View Full Version : Influences on oil pricing

08-19-2008, 01:35 PM
I thought you might enjoy reading this, shamelessly copied from an investor newsletter I get. You think maaaaaybe there is room for some regulation and intervention here? This is what keeps me from being a fan of ruthlessly free markets:
How are prices set?
Crude is a commodity, a raw material like natural gas, corn, wheat, gold, coffee, and cattle used to produce other goods. The costs of extracting oil from its source could vary widely from $5.26 a barrel in the Middle East region to $63.71 for U.S. offshore crude, based on 2004-6 averages from the EIA. Petroleum is bought and sold under exotic names like Nigerian Bonny Light, North Sea Brent Blend, and West Texas Intermediate on a variety of futures markets -- where traders deal for the rights to buy and sell product at a specific price on a future date -- around the world and governed by the rules of a particular country.

"The energy markets are among the largest and most liquid," says Timmer. "The oil market is no different from the stock market in that oil futures are traded on exchanges where buyers meet sellers." For an outsider, however, locating precise figures to explain how crude is currently priced is harder to unearth than a gusher in Central Park.

Generally, there are two ways to trade commodities: either market trading or over-the-counter trading (OTC). Market trading takes place through the New York Mercantile Exchange (NYMEX) and is self-regulated with oversight by the Commodities Futures Trading Commission (CFTC), the government agency charged with regulating the commodities markets. In contrast, OTC trading is conducted without any such regulatory controls.

Only about 25%-35% of all energy trading occurs on the NYMEX,4 which means up to 75% of all oil contracts go unchecked by the federal government. Because OTC trading is unregulated, the exact volume of trades -- not to mention the legality -- is unknown. To compound matters, despite growing activity in the commodities markets, the CFTC has a staff of less than 500, compared to 3,700 for the Securities & Exchange Commission.

Other legal escape routes allow energy trading on so-called "dark markets," exchanges not subject to the transparency and accountability laws governing U.S. exchanges. For example, the "foreign markets loophole" lets investors buy and sell millions of barrels of U.S.-bound oil multiple times overseas before ever reaching American shores, thereby driving up the price with each change of hands.

The standards for trading crude oil and setting prices should be, theoretically, consistent among different international market regulators. However, recent U.S. congressional hearings have introduced terms like "dark markets" and "swaps loopholes" used by some investors to skirt largely toothless government controls. Oil speculators -- typically hedge funds and investment banks -- have come under a spotlight amid allegations of exploiting gaps in the regulatory system.

According to the CFTC, the government agency charged with regulating the commodities markets, the percentage of petrol contracts controlled by speculators has surged to 71% in 2008 from 37% in 2000.

The International Monetary Fund has concluded that speculation has played a significant role in the run-up of oil prices, according to testimony at a June 23 House Energy & Commerce subcommittee. Also at that meeting a Lehman Brothers analysis suggested that more than half of the price of a barrel of oil may be attributed to speculation. Even the Saudis, the world's largest oil producer of 9.7 million barrels a day as of July, contend that supply-and-demand seems to be in balance and that there is no substantive basis for current price levels.5

At this stage, however, no one knows for sure if any improper oil transactions have been executed. In part, that's because American authorities can neither fully police nor gain access to data in most overseas commodities markets.

It would take someone with both chutzpah, and deftness in foreign policy. Where is Colin Powell when you need him.