The “Dangers” of Oil Speculation & More Nonsense from the Obama Administration
by , Investment U Chief Investment Strategist
Monday, May 14, 2012: Issue #1772

Is oil speculation truly a financial force for destruction, or has the Obama Administration just found a new scapegoat?

Every great leader I’ve known had one quality in common: a strong propensity to give credit to others when things go right and take personal responsibility when things go wrong.

Yet by that standard, Obama is no leader at all.

Nearly four years into his term, he still blames high unemployment and the state of the economy on his predecessor. He blames his trillion-dollar-plus deficit on the intransigence of his political opponents, even though his own party can’t even propose a budget. He insists that middle class Americans are suffering because “the one percent” – the folks who take risks, create jobs and experience economic success – are somehow denying opportunity to the rest of us. (I’m still waiting to hear how.) But this time he’s really outdone himself, blaming high oil prices on “greedy” traders and investors like us.

In a recent White House speech on April 17, Obama said, “We can’t afford a situation where speculators artificially manipulate the market by buying up oil, creating the perception of a shortage and driving prices higher, only to flip the oil for a quick profit.”

“Quick profit.” Man, that sounds ugly.

Of course, if you believe the federal government is hiding an alien space ship in Area 51, you may have stood and cheered his words. The rest of us were less impressed, including Terry Duffy, the Executive Chairman of CME Group, the world’s leading derivatives marketplace.

“People need to study their facts before criticizing speculators,” said Mr. Duffy. He points out that futures traders aren’t just exercising their freedom to take financial risk (and shoulder any resulting losses). They also increase liquidity, reduce spreads and, ironically, help the Treasury Department and American taxpayers save money on the cost of sovereign debt by allowing traders to hedge risk on Treasuries.

Of course, whenever oil prices surge, conspiracy theorists raise their heads again. Even though the facts regularly beat them down like so many whack-a-moles.

Four years ago, the Commodities Futures Trading Commission (CTFC) created a special task force to study whether speculation was responsible for the run-up in oil prices. It included experts from the Agriculture, Energy and Treasury Departments, the Federal Reserve, the Federal Trade Commission and the SEC.

Its conclusion? (Try to stifle that yawn.) That oil price increases were due to fundamental supply and demand factors.

I know it sounds humdrum to conspiracy theorists, but oil demand is what economists call “price inelastic.” People need to drive cars, heat homes, fly in airplanes and run factories. These things take oil. (Although an increasing shift to natural gas by utilities is already starting to undercut oil prices.)

The CTFC report found that growth in world oil demand – especially by China and other developing economies – was outstripping new production capacity. As a result, the market tightened and prices rose.

Moreover, the futures market is far less susceptible to bubbles than the stock or bond markets. That’s because, by contrast, the futures market is a “zero-sum game.” One investor’s gain is exactly equal to another investor’s loss.

Under the standard futures contract, one investor agrees to buy a commodity (say, 1,000 barrels of oil) at a future date for a given price, and another investor agrees to sell for the same price. If the price is up on the settlement date, the buyer wins. If it goes down, the seller reaps the profit. The loser pays the winner; actual commodities are rarely transferred.

Obama – forever in search of a new scapegoat – must surely know this. Then again, as someone who has never started a business, managed a company, taken a significant financial risk, or even held a job in the private sector, maybe he doesn’t.

Either way, demonizing speculators solves nothing. If Obama really wanted to help middle-class families by reducing oil prices, he could encourage production, conservation, or alternative fuels like natural gas.

Of course, that would mean telling the truth and taking responsibility. And those aren’t his strong suits.

Good Investing,

Alexander Green