Saturday, July 12, 2008

Oil speculation: Why we don't have answers

From Fortune:
There's a lot we don't know about how the oil futures markets now work. Congress should find out.
The debate over whether oil prices are being driven by speculators in the futures market or by the fundamentals of supply and demand for the physical product slides right on by a central point. The question Congress and regulators should be focusing on isn't who is driving prices, but how prices are being driven.

And the truth is, there's an awful lot we don't know.

Futures prices are supposed to bear a relationship to the present, or "spot," prices of various commodities. Exchanges were created with this in mind. Historically, roughly 70% of market participants used exchanges for commercial purposes. So a farmer could "hedge," or protect against, a higher future cost of seed or a lower price for his wheat by buying or selling a futures contract.

Speculators were always welcome, to some degree, to provide liquidity to the market by taking "the other side of the trade." Heating, airline, and trucking companies used the oil futures market to protect themselves against rising fuel costs. Investment banks facilitated trades. Futures contract prices were based on spot prices. Speculators were outnumbered almost three to one. Transactions were largely transparent.

That's not our present world, though....

Nomi Prins is a senior fellow at the public policy group, Demos, and a former managing director at Goldman Sachs. She is author of the bestselling book, Other People's Money: The Corporate Mugging of America....MORE