Monday, June 23, 2008

Regulate speculators in oil market

Regulate speculators in oil market
Deepak Seth • Guest essayist • June 23, 2008

The soaring prices at the gas station have got all of us flustered. While some may argue that the high prices will finally ensure that other competing products/technologies get a fair chance, most agree that these prices are detrimental to our global competitiveness. US industry unlike European & Asian industry has evolved under the premise of cheap and abundant availability of oil which would keep the cost of transportation low. The rising prices strikes at the foundations of the US production model.

Unfortunately, an issue of so much importance to the economy and national security is caught up in partisan wrangling. One side argues for opening up more domestic areas for drilling notwithstanding industry reports indicating that oil from new areas like ANWR will have an insignificant effect on oil supply & prices in the short term. Moreover, domestic oil production from existing oilfields in Alaska has been declining every decade despite increasing prices. Oil companies are global conglomerates and business economics dictates that they source from wherever they find oil cheaper. New oilfields in the US will produce oil at a higher cost than older fields outside the country.

The other side argues that any new drilling will destroy the environment. They ignore the fact that the mad rush towards bio-fuels is leading to massive deforestation in the Amazon region for planting more bio-fuel crops. That is as or more damaging to the environment as drilling in ANWR would be. Climate change is a global phenomenon so destruction of the Amazon rainforest affects the US environment too.

Oil companies, OPEC and the US government all seem to be in agreement that the prices are being driven more by speculative pressures rather than any demand-supply equilibrium related reasons. The government and regulators have a role to play in correcting any distortions in the market caused by fraudulent activity or structural deficiencies. Public memory is short and most people seem to have forgotten the havoc wreaked by Enron in the Energy Futures markets in an under regulated environment. A few ways in which the government can step in:

1. Impose a cap on volume of oil trades allowed in the Mercantile Exchange
2. Install price governors which stop trading if the price hits above/below a certain specified range.
3. Increase margin money norms for trades.
4. Impose a tax on the profits from speculative oil trades. This tax is not on oil or oil companies but on profits from speculative trading in oil.
5. Aggressively investigate fraudulent activity in oil trading.

However I do not expect any action in the near future as the current Administration prepares for transitioning to a new one. With the lack of action I will not be surprised if prices hit $5 a gallon at the pump before the year is up.

4 comments:

Speedmaster said...

Deepak, you're scaring me! ;-)

Take a peek at these.
http://townhall.com/columnists/WalterEWilliams/2008/05/28/futures_markets
http://townhall.com/Columnists/JohnStossel/2008/06/25/bless_the_speculator
http://online.wsj.com/article/SB121426475050198395.html

Mid said...

the idea of regulating the speculators is part of the fluster.

They'll get their heads handed them soon enough (just like all traders and speculators do when a bubble is happening.
----
my idea would be that the trading day before the fed meets again the U.S. gov sells 1/2 of the SPR, the next day fed raises rates, USD rises, gov't announces a lift on the ban of domestic drilling - inside of 16 trading hours spot prices will drop by over 50%.
---
Side note, I have a feeling that the market is speculating military conflict between Iran and Israel as well.

Deepak Seth said...

Speedmaster,

I am not against speculation per se. But I am against unbridled speculation by people who have no skin in the game. The ante should be upped for people who want to play in the oil speculation game.

Deepak Seth said...

Mid,

Interesting observations. Yes, the falling dollar is a big reason for the prices going up.

And the oil sector uses every bit of information to push prices up whether it is 2 guys with guns kidnapping an oil worker in Nigeria or a potential Israel-Iran conflict. Surprisingly or not so surprisingly, good news does not push the prices down. So while Hmas firing rockets into Israel will be a reason for pushing prices up, Israel-Hamas declaring a ceasefire will not push them down.

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