What Exactly are Oil Speculators, and What to Do About Them

by Tyler on April 19, 2012

When oil prices rise, you can bet that a certain group of people will come back in to the news: oil speculators. To keep it simple, let’s think of an oil speculator as somebody who isn’t using the oil markets to trade physical oil, but instead, uses it to trade oil contracts just as traders would do in the stock market.

To be fair, that’s not always true. Some of the largest oil speculators are large Wall Street banks and they have been known to park tankers full of oil in the ocean waiting for the right price to hit the market. It’s also important to note that speculators aren’t just people. They can be mutual funds, exchange traded funds, and even countries.

So what’s the problem with oil speculators? Well, here’s how it works, using the analogy of another commodity. Let’s say that you own an orange farm in Florida. It takes a lot of money to tend to your orange trees, hire workers to pick the oranges and keep all of equipment running. Because of that you can sleep a lot easier at night if you know the price you’ll get from your oranges once they’re ready for harvest.

By locking in a contract with a buyer, you can easily budget your expenses. You can also use the market to hedge or insure yourself against losses. What if unseasonably cold weather strikes and you lose the current crop?

Speculators have a different goal. They often buy and sell futures contracts before the delivery of a physical commodity is required. They trade the ups and downs of the contract hoping to profit.

The President’s Efforts

You, as a consumer, want oil prices as low as possible in order to keep gas prices low. When these speculators get involved in driving the price up or down, what you pay at the pump may not truly represent a price based on supply and demand. President Obama wants to change that.

In April of 2012, Obama announced a $52 million plan that has four main parts:

•    Dramatically increase the amount of surveillance and enforcement staff to better supervise commodities trading.
•    Increase technology spending to provide better surveillance of the energy markets.
•    Increase the civil and criminal penalties from $1 million to $10 million.
•    Give the Commodity Futures Trading Commission the authority to increase the amount of real money a trader has to put up in order to trade commodities contracts.

Sounds like a good plan, right? Well, Republicans argue that it’s largely an election year stunt. They point out that Obama already has much of this authority right now, and it doesn’t take an act of Congress to make this happen.

If Obama really wanted to clamp down on this problem he would have already done it and he could greatly increase the supply of North American oil in the U.S. markets by approving the Keystone XL pipeline.

Bottom Line

Although there is no smoking gun that shows that markets are being manipulated, the numbers seem to suggest that it’s happening, but nobody knows to what degree. Like most legislation in an election year, the chances of Obama’s proposal making it through Congress is slim.

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