Rising Oil Price Intensifies Speculation Debate

It happens every time the rising price of crude oil pushes a gallon of gasoline toward $4 in the    U.S. -- the debate over the role of speculators in commodities markets grows louder and sharper.

Do speculators -- that is, traders who purchase futures contracts purely for profit and with no intention of taking delivery of the product -- play a necessary role in creating liquid markets for everything from oil to orange juice? Or do they manipulate prices for their own benefit often at the expense of consumers?

The answer, of course, is 'yes' to both questions. But there seems to be a heightened urgency to the debate this time around as global economies struggle to recover from the worst economic downturn in decades.

The concern is that by artificially pushing the price of oil higher, the speculators are threatening the already fragile global economic recovery, especially here in the U.S.

As everyone knows, the price of crude oil and the price consumers pay for a gallon of gasoline are inextricably linked. When crude rises, so does the price at the pump, and that takes money out of the pockets of U.S. consumers, whose spending comprises 70% of domestic economic activity. Since late January, when political turmoil began to spread across the Mideast, the average price of a gallon of gasoline has risen more than 40 cents to $3.52 from $3.10, according to the U.S. Energy Information Administration.

“The real loser becomes the domestic economy,” said Hamza Khan, an analyst with the Schork Report, an energy markets newsletter. “When consumers have to pay more at the pump they’re going to cut back elsewhere and that is going to hurt U.S. companies.”

While traders -- especially pure speculators -- thrive on market volatility, profiting on sudden surges and plunges, that same uncertainty wreaks havoc on small business owners trying to plan for their future.

Eventually that uncertainty will put a crimp in hiring, Khan warned. “Who’s going to hire if they might be going out of business in two weeks?” he asked.

The violence roiling the Middle East has raised genuine concerns that disruptions in the oil supply could create a shortage. Earlier this week a barrel of crude hit a two-year high of $105.

But the concerns so far are nothing more than that -- concerns. In Egypt, security along the well-traveled Suez Canal and the important Suez-Mediterranean pipeline was beefed up almost simultaneous to the outbreak of political unrest there. The situation in Libya, which controls the largest oil reserves in Africa, is murkier, but to date global production has not been markedly curtailed by the violence in that country. Besides, Libya only produces 2% of the global oil supply.

Meanwhile, stockpiles remain plentiful and, if anything, demand is expected to slow as China puts the brakes on its overheating economy.

Nevertheless, big speculators (primarily hedge funds) are pouring money into the oil market in the form of net-long positions, or bets that the price will continue to rise. According to data from the Commodities Futures Trading Commission, net-long positions rose by 30% in the days immediately following the outbreak of violence in Libya.

Khan said the disparity between what’s actually happening in the oil markets and the number of contracts betting on a rise in prices represents a “disconnect,” one that detracts from speculators’ important role of providing liquidity and transparency to markets.

By some estimates speculators have added $15 a barrel to the price of oil.

Kevin Kerr, president of commodities firm Kerr Trading International, pulled no punches, calling the current price levels “simply a money grab and fear trade.”

“Speculators in the energy markets right now have a lot of risks to consider but unfortunately it can get overdone and I hope that the various funds and large speculative entities will take a step back and really evaluate the true fundamental picture. We do have plenty of oil on the market right now and while some fear premium is certainly legitimate, in my opinion it is not a justification for over $100 right now,” he said.

Kerr said the escalating violence in Libya, as rebel forces attempt to oust long-time dictator Col. Muammar al-Qaddafi, raises legitimate concerns for “real disruption,” but still does not justify the current prices.

Kerr also warned of the global impact resulting from artificially high oil prices: “Speculators and funds who are driving up the price of oil based on fear premium and the weak dollar will hopefully evaluate the implications for driving the price much higher than it really needs or deserves to go, at least at this stage,” he said.

Finally, Kerr recalled “the extreme liquidation” that followed the last precipitous rise in oil prices, when a barrel passed $147 in the summer of 2008 and then plunged below $40 in a matter of months.

“I would like to say that rampant speculators learned from what happened in 2008 but it seems fiduciary responsibility and true market fundamentals are still on the back burner,” Kerr concluded.