10/27/08

Oil in the news

Today's SF Chronicle included this front-page story: Low oil prices take wind out of renewable fuels.
Now oil costs less than half what it did this summer. Ditto natural gas. If prices keep dropping and stay down, future fuels like cellulosic ethanol and biodiesel will have a harder time competing. So will solar and wind power projects, which compete against power plants that burn natural gas. Public interest in alternative energy may dwindle as well.
The headline reminded me a passage from Zoom: The Global Race to Fuel the Car of the Future, a book written by two correspondents for The Economist. The authors spoke with Vinod Khosla, a venture capitalist at Kleiner Perkins Caulfild & Byers, who put is own money into start-up firms developing cellulosic ethanol.
Khosla himself says that after he made his ethanol pitch at a recent Davos summit of world leaders and corporate titans, a senior Saudi oil official sweetly reminded him that it cost barely a dollar to lift a barrel of Saudi oil out of the ground, adding, "If biofuels start to take off we will drop the price of oil." (p. 256-257)
The Chronicle article goes on to describe increased demand for oil in China and India, a similar spike and drop in oil price during the 1980s, and new legalisation that may keep alternative fuel efforts afloat during the current dip. It also references the per barrel cost of oil on the New York Mercantile Exchange, the peak being $145.29 per in July 2008 and last Friday's close being $64.15. What article doesn't mention is the influnce of unregulated exchanges on this market.

Last month McClatchy newspapers ran this article: Did speculators use unregulated markets to drive up oil prices?
[U]nregulated markets account for about two-thirds of oil trading on financial markets, and they could be used to manipulate oil prices on the regulated exchanges that account for the remaining oil trading. 
The finding that some speculators exceeded positions allowed in regulated markets is sure to spark debate about how much the [Commodity Futures Trading Commission] knows about the markets it regulates, whether more stringent reporting requirements are needed and whether the government should require more disclosure from speculators and investment banks.
In a recent interview, CFTC Commissioner Bart Chilton told McClatchy that his agency lacks all the tools it needs to gather market information. 
"It's not responsible to reach conclusions about speculators based uponcurrent data," he said.
Apparently, even participants in the regulated markets are tough to keep tabs on. Two months ago, The Washington Post published this story: A Few Speculators Dominate Vast Market for Oil Trading. The Post detailed techniques used by firms to gain tremendous influence in the regulated markets.
The [Commodity Futures Trading Commission], which learned about the nature of Vitol's activities only after making an unusual request for data from the firm, now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency.
The article continues by supplying background on the unregulated markets referenced in the McClatchy piece.
The most successful of the private platforms was InterContinental Exchange, or ICE, founded by Goldman Sachs, Morgan Stanley and a few other big brokerages in 2000. ICE soon opened a trading platform in London, allowing its founders to trade vast quantities of U.S. oil overseas without being subject to regulation. 
The exemptions for swap dealers and the development of overseas markets allowed big brokerages to open the door for more hedge funds, pensions and big investors to move into commodities. 
In the coming years, commodity investments by funds could grow to $1 trillion, veteran hedge fund manager Michael Masters said in testimony before the Senate earlier this year. In an interview, he said this trend could raise commodity prices for everyone in the coming years and "have catastrophic economic effects on millions of already stressed U.S. consumers."
The article points to the Commodities Futures Modernization Act as the enabler of these practices. "The law formally allowed investors to trade energy commodities on private electronic platforms outside the purview of regulators. Critics have called this piece of legislation the 'Enron loophole,' saying Enron played a role in crafting it." Antonia Juhasz, author of Tyranny of Oil, does a fine job of describing the 1999 passage of that measure in this recent Fresh Air interview.

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