When oil prices hit a record $147 a barrel some three years ago, in July 2011 to be exact, Saudi Arabia was warning major consumers, in behind-the-scene meetings and even at the highest levels, that Wall Street speculation and not a shortage of physical crude was driving the prices up then.
In a confidential US State Department cable dated Sept. 28, 2008, Saudi Oil Minister Ali Al-Naimi told the then US Ambassador Ford Fraker that finding customers for the additional crude was difficult. This may not be something of news, yet is documented — now.
“Saudi Arabia can’t just put crude out on the market,” diplomatic cables made available to McClatchy Newspapers by the WikiLeaks website quotes Minister Al-Naimi saying.
Instead, he suggested, “speculators bore significant responsibility for the sharp increase in oil prices in the last few years.”
Minister Al-Naimi has been stressing this in public too.
Quantifying the impact of speculative money into the crude markets, one could vividly recall him reminding the press a few years ago that the US bond and equity markets alone were valued at roughly $50 trillion.
In times of uncertainty and when dollar gets weak, fund managers rush to commodities to hedge against inflation.
And with oil being the world’s largest traded commodity, most of this money comes into crude.
And if money managers decide to reallocate a nominal one-half-of-one percent of those assets into the oil, "it could mean the influx of $250 billion funds in the crude. And this equaled the value of the entire NYMEX WTI markets," the minister argued.
The role Wall Street plays in oil markets is under hammer now. There’s been some agreement lately that speculators are driving oil prices up. Despite weak demand, crude price has surged by more than 25 percent in the past year, reaching a peak of $113 on May 2 before falling back to a range of $95 to $100 a barrel.
A futures contract is just a simple agreement between two parties to buy and sell a quantity of oil at a future date at an agreed upon price.
Two types of traders are operating in oil markets and both primarily trade oil futures.
Of these, the “hedgers,” are firms that either produce or consume crude oil (such as refiners and airlines), seeking to guarantee a future selling or buying price.
The “speculators,” on the other hand are institutions (hedge funds, banks) or individuals who don’t use oil. They are simply betting on the level of oil prices by trading in oil futures. If they think that the price of oil will increase, they will buy futures; if they think it will fall, they will sell futures.
A key provision of oil futures contracts is that they allow cash settlement. This means that when it is time to settle up on the futures contract (one party selling and the other buying), no oil actually changes hands. Instead, one party either pays or receives cash based on the difference in the previously agreed upon futures price and the actual price on the settlement date. This feature of futures contracts makes them attractive for speculators.
US administrations have been slow in reining in the speculators.
That is in for some change now.
Last Tuesday, the US Commodity Futures Trading Commission, charged a group of financial firms with manipulating the price of oil in 2008. But the commission hasn’t yet enacted a proposal to limit the percentage of oil contracts a financial company can hold.
This needs to be done too — some feel.
Saudi Arabia has been insisting for years now that steps need to be taken to curb the influence of speculators on oil markets.
Revealed diplomatic cables now affirm that the subject has been discussed in various working group meetings of the US and Saudi officials, in one-on-one meetings with American diplomats and at least once at the highest level with the former President George W. Bush himself.
Saudi officials evidently had two primary worries about the artificially high crude prices: They’ll dampen the long-term demand for oil and that the wide price swings, typical of commodity speculation, make it difficult for them to plan future oil field development. After that $147 a barrel peak in 2008, for example, prices plunged to $33 a barrel.
One cable recounts how in July 2009, Majid Al-Moneef, Saudi Arabia’s OPEC governor, explained what he thought was the impact of speculation to US Rep. Alan Grayson.
Al-Moneef suspected that “speculation represented approximately $40 of the overall oil price when at its height.”
Asked how to curb such speculation, Al-Moneef suggested by “improving transparency” — in a reference to the fact that most oil trading is conducted outside regulated markets. He also insisted on better communication among the commodity markets, as this could make it difficult for the speculators to hide the full extent of their trading positions.
Al-Moneef also suggested the US to consider “position limits” — restrictions on how much of the oil markets a company can control. Saudi concerns also came up during a May 2008 meeting between US officials and Prince Abdulazziz bin Salman, the assistant petroleum minister.
The prince appeared “extremely worried,” stressing high prices would destroy the demand for oil, a May 7, 2008, account of the meeting with US Embassy officials said.
“Aramco is trying to sell more, but frankly there are no buyers,” he added.
And “we are discounting crudes.”
Another cable quotes him expressing concern to Ambassador James Smith that Saudis could be “greened” out of the US market, noting that in 2009 the US for the first time consumed more ethanol than the Saudi oil.
A McClatchy investigation earlier this month showed the extent to which financial institutions influence the price of oil.
Until recently, end users of oil — such as airlines, refineries and other consumers of fuel — accounted for about 70 percent of oil trading as they tried to hedge against price fluctuations.
Today, however, speculators who will never take possession of oil account for 70 percent of oil futures trading.
The volume of speculative trading has grown fivefold.
Big banks too are capable of moving the market.
The fanfare that greeted increased price forecasts by two of the world’s biggest banks raised questions over how much influence they command.
Goldman Sachs Group and Morgan Stanley raised their oil-price forecasts, predicting Brent would hit $120 a barrel by the end of the year.
Such forecast revisions by major banks are closely watched by the oil markets.
Goldman famously predicted in 2008 that oil could spike up to $200 a barrel, shortly before the price rose to record highs of $147 a barrel. And a bearish note that Goldman put out last April, predicting a sharp correction in prices, was blamed for a mini sell-off.
A few weeks later, Brent crude fell by $10 a barrel in one day.
The oil game is too complex and indeed mind-boggling.
Too many variables continue to impact at one point in time — pulling it in contradictory directions – confusing both, the pundits and commoners like me alike.