Thursday, May 29, 2008

Institutional Investors: The Real Profiteers at the Pump

Futures trading is complicated, so complicated that there is an entire commission devoted to overseeing it. We'll get back to that later.

In this pretend game of Futures Trading we have four players: Drew the Driller, Ben the Banker, Ike the Investor, and Ron the Refiner. Drew the Driller ships oil overseas, and as soon as he knows how much he is going to ship he calls Ben the Banker to buy it. Ben offers to buy it at the expected future price of, say, $120 per barrel. Drew happily accepts.

Ben now holds a contract for oil at the Future price of $120 per barrel. Ike the Investor hears about Ben's Futures, and thinks the actual future price will be $125 per barrel. He is willing to bet on this, so he calls Ben and offers to buy it at $122 per barrel. Ben accepts, having just made $2 per barrel for doing almost nothing with extremely low risk. The day finally comes when the oil actually arrives at port and is ready to be sold. Ike the Investor is required to sell it. Ron the Refiner needs as much crude oil as he can get--refineries are already operating at only 84% capacity and he cannot afford to further reduce his supply. Ike the Investor offers it at $125, and he grudgingly accepts.

This is how institutional investors drive the cost of oil up. In our fictitious and oversimplified scenario, the Refiner paid $5 more than the Importer received, to people who had nothing to do with the production of oil. I suspect the actual amount of money going into investor's pockets is more than $5 per barrel, but the government is too busy pretending the problem doesn't exist to publish any facts on this.

This same speculation is happening in food markets, aided by increased competition from biofuels companies, who are reaping more profits due to the relative high price of oil. This is increasing inflation and putting all of us at risk for an economic downturn. I'm not sure I have all of my facts straight, or if I really even get how Futures work, but I've done some research on the subject and this is what I've come up with:

Oil Futures & Speculation FAQ

  1. Who Regulates Futures Trading? The Commodity Futures Trading Commission (CFTC), which is a lot like the SEC (only not).

  2. What is the CFCT doing about it? Worse than "doing nothing," the CFTC is contributing to the problem by regulating institutional investors as if they are commercial buyers. That means Ben the Banker and Ike the Investor follow the same rules Drew the Driller buys, even though Ben and Ike are "speculating" and Drew actually needs the oil.

  3. Who are these idiots at the CFCT?
  4. The CFTC Chairman is Walter Lukken, a lawyer appointed by President Bush. He is not an economist. He has no previous experience in oil futures trading.

  5. Why would these idiots want to protect institutional investors?
  6. They think they are preventing a Great Depression. Institutional Investors suffered massive losses due to inflation in the real estate market, and if they don't start making money the USA will not have the credit/funding necessary to continue growth, and we'll all fall apart.

    What they seem to be ignoring is the glaringly obvious fact that by allowing investors to inflate oil and food, they are contributing to inflation and increasing our risk of entering a depression. I think they are just scared, and doing nothing seems safer than the drastic tinkering of financial markets that is necessary to restore sanity to the Futures markets.

  7. But I thought this was all caused by decreased oil and food supply while demand increases?
  8. It is. Sorta. Kinda. Investors are drawn to these markets because the increased demand and reduced supply = price increases, so Commodities Futures are considered low risk. However, it is the competition among investors to buy these commodities contracts that is driving up prices further than they would if they would fuck off and let supply/demand determine the price.

  9. What can we do?
  10. Well, both politicians and the media seem content to ignore the problem. The only article I could find that implies the CFTC is full of shit was published in the UK. The US version of the same testimony, also published by Reuters, simply states and affirms the CFTC's position. If you want to be REALLY daring, tell everyone you know that the federal government is allowing banks to profit at the pump.

  11. Is that ALL I can do?
  12. There are many news reports of people stockpiling food and fuel. This is actually a good idea politically, and possibly a bad idea for your pocketbook.

    You see, the more people stockpile the lower future demand will be. Remember when I said increased demand was drawing investors? Knowing demand is going down will cause them to flee from the markets, and while they whine to congress for Relief we will benefit from low food prices. The $4 bags of flour in your pantry may seem silly when it's on sale for $1, but you can feel good knowing your stockpiling fucked with the market enough to make a difference.

    It's also a great time to BUY LOCAL and REDUCE YOUR SPENDING ON NEW GOODS.

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