Re: New York Times Article On The Futures Market For Oil And Gas

May 2, 2006


Dear Colleagues:

The appended blog that was sent out yesterday contained the wrong article from The New Times. The corrected article has been appended to the end of the blog.

Sincerely,

Lawrence R. Velvel

May 1, 2006

Re: New York Times Article On The Futures Market For Oil And Gas.

From: Dean Lawrence R. Velvel VelvelOnNationalAffairs.com

Dear Colleagues:

Nearly a week after an MSL press release explaining that the futures market is responsible for the increasing price of oil and gas, The New York Times wrote an article on this. That article, preceded by an MSL press release concerning it, is appended below.

THE TIMES PUBLISHES AN ARTICLE ON THE EFFECT OF THE OIL AND GASOLINE FUTURES MARKETS

On Saturday, April 29th, not quite a week after MSL sent round a press release detailing the one hour television interview in which Tyson Slocum of Public Citizen said that the future markets were responsible for the rising price of gasoline, The New York Times ran a lengthy, page one article on the matter. That article is appended below.

The Dean of MSL, Lawrence Velvel, who conducted the interview with Slocum, said the following about The Times’ lengthy article:

“In the typical journalistic fashion of obtaining quotes from differing sides as if this represents truth, The Times ran quotes from people of varying views -- including those who claim that the futures market does not raise the price even if it does contribute to volatility. (How the market can contribute to volatility -- which means prices sometimes rise -- without affecting price, is not explained. This is typical of today’s shallow journalism.) However, as was “said by BPs chief executive, Lord Browne,” “‘it is the case that the price of oil has gone up while nothing physically has changed.’” Similarly, a Washington energy consultant is quoted as saying that “‘Gold prices don’t go up just because jewelers need more gold, they go up because gold is an investment. The same has happened to oil.’””

“So it seems pretty clear,” continued Dean Velvel, “that even the stodgy New York Times is now conceding an effect from the futures market even though, like the rest of the media, for years it did not cover this story.”

“But it is also true,” added the Dean, “that The Times’ story totally fails to mention one of the most important aspects of the Slocum interview. It does not mention that the prices of oil and gasoline are almost totally divorced from the costs of drilling, transportation and refining. Although The Times quotes individuals who say that the price supposedly is determined by the fundamentals of supply and demand, it neglects to deal with the fact that one of the most important fundamentals of economics often does not apply in markets where, as in the oil industry, there are huge and powerful companies (e.g., Exxon/Mobil). That is, the story neglects to say that in such industries the price can become totally divorced from costs regardless of the normal operation of supply and demand. This divorce has now occurred with oil and gasoline because of the operation of the futures markets.”

*This posting represents the personal views of Lawrence R. Velvel. If you wish to respond to this email/blog, please email your response to me at velvel@mslaw.edu. Your response may be posted on the blog if you have no objection; please tell me if you do object.

April 29, 2006
Trading Frenzy Adding to Rise in Price of Oil

By JAD MOUAWAD and HEATHER TIMMONS

A global economic boom, sharply higher demand, extraordinarily tight supplies and domestic instability in many of the world's top oil-producing countries — in that environment higher oil prices were inevitable. But crude oil is not merely a physical commodity that fuels the world economy; powers planes, trains and automobiles; heats cities; and provides fuel for electricity. It has also become a valuable financial asset, bought and sold in electronic exchanges by traders around the world. And they, too, have helped push prices higher. In the latest round of furious buying, hedge funds and other investors have helped propel crude oil prices from around $50 a barrel at the end of 2005 to a record of $75.17 on the New York Mercantile Exchange last week. Back in January 2002, oil was at $18 a barrel.

With gasoline in the United States now costing more than $3 a gallon, high energy prices may be a political liability for the Bush administration. But for outside investors — hedge funds, investment banks, mutual funds and pension funds and the like — the resurgence in the oil market has been a golden opportunity. "Gold prices don't go up just because jewelers need more gold, they go up because gold is an investment," said Roger Diwan, a partner with PFC Energy, a Washington-based consultant. "The same has happened to oil." Changes in the way oil is traded have contributed their part as well. On Nymex, oil contracts held mostly by hedge funds — essentially private investment vehicles for the wealthy and institutions, run by traders who share the risks and rewards with their partners — rose above one billion barrels this month, twice the amount held five years ago. Beyond that, trading has also increased outside official exchanges, including swaps or over-the-counter trades conducted directly between, say, a bank and an airline. And that comes on top of the normal trading long conducted by oil companies, commercial oil brokers or funds held by investment banks. "Five years ago, our futures exchange was a small group of physical oil players," said Jeffrey Sprecher, the chief executive of Intercontinental Exchange, the Atlanta-based electronic exchange where about half of all oil futures are traded. "Now there are all sorts of new investors in trading commodity futures, much of which is backed by pension fund money."

Such trading is a 24-hour business. And more sophisticated electronic technology allows more money to pour into oil, quicker than ever before, from anywhere in the world.

In the Canary Wharf business district of London, for example, the trading room of Barclays Capital is filled with mostly young men in identical button-down blue shirts, staring intently at banks of computer screens where the prices of petroleum products — crude oil, gasoline, fuel oil, napthene and more — flicker by. Occasionally a trader breaks from his trance to bark instructions to a floor broker a couple of miles away, delivering the message through a black speaker box. Above them is a television screen, where President Bush this week was telling America to "get off oil."

Experienced oil traders are in heavy demand, and average salary and bonus packages are close to $1 million a year, with top traders earning as much as $10 million.

The rush of new investors into commodities has meant a rash of new clients for banks like Barclays. Lehman Brothers and Credit Suisse have recently beefed up their oil trading teams to compete with market leaders like Goldman Sachs and Morgan Stanley.

"Clearly the big attraction of commodity markets like oil is that they've been going up," said Marc Stern, the chief investment officer at Bessemer Trust, a New York wealth manager with $45 billion in assets. "Rising prices create interest."

This year alone, oil prices have gained 18 percent; they were up 45 percent in 2005 and 28 percent in 2004, a performance far superior to the Standard & Poor's 500-stock index, whose gains in these years have been in the single digits. And to some extent, the rising price of oil feeds on itself, by encouraging many investors to bet that it is likely to continue doing so.

"The hedge funds have come roaring into the commodities market, and they are willing to take risks," said Brad Hintz, an analyst with Sanford C. Bernstein & Company, an investment firm in New York.

Energy funds make up 5 percent of the global hedge fund business, with about $60 billion in assets, according to Peter C. Fusaro, principal at the Energy Hedge Fund Center, an online research community.

The gains on the oil market have attracted a fresh class of investors: pension funds and mutual funds seeking to diversify their holdings. Their investments have been mostly channeled through a handful of commodity indexes, which have ballooned to $85 billion in a few years, according to Goldman Sachs. Goldman's own index holds more than $55 billion, triple what it was in 2002.

Pension funds have been particularly active in the last year, said Frédéric Lasserre, the head of commodity research at Société Générale in Paris. These investors, seeking to diversify their portfolio, have added to the buying pressure on limited commodity markets.

While all this new money has contributed to higher prices, by some estimates perhaps as much as 10 percent to 20 percent, the frantic trading ensures that even the biggest players — including the major oil companies — cannot significantly distort the market or tilt it artificially in their favor. It also makes oil markets more liquid, meaning a buyer can always find a seller.

"The oil market has been driven by speculators, by hedge funds, by pension funds and by commodity indexes, but the fact of the matter is that it's mostly been driven by the fundamentals," said Craig Pennington, the director of the global energy group at Schroders in London. "Prices are supported by the fact that there is no spare capacity."

The inability to increase output fast enough to keep up with global demand accounts for most of the oil price rise over the last three years, analysts say. And until more investments are completed in oil production and refining, markets will remain on edge, with the slightest bit of bad news likely to push prices up further.

"The reality is that the world has no supply cushion left," said Edward L. Morse, an executive adviser at the Hess Energy Trading Company, a New York oil trading firm.

Political strife and circumstance played major parts as well. A crippling strike in Venezuela's oil industry in 2002, the invasion of Iraq, civil unrest in Nigeria, and last summer's hurricanes in the Gulf of Mexico, among other things, have all contributed to pinching supplies.

"If we didn't have politics," said William Wallace, a trader on the Nymex for Man Financial, "we'd be like corn." According to Cambridge Energy Research Associates, an energy consulting firm owned by IHS, Iraq is 900,000 barrels a day below its prewar output; Nigeria has shut 530,000 barrels a day; Venezuela is still 400,000 barrels below its prestrike production; and the Gulf of Mexico remains down by 330,000 barrels a day. In all, this amounts to more than two million barrels of disrupted oil, Cambridge Energy estimates.

The latest reason for gains on energy markets is the growing fear that the diplomatic standoff between the Western powers and Iran over nuclear technology will get out of hand.

"All the risk," said Eric Bolling, an independent trader on Nymex, "has been on the upside."

One characteristic of today's futures market is the sharp increase in volatility, which industry insiders largely attribute to hedge funds and other speculators looking for a quick profit.

"It is the case," complained BP's chief executive, Lord Browne, "that the price of oil has gone up while nothing has changed physically."

In the end, supply and demand call the tune.

"The idea that speculators can systematically push the price up or down is wrong," said Robert J. Weiner, a professor of international business at George Washington University and a fellow at Resources for the Future, a nonpartisan think tank. "But they can make it more volatile. They can't raise water levels but they can create waves."

Not all bets have turned out to be profitable. Veteran commodity market traders have been stymied by the high prices of oil, which have exceeded their expectations, and many now predict a steep decline in prices is ahead. But they have been wrong so far.

"We found the last 18 months difficult," said Russell Newton, director of Global Advisors, a New York and London hedge fund with $400 million in assets under management that had a down year in 2005.

In one often cited example, the Citadel Investment Group, a Chicago-based hedge fund, lost tens of millions of dollars after betting oil prices would fall just before Hurricane Katrina struck.

"Everybody is jumping into commodities, and there is a log of cash chasing oil," said Philip K. Verleger Jr., a consultant and a former senior adviser on energy policy at the Treasury Department.

"The question is when does the thing stop. Eventually they will get burned."