President Unfortunately Gets No Help Attacking Oil Speculation

The president's proposals to limit speculation in the oil markets does hint at political rhetoric. There is an instant suspicion, and rightly so, when President Obama unveils measures to attack "high gas prices" and asks for congressional help he knows he's not going to get in an election year.

But political posturing aside, the president is not wrong: Oil speculation, in its many forms, has driven prices upwards and away from the true supply and demand fundamentals that exist.

What's maddening to me, even discounting the political calculus of an electioneering president, is how fast the "defenses" of speculation reemerge whenever any help of new regulations are proposed. While never thinking my book on the topic, "Oil's Endless Bid", would be the last word on the subject, I had thought that the conversation on the financial influences on oil would have progressed. It doesn't have seemed to.

Indeed, from editorials on Bloomberg extolling the "positives" of rampant speculative activity, to the very tired memes of real risk being reflected in price proffered by the Chicago Mercantile Exchange, home to oil futures trading, we continue to argue the same stuff, over and over. From my perspective, it is a continual effort to rage against the machine: No matter how hard or often I tell the real truth of how oil prices are arrived at, there appear an army of protectors of Wall Street profit machines ready to fight. So, again, I will quickly explain why the common arguments that are most often made against speculative influences in oil are inherently wrong.

1 -- High oil prices are reflecting real future supply risks.

Leave for the moment that the market is more than adequately supplied presently, we are in fact swimming in oil, borne out by recent statements by the Saudi oil minister Al-Naimi and our own domestic export of finished products. But if in fact there are very real supply risks in the future, shouldn't the prices in the future be higher than today? In a futures market, we can actually see what prices are expected to do in the future, unlike most other asset markets. And in oil? We are in backwardation -- meaning that as time goes on, prices goes DOWN. A lot.

2 -- Speculation isn't to blame, it's the easy money Fed, devaluing dollars in which oil is priced.

This one has some truth to it, but it is greatly overrated. We saw a $147 peak oil price, for example, in 2008, before the world ever heard of QE, never mind Operation Twist and LTRO's and in a not particularly weak dollar environment. Historically, some of the strongest years in oil inflation were in years of a RISING dollar, particularly 2005. In short, the dollar matters, but not nearly as much as the money chasing the oil trade.

3 -- Speculators help smooth out volatility and crushing them would make oil prices less reliable.

This one's too silly to even challenge. Before the explosion of "liquidity" from high-frequency algorithms, hedge fund programs, investment bank trade and institutional and retail investment, volatility was a fraction of where it is today. Believe me, I've been trading oil for 25 years -- no one EVER complained of a lack of liquidity before 2005, and everyone with a legitimate interest in real oil hedging managed to get whatever they needed to do done. And oil never moved two dollars a day, which it does regularly now.

4 -- Attacking speculators is an attack of floor traders, just regular joes trying to make a living.

Please, the game has moved so far past us now -- we've got nothing to do with what oil trade is about anymore and haven't had any influence (if we ever did), since about 2003. The oil game is overrun with IB desks, hedge funders, long/short punters, algos, HFT's and private trade houses like Vitol, Trafigura and Glencore. And yes, Virginia -- fraud can happen: We've forgotten too quickly about such stellar examples as Enron and Amaranth.

These are not the guys that anyone should look to protect. They absolutely jack up the prices of oil that you and I are forced to pay at the pumps. But they are the beneficiaries of the continued defense of the broken oil markets as they are today. We haven't made much progress.