“We can’t afford a situation where speculators buy up oil, creating the perception of a shortage, driving up the prices, then flip it for a quick profit.” – President Obama, today

Last week we talked about the hidden issue that greatly contributes to high gas prices. We determined that the classic factors of supply and demand were not to blame for the price hikes in and of themselves, but that a hyper-inflated sense of “demand” is artificially created by speculation in oil commodities.

High-volume trading in oil commodities markets creates the sense that there is a higher demand for a commodity than actually exists. In other words, people are not buying as much oil as it looks like in a bare assessment of supply vs. demand. They are simply parking their money in oil futures because it seems to be a sure market. And, as long as they continue to pump money into that market, the prices will continue to rise.

This kind of investment behavior is actually illegal in the United States, due to its volatile effects on a market that so many people depend on – in this case, oil. Mutual funds, for example, have historically been restricted from investing more than 10% of their holdings in commodities. However, some investment companies have found a way around these legal impediments by setting up offshore corporations that do the investing in commodities for them, then buying stock for their funds in those offshore companies. It is a shell game. And this game artificially hikes up prices at the pump.

ExxonMobil CEO Rex Tillerson said recently that he estimated that such speculation contributed an extra $30 to the price of a barrel of oil. Oil currently is $104 per barrel. That’s about 29% of the cost of oil that is artificially added due to illegal market manipulation. A very simplistic calculation of gas prices tells us that, if this kind of speculation were stopped, gas would only be $2.84 a gallon.

Even the oil minister for the United Arab Emirates has said that he felt the price of oil was too high.

President Goes On Offensive

Now President Obama is addressing this issue and others related to it, such as fraud and manipulation in the oil markets. According to CNN, the president’s plan will call for increased regulation of commodities markets to monitor fraud that hikes gas prices. The president will call on Congress to:

boost spending on technology to improve oversight and surveillance of energy markets

increase by six times the money spent on surveillance and enforcement staff of the Commodity Futures Trading Commission to better deter oil market manipulation

increase from $1 million to $10 million civil and criminal penalties against firms that engage in market manipulation

in an effort designed to limit energy market disruptions, give the Commodity Futures Trading Commission authority to increase the amount of money that a trader must put up to back a trading position

In a White House press conference today, President Obama outlined the steps above that he is asking of Congress. Quotes from the conference included:

“When gas prices go up, it’s like an additional tax right out of your pocket.”

“There are politicians that say that if we just drilled more then gas prices will come down right away. What they aren’t saying is that we have been drilling more.”

“Even as we’re tackling issues of supply and demand, we still need to work extra hard to protect consumers from factors that should not affect prices of a barrel of oil.”

“Today we’re announcing new steps to strengthen oversight of energy markets.”

“Imagine if the NFL quadrupled the number of teams, but did not increase the number of refs.”

President Obama pointed out that commodities markets regulators are currently operating with equipment and software that is inferior to the firms they are charged with policing. His call to Congress to increase spending in this regard was to better outfit the regulators that keep these markets from controlling the oil supply.

To be clear, commodities trading is supposed to be a tightly controlled, well-regulated affair with strict rules. What President Obama and others have pointed out is that investment firms are deliberately gaming the system, not through legal means, but by cheating and out-teching their overseers. In doing so, they are making profits for their investors at the expense of every person who pumps gas.

Another Opinion

Recently, I went looking for other viewpoints on this matter. I wanted to know if someone else had a contrary take on this that should be presented. I found just such a candidate at the website Oil Prices Today. In an article called “The Forces Driving Oil Prices Today”, an unbelievable argument for speculation and higher oil prices was made.

Regardless of what traders do on a daily basis, supply and demand is the single most important factor in determining the price of commodities over the long-term. A quick look at how the market reacts when the Energy Information Administration releases new inventory supply numbers is one of the best ways to see this in action. Major supply disruptions or even news stories that imply a possible future problem have historically resulted in turbulence or heightened buying activity.

All this means is that supply and demand shifts would more radically affect oil prices than speculation would. That sounds fine, except that speculation IS demand. It is an artificial demand that drives up prices for profit-taking.

Are rising oil prices good or bad? The answer depends on your relationship to the commodity. If your only exposure to the oil market is on the consumer side, expensive fuel is a clear negative. It drains your budget and drives up the cost of food, air travel, shipping, etc. On the other hand, if you hold an interest in a company that produces gas and oil related products or services, you’ve likely enjoyed some impressive returns in your portfolio.

Sure, rising oil prices is bad if you buy gas. But if you are an oil commodity speculator, it’s great news!

For those of you who find yourselves shaking your head each time you pass your local service station, one way to cushion the effects of market volatility on your daily life is to adopt an oil-neutral stance. This is a simple strategy almost anyone can adopt where you invest a small portion of your portfolio in gas and oil related stocks to create a hedge against rising prices at the pump.

If you don’t want to get hosed by oil prices, invest in oil yourself. Except, your stock prices will then be just as vulnerable to the activities of unscrupulous, illegal commodities traders. Unless…

Aggressive investors who have a considerable amount of trading experience and are willing to take on more risk can participate directly in the oil futures trading market using services such as Options Express and Interactive Brokers.

So, you can always become one of the sharks, trading in the oil futures market yourself. If you can shut your conscience off long enough. If you can drive past a gas station and not care about the people standing there making life decisions in front of the pump while you steal their money. Remember that list of negatives, up above?

It drains your budget and drives up the cost of food, air travel, shipping, etc.

Hey, at least you’ll be part of the problem, not suffering from the problem.

Illegal oil commodities futures trading is happening, and some of that activity could even be making its way into your own 401K. You could be getting money from the misfortunes of others. If you are, what do you think will happen to your 401K when that illegality is finally rectified? Responsible corporations should speak with their investment professionals to ensure that they are not feeding this gas price frenzy with their own retirement investments.

Almost a third of your gas money goes to these pirates every time you fill up. Think about that next time you wince at the pump.