Did Speculation or Manipulation Fuel the Oil Price Surge?
Commentary of “60 Minutes” Broadcast 1
By Mitch Gurney, January 2009
After watching a “60 Minutes” broadcast recently entitled, "Did Speculation Fuel Oil Price Swings.” I came away with the impression that deregulation of the commodity market had enabled major investment firms to control the price of oil despite the traditional economic principals of supply versus demand. If this is true, then this allows investment firms to have an unfair advantage in determining the commodities market, which I perceive no different than insider trading. Obviously the market is speculative by nature and this implies taking a risk for an uncertain outcome. But is it truly speculative trading, and for whom, if prices can be manipulated and controlled by certain exclusive parties? Since the markets were explained as unregulated, it appears that various entities, in an effort to attain profits, could create price bubbles which adversely affect market segments and consumers globally.
“60 Minutes” began by stating that “to understand what happened to the price of oil one has to understand how it is traded. For years oil has been bought and sold on the commodities futures market. It’s traded on the New York Mercantile Exchange (NYMEX), along with cotton, coffee, copper, and steel by brokers who buy and sell futures contracts to deliver those goods at a certain price at some date in the future.”1 Equally as beneficial is to understand the history of commodity trading along with the turfs and battle ground over regulation versus deregulation which adds greater significance to the “60 Minutes” broadcast.
“60 Minutes” explains, “…the commodity market was created so that farmers could gauge what their un-harvested crops would be worth months in advance, so that factories could lock in the best price for raw materials, and airlines could manage their fuel costs. But more than a year ago those markets started to behave erratically. And when oil doubled to more than $147 a barrel, no one was more suspicious than Dan Gilligan, the president of the Petroleum Marketers Association” and interviewed by “60 Minutes.” 1
“60 Minutes” mentions Enron’s responsibility for deregulation but gave no specifics. This raised additional concerns because if commodity trading had been deregulated this would have required legislation in Congress, yet no details were provided. What was this legislation and who were the congressional members that sponsored it? The impression given was that deregulation is an unresolved issue, but is it?
Following Enron’s collapse in 2001 volumes of discovery have been made through the investigations and Congressional hearings held at the time and thoroughly documented in an article “Blind Faith” published in 2001 and among others that I have quoted here. Certainly this would have given Congress insight on precisely what had gone awry. 1 5 6 7 10
I became suspicious when “60 Minutes” stated, “…the oil bubble began to deflate early last fall when Congress threatened new regulations and federal agencies announced they were beginning major investigations,” 1 but no specifics were given. Recalling the Enron scandal, it seemed we’d been down this road before. Did Congress only threaten? Was legislation enacted to remedy the situation? If any actions were undertaken what affect did this have on the price of oil? What had become of any of the investigations the federal agencies were to conduct? If abuse had occurred will anyone be held accountable? I will attempt to answer some of these questions here.
I have concluded after extensive research that there is a much bigger story here and “60 Minutes” barely scratched the surface. So with that let’s begin with a bit more background to round out this story.
The road to deregulation reads like a suspense and history novel all rolled into one, loaded with plenty of political intrigue and backroom deals. The cast of characters is lengthy but the principals serving in government policy making roles whose actions eventually lead to deregulation were former Senator Phil Gramm (R-TX) and his wife, Dr. Wendy Gramm, former Chairwoman of the Commodity Futures Trading Commission (CFTC) serving an appointment during the Reagan administration, which ended with the Clinton Presidency. 6 Interestingly Phil Gramm also sponsored the bank deregulation legislation, the Gramm-Leach-Bliley Act 1999 which repealed the Glass-Steagall Act of 1933.
The history of the commodity markets along with its regulations date back to the early 1900’s and is decently explained in an article, “Commodity Clash,” published in October 1997 while discussing deregulation debates in Congress of that year, and states “most of the trading and profits for commodity exchanges today come in financial futures, but the futures industry is firmly rooted in 19th century domestic agriculture.” 2
The Exchanges were discovered by market participants as the most efficient and perform two key functions; price discovery and risk shifting. By bringing together over 64,000 buyers and sellers the “exchange trading floors became the most effective places to determine the value of commodities.” 2 “The prices established by the futures markets directly or indirectly affect all Americans. They affect what we pay at the grocery store and at the service station, what we pay for our silverware, our copper plumbing, and our lumber.” 5 Because commodities are priced in dollars the prices established in the futures market directly impact prices on a global level, transcending far beyond just American consumers.
The chaotic and boisterous environment of the exchange floors and the speed of trading make it extremely difficult to monitor and track these transactions creating an “opportunity for illegal and unethical activity.” 2 Apprehensions that such behavior may be occurring far more frequently than realized has been further exacerbated by the technical advances in electronic market trading that came about following deregulation that has increased the speed of these trades.
Market participants have long feared “that the owner of a large amount of a commodity would "corner the market" by trading to raise prices and force sellers with contractual obligations to buy the product at a high price to fulfill their contracts. Market participants are also apprehensive that traders will take advantage of market congestion-moments when trading is heavy to engage in insider trading and other shady deals.” 2
“Commodity exchange activity was deemed so important to the U.S. economy that abuses and fear of abuse led Congress to begin regulating exchanges. “The first futures trading laws enacted were The 1914 Cotton Futures Act and the1922 Grain Futures Act followed by the Commodity Exchange Act (CEA) in 1936, which set up the Commodity Exchange Authority.” 2
“In 1974, Congress enacted the Commodity Futures Trading Act (CFTA), which established the Commodity Futures Trading Commission (CFTC), replacing the Commodity Exchange Authority. CFTC is a five-member commission including a chairperson, all appointed for staggered terms by the President and confirmed by the Senate. The law gave the new agency authority to regulate "any item of goods or services traded on a futures basis." 2
“A 20-year agency history published in 1995 shows the CFTC has intervened in some of the biggest fraud cases and historical events of the last two decades. The commission was “established with a "sunset" provision requiring periodic congressional review of its performance and need for existence.” 2