Comfort Line - Questions and Answers

This quarter our Questions and Answers segment discusses attempts by our federal and state fuel dealers’ associations to control speculation in the energy futures markets.

What is S.O.S.?

S.O.S. is short for Stop Oil Speculators, a movement by federal and state oil associations to get Congress to understand the effect that market manipulation in the energy futures markets has had on driving up energy prices and increasing their volatility. When crude oil prices were well over $100 per barrel, some experts believed that as much as 60% of the cost of a gallon of gasoline, diesel fuel and heating oil could be attributed to manipulative trading practices by speculators in the energy futures markets.

What are energy futures markets?

These are markets where energy contracts are traded on a daily basis. The most well known exchanges are the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE). Contracts traded on these exchanges are denominated in 42,000 gallon (1,000 barrel) increments. Trading is never for the current month, only for future months. More than 98% of the contracts traded are canceled without delivery ever being taken, yet these contracts have a profound and immediate effect on energy prices. Unfortunately, a majority of these trades occur on the ICE, which, unlike the NYMEX, is not subject to regulation by the Commodity Futures Trading Commission (CFTC).

Are energy futures prices determined by supply and demand?

In many cases, the prices set on the futures exchange have become disjointed from the supply and demand for petroleum products. The futures markets have turned what were once commodities into financial instruments. An example of the disconnect between the futures markets and supply and demand occurred on Monday, September 22, 2008, when crude oil prices increased more than $16 a barrel, the biggest one-day jump ever. In the past, a price increase of that magnitude would have occurred only as a result of a major world event such as the U.S. invasion of Iraq.

In an article in the Wall Street Journal the following day, the reasons given for the $16 increase were as follows: “Traders blamed the spike on one or more players who had been bearish on oil getting caught in what is known as ‘a short squeeze.’ In such a situation, a trader who had previously agreed to sell oil at a much lower price than where the market has risen faces a choice: Either post significant collateral to stay in the game, or enter into offsetting contracts to buy oil at much higher prices to cancel out the bet. But Monday, the contract for oil for October delivery was expiring, and so the player may have had only one choice if he didn’t want to make delivery of the oil: Unwind the bad bet.”

The article quoted Stephan Schork, a former NYMEX trader, “This was just a short squeeze of absolute epic proportions. There are absolutely no fundamentals to justify where we were today.”

While someone made money on this price spike and someone lost money, it cost the country billions of dollars in the form of higher energy prices. We have to ask ourselves whether situations like this should have a place in setting the price for a commodity that is vitally important to our economy and our everyday lives. We respectfully suggest that this type of manipulation has no place in our society and needs to be stopped.

What can I do to stop oil speculation?

We need to pressure Congress to regulate markets like the ICE, that are not subject to the jurisdiction of the CFTC. In addition, Congress needs to limit the sales of commodity futures to people in the business who have the potential to take delivery of the product or to place severe position limits on buyers of energy futures. Hedge funds, money funds and pension funds have no business investing in commodity futures. Our state and federal associations have set up the www.stopoilspeculators.com website to address energy market issues. Please log on for more information and to encourage your legislators to reign in speculation in the energy futures markets.