Oily Roller-Coaster Ride…

Okay, I have more to add to my Blog about supply and demand for OIL. As former geologist and energy executive, I have studied my industry, and know oil is plentiful; but over the past year, the American public has been led to believe we are truly running out of oil. In prior narratives, I have talked about oil being plentiful and about supply/demand for oil being controlled largely by OPEC. OPEC, primarily Saudi Arabia, determines available supply of oil on world markets. The world in which Saudi makes decisions is the what is called the “physical” world. The physical world is where oil is produced and consumed. The physical world impacts every aspect of world politics and economics as we see almost daily in turf wars in the Middle East. However, harking back to my days with Enron, I know there is another world that impacts the price of oil… that being the “financial” world. The financial world is the “futures market”… this is where oil is traded on paper. In the “financial” world, oil is bought and sold on phantom markets where supply and demand is theorectical. Typically, the “financial” world price and the “physical” world price converge upon delivery of the commodity, so that the final price of a commodity is in sync in both worlds. Financial or futures markets were developed by farmers to manage their risk of prices of their crops back in the 1800’s. But in 1990, under the leadership of Jeff Skilling, Enron was able to dramatically expand futures trading of oil and natural gas in the financial market by getting approval of “mark-to-market” accounting by the SEC. By this seemingly meaningless event, suddenly the world market for petroleum products changed. Of course, few realized the implications at the time. Looking back over my career, I have determined that the seed planted by Skilling in 1990, has grown into a “venus fly-trap” and created a false sense of “supply and demand” for petroleum products. To this end, it is clear that when the market price for oil ran up to $149/barrel this past summer of 2008, it was due entirely to “speculators” rather than consumers. And when our dim-wit Congress was harranging oil company executives from ExxonMobile, they should have been interrogating management of Morgan Stanley and other investment banks. I can now look back and see the manipulation by these companies… the proof is all around us. Prices for petroleum have fallen even faster than they ran up, but in both cases no one can point to a meaningful reason. Moreover, there seems to be a complete disconnect between the “physical” and “financial” worlds of commodities worldwide. Therefore, I bite my tongue in saying this, but the time has come to add more regulation to trading of commodities… particularly petroleum products. I am not suggesting that the government of the United States intervene directly, but it is now clear to me that tighter oversight is necessary. Petroleum has become the life blood of the world and we can no longer allow speculators to manipulate prices. My suggestion would be a higher “margin” requirement. The futures markets as set up today allows a 10-fold leverage your money by using futures positions. In other words, I only have to pledge $1 dollar to leverage $10 dollars of commodities. This means that I risk only $1 dollar to purchase $10 dollars in futures contracts. If I win my futures bet, I get a 10 fold return, yet my downside is minimal. This leverage has resulted in wild swings in nearly all commodity markets, and these swings have nothing to do with “supply and demand”. While I enjoyed the financial benefits of the futures market leverage, I saw the implications as early as 1994 while still working for Enron. I saw the ugly side of allowing “speculators” the ability to leverage futures as if one were gambling in “Vegas” While I hate regulations, there are times when regulation is necessary, and in the futures markets today… regulation is necessary to prevent a world-wide depression. I see this as necessary, will regulators?

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