work.
Either way, it doesn’t provide the slightest bit of support for the ThinkProgress claims. Completely different market conditions.
Hey, jimbob, buddy, here’s a pro-tip: This ain’t the place to come armed with a half-quiver of knowledge. On damn near anything.
I’m also with Neal. This is bullshit. Here are world spot prices (somewhat higher than US) since 1978. Yes, there was a big-ass spike in Summer 2008, followed by a collapse–all the way down to $35 a barrel–as world finances went kablooey. But then prices got back up into the 60s by mid-2009, and have been climbing ever since. Are they seriously trying to tell us that the price should be in the mid 50s, a price which, barring the crash, hasn’t been seen since early 2007? What, has growing demand from China and India been a hoax all this time?
Looks like Lil Austan Goolsbee’s done lying about the “jobless recovery”, and is exiting stage right from the WH.
Fuck Austan Goolsbee and the Neo Liberal* horse he rode in on.
*Sorry Flip if you feel that mischaracterizes Mr. Goolsbee in any way.
Ha ha! Schooled. Thanks, all.
Well, I am not trying to debunk the idea that speculation can increase oil prices substantially through market manipulation, for no reason related to fundamentals of damend.
Production can be manipulated, and I have not seen solid estimates of total storage capacity, though economists who claim to have looked into it (whatever that is worth) say that no more than a few days worth of production can be stored.
There have been poorly regulated OTC petroleum futures markets where, i have read, people can buy and sell futures contracts and take them home put them in a shoe box at the end of the day if they want. For futures markets to function as a way to discover the right price now that takes into account future fluctuations in demand, the number of contracts to buy should equal the number of contracts to sell at each date, and this should be settled periodically. That is one of the important reasons to only trade futures and derivatives on formal exchanges.
And there are lots of nasty people with lots of cash. There are only a few major international oil companies, and Arab OPEC controls, I think, almost a quarter of world production.
Maybe the right people have been cooperating. I would like to read a detailed explanation of the mechanics with evidence that it in fact happened, but I have not found one.
If anyone with detailed knowledge of energy futures and derivatives markets wanders by, spill your guts and let us know how it works.
Gordon, The Big Express Engine
@Citizen_X: one interesting recent dynamic is the disconnect between Brent and WTI, with Brent being quite a bit higher. We are producing (see the current piece in the New Yorker about the Bakken play in North Dakota for example) and importing from Canada a lot more oil than we used to and this oil is having trouble finding an outlet to our big refinery complex on the Gulf Coast. It is putting a bit of a cap on WTI and Cushing is full up at the moment.
@Gordon, The Big Express Engine: Ah! Thanks for explaining that.
Sorry, mate, that’s about all I can agree with in your last post.
ETA: Better said “affirm”, than “agree with”.
J. Michael Neal
@jl: I’m not sure that I consider a producer that owns oil in the ground in the same way as a speculator of the type that ThinkProgress is talking about. Pretty much by definition, that producer has to take delivery, since they already have the oil. They are also capable of speculating without entering into any paper financial transactions at all.
If they decide to pump less oil and wait for prices to go up, that’s what fundamental supply and demand means. Just because someone has a commodity doesn’t mean that they are obligated to sell it to anyone at a particular time.
Gordon, The Big Express Engine
@jl: the amount of storage is not sufficient to manipulate prices by “holding back” the supply. Utilization (or lack thereof) of existing production capacity is a far greater hammer to wield in this regard. My feeling is that OPEC greatly desires a price band (call it 60 to 90 bucks per barrel) that keeps them flush, but is not high enough to encourage real investment in alternatives. Their formal meetings are held largely with the intent to strike such a balance.
I am also with J. Michael Neal. Anyone who thinks the market is consistently overpricing the real price of oil, has an obvious remedy:
Short the market, put your money where your mouth is.
If you are right, you will make a killing when supply & demand forces the price to correct to the market-clearing price.
J. Michael Neal
@jl: Also, I’m curious to find out how any derivatives market can have different numbers of buy and sell contracts open. How do you have a buy side with no sell side?
@J. Michael Neal: I agree, but I have read theories where major producers can cooperate with large players on OTC futures markets to produce a large purely speculative premium. To be honest, I do not fully understand the story, since it involves taking advantage of feedback from futures prices into benchmark price indices used for contracting. And I have not seen any evidence presented that it actually happened.
The story where producers can be said to be involved in speculation requires that they coordinate production decisions with manipulation of poorly regulated futures markets. That is more than just deciding how much oil to pump, and hedging on organized futures markets.
@J. Michael Neal: I have read that it can happen on unregulated OTC futures markets, if the buy side and sell side are cooperating and their is no monitoring of settlements.
I am not advocating for any theory that speculation drives prices, because I have not seen one that I understood, believed was plausible, and that presented any evidence that it actually happened.
So, I threw out some elements of the theories I have read in hopes some energy expert here would debunk them, or explain them. I should have been more explicit about why I was tossing out elements of speculation theories.
I agree with you on this.
Gordon, The Big Express Engine
@J. Michael Neal: I don’t think you can, but could you have trades on something – oil, nat gas, cotton, or say credit default swaps maybe (!) – where the total volume of derivatives dwarfs the underlying asset? I think the answer is that you can…
@J. Michael Neal:
Yep. I don’t think a day of my life has gone by without having this thought at least once.
@J. Michael Neal: Final blast for tonight: if you want to see debates on the how the speculative mechanism might work, and whether manipulation of speculative markets can cause large and prolonged increases in the price of oil check out Naked Capitalism blog.
That is where I read about possibilities for manipulation on unregulated OTC markets and how it would work. For awhile I read the fights until my eyes glazed over, but recently I gave up.
J. Michael Neal
@Gordon, The Big Express Engine: Oh, sure. You can have derivatives markets that are much bigger than the underlying. That could lead to a very short term price spike right at expiration *if* the buy side players are prepared to take delivery. If they aren’t, they’re bluffing.
What jl seems to be saying, though, is that there are poorly regulated markets in which someone can have a long position without someone else being short. I’m disputing that that’s possible. I’m sure someone can write on a piece of paper that they are long, but it doesn’t mean anything. One of the attributes that I’m assuming for these poorly regulated markets is that they are OTC. That means that, by definition, you have to be trading with someone specific. If you go long, you can *only* do it with someone who goes short at the same time.
This is another thing that I won’t believe is true unless someone can explain to me how it happens. No citation to a source that doesn’t explain this can be convincing.
J. Michael Neal
@jl: I’ve checked out Naked Capitalism before when someone made this claim. The piece they sent me to didn’t support the argument. All it did was make the same assertion without any explanation, or link to a piece that did. I’m not chasing that rabbit again. If someone wants to link me to something specific, great, but the burden of proof is on you guys.
@J. Michael Neal: Final final final blast for tonight: I agree with you, dude. Please take ‘yes’ for an answer. I tried to use due diligence and check out sources like Naked Capitalism, and oil trading blogs, and came up empty. So, no, I am have nothing to recommend to you for reading in particular, if you have already taken a look.
@jl: Just read about the California energy crisis. The state had 2x the capacity as the state demanded, yet the speculators were able with a bit of legislation that limited how consumers could buy but didn’t regulate how suppliers could sell, to be able to drive demand about 10% in excess of supply which spiked prices by about 20x. Energy markets are extremely inelastic that way. You don’t need to push demand much over supply for prices to explode because, as I keep saying, a free market requires consumers the ability to leave the market – which isn’t realistic with energy. Hospitals and cities and industry and individuals need electricity and oil and will pay pretty near any price for it. Gas prices tripled before consumption even leveled off. In an elastic market, you’d have expected demand to go down proportionate to the increase in price, but that never happens. Ever.
Do you honestly think there’s less speculation during times of lower gas/oil prices than high prices? Do speculators go away when the price is down? No. There are just as many speculators at work during rising prices as during falling prices. This perception that speculators are to blame for high gas/oil prices is totally inaccurate. There are people and companies that engage in commodities speculation, and it has nothing to do with the current price of the commodity. Sure, it affects HOW they place their bets, but does anyone really think that speculators go away entirely for periods of time, and it’s during those times when no one is speculating that the prices drop?? Use some common sense here. It’s like saying that stock prices rise when there are people trading stocks. Well, there are always people trading stocks, and sometimes the price of stocks go up and sometimes they go down, but it has nothing to do with the presence of the traders. It has to do with other market forces, which these speculators use as part of their strategy in speculating. But the speculators are always out there, speculating – when prices are up and when prices are down. They don’t cause the increases anymore than they cause the decreases. Jeez, people, wake up.
@J. Michael Neal:
True, within the confines of that particular market. But when you open up to the broader set of markets that are interplay with each other, I’m not so sure. It’s certainly possible to be long in an equity market and short in a derivative market. Hell, I’ve gone equally long and short in a derivative market, used each as a collateral against the other and profited on both simply by exploiting the timing of when I executed each trade. On the other side of those trades I’m almost certain was an institutional investor that was long/short on the equity and the opposite on the derivative, used as a hedge.
Now, with equities, that balance is easier to visualize being maintained because equities are persistent. They don’t go away unless they’re brought home. Derivatives vanish all the time, since they’re time based. You can sell a contract for the price of a security to drop a certain amount and still be long the security because you don’t believe the security will go down by the degree you set at in the time period the derivative is valid. That time variable really fucks with how you define ‘long’ and ‘short’.
In the case of commodities, they’re not persistent either. You can stop pumping oil, or store it and remove it from the market. Hell, there are scenarios where burning it is profitable (see CA energy crisis). So I don’t think it’s so clear cut in many cases.
@Corner Stone: I don’t care how you characterize anyone when you’re just drawing conclusions from what you know/have seen/understand. I care when you willingly misread statements, like the other night, not because I particularly give a shit about Austan Goolsbee but because I care about the English fucking language.
Um, no, because oil is not an elastic market. Look, this really isn’t that complicated. If you change the price of the commodity, the demand isn’t going to change. There’s untold evidence of that – demand is based more on seasonal behavior than on the price of oil. So, you don’t have a market dynamic that operates in the classical sense. There’s little profit to be made to increase the gap between demand and supply relative to the profit to be made to close that gap. So because the market is inelastic, the economic forces push speculators to keep supply and demand as close as they can manage because there simply isn’t any real money to be made doing the opposite unless it’s a temporary move against a longer strategy.
Won’t You Go Galt, Paul Ryan?
to the tune of “Bill Bailey”
Won’t you go Galt, Paul Ryan?
Won’t you go Galt?
We’ve fought you all day long
You’re killin’ old folks, baby
You’re cuttin’ SNAP
How have we done you wrong?
You remember that happy day, boy
We dressed you out,
Put Medicare in that vault?
Your zeal is to blame, and ain’t that a shame?
Paul Ryan, won’t you please go Galt?
I think this would be the wording from Goldman Sachs most relevant to this discussion.
The write-up below is from Reuters.
Needless to say, the actual document from Greely from early April discussed a broad range of factors, and situated net length speculation in the context of the variability of the Middle East situation.
The National Energy Policy Institute (Tulsa) has had a discussion on its blog of economists’ research and modeling of the relationship (or not) between futures pricing and oil pricing.
From the most recent post.
@J. Michael Neal:
What’s the mystery? Look at real estate price run-ups during the last decade due to speculation fever, which was fueled by leveraged investing. Speculation raises prices by having more dollars chase the same amount of product. Unregulated derivatives become a device for multiplying the amount of dollars that can chase the product through leveraging. Does it sustain itself permanently? No. But it greatly exaggerates the upswings caused by such events as the Libyan oil going off the market.
Thanks for the h/t. The article certainly pulls all the right strings, but I guess in retrospect I would have also wished for a more detailed description of how it works, and especially a link to the Goldman quote. I have no doubts though that the price is somewhat inflated so I was very happy to see a specific number.
I believe that, since the Lehman Brothers crash there is a lot of free money around that is looking for opportunities. Some people are simply buying oil with the hopes of rising prices, not because they use it. That creates an artificial demand that increases prices. At some point people accept this new price as the new normal and we suddenly have a bubble.
Koch Industries certainly aren’t the only one, but hey, that’s the angle that gives links. And the inclusion of Gramm is very useful, in my opinion. For decades the price of oil was hovering around $20/barrel. And in 1999, it was just above $10, and that was with the tech bubble in full swing. Also in 1999, the price of gold hit a 28-year low. And that was when Clinton’s most harmful deregulations took place. And the price of oil never got even near these levels again. When the tech bubble imploded, speculators were looking for the next big thing. And they chose commodities and housing. Markets repeatedly behaved very irrationally. The Dow Jones moved between 10000-12000 for most of the last decade, except for the final months before the crash when it broke out of this corridor and climbed above 14000 even with signs of a beginning recession. And just watch the price of oil from 2007 to the crash. In early 2007, the price was in the 50’s only to climb to 150$ within 2,5 years (similarly the price of gold which seems to increase no matter how the economy is doing). And right now, with a troubled US economy, a Europe with deep problems and a China that is contemplating a rise in interest rates to slow down the economy and inflation, prices are far above $100, that is more than double the price of 4 years ago. It looks as if the irrational 2007/2008 prices are accepted as the new standard and we have a new bubble.
“Science of Liberty,” eh? Meaning, I guess,the freedom to steal and rob, and leave the rest of us in debt slavery.
Ah, the “magic of the marketplace”–making our money disappear into the pockets of the undeserving few.
@J. Michael Neal:
That’s because your understanding of the oil market is too simplistic.
I don’t think it’s that simple. Rather, as the stuff El Cid posted points out, the futures price can influence the spot price, but through presumably more complicated mechanisms.
Furthermore, if you read some of the posts over at Naked Capitalism which I just linked to in my previous comment, you’ll see that a lot (IIRC most) oil isn’t bought and sold on the spot market, but rather using long-term contracts whose prices are set using information, much of which is futures prices.
J. Michael Neal
Not really. The stuff at Naked Capitalism posits a mechanism through which speculation can increase prices, and it’s exactly the same one I keep mentioning: it can only happen if it actually reduces the supply of oil on the spot market. I’ve said that over and over again.
It should also be noted that Yves Smith not only doesn’t provide any evidence that this is happening, she pretty much concedes that it isn’t speculators that are taking supply off the market. The closest she can come to doing so is to say that there are lots of places that oil can be stored by regular producers if they think that they will be able to sell it for more at a later date, presumably accounting for storage costs and interest rates.
The problem with this argument is that, if it’s purely speculation that’s causing this price increased, the people hoarding the actual commodity are going to get killed. Unless there is a fundamental supply/demand reason, that price they were hoping to sell at is going to collapse when all of the oil comes back onto the market.
Speculation can produce short lived spikes. It cannot produce extended higher prices without reducing supply of the commodity, and in practice, attempts to do so are going to result in someone losing their shirt.