CBS: Did Wall Street speculators create oil price bubble?
David Edwards and Muriel Kane
Published: Monday January 12, 2009

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One of the most inexplicable economic events of the past year involved the doubling of the price of oil last spring and summer from $69 a barrel to nearly $150 -- driving gasoline and heating oil costs through the roof -- followed by its even more rapid collapse this fall to under $50

60 Minutes looked into various theories of what happened and concluded that "many people believe it was a speculative bubble .. and that it had more to do with traders and speculators on Wall Street than with oil company executives or sheiks in Saudi Arabia."

Oil is traded on the commodities futures market, whose original purpose was to enable farmers and manufacturers to stabilize their expenses and receipts. But in 2007, those markets began to behave erratically.

Last summer, Dan Gilligan, the president of the Petroleum Marketers Association, told 60 Minutes that his members were being blamed for price gouging but that the real problem lay with speculators.

"Approximately 60 to 70 percent of the oil contracts in the futures markets are now held by speculative entities," Gilligan explained. "Not by companies that need oil, not by the airlines, not by the oil companies. But by investors that are looking to make money from their speculative positions."

Around the same time, hedge fund manager Michael Masters noticed that huge amounts of money were flowing out of stocks and into commodity futures.

According to CBS's Steve Kroft, "In a five year period, Masters said the amount of money institutional investors, hedge funds, and the big Wall Street banks had placed in the commodities markets went from $13 billion to $300 billion. Last year, 27 barrels of crude were being traded every day on the New York Mercantile Exchange for every one barrel of oil that was actually being consumed in the United States."

Wall Street bankers insisted at hearings last summer that the rising oil prices were a result of supply and demand, not excessive speculation. But prices continued to go up, even jumping by a record $25 on a single day when there were no supply disruptions to justify the increase and demand was actually going down.

Two investment firms, Morgan Stanley and Goldman Sachs, may have set off the speculative bubble last March by their predictions of soaring oil prices. However, both firms deny deliberately manipulating prices, and federal law doesn't give regulators the jurisdiction to find out.

The bursting of the oil bubble comes as no surprise to some. In March, Citigroup energy futures analyst Tim Evans told the libertarian Reason magazine that "the futures and options market has become more important than the physical supplies in driving the price. We are seeing investment flows into the oil market that don't have anything to do with the demand and supply of oil."

However, other energy market experts argued that the many large institutional investors who were moving into commodity futures at that time were merely seeking "an investment vehicle that provided a hedge against volatility in stock markets while also promising excellent long-term returns."

Nobel Prize-winning economist Paul Krugman even suggested that "all through the period of the alleged bubble, inventories have remained at more or less normal levels. This tells us that the rise in oil prices isnít the result of runaway speculation; itís the result of fundamental factors, mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China. The rise in oil prices these past few years had to happen to keep demand growth from exceeding supply growth."

Krugman also pointed out that the most insistent claims of an oil bubble were coming from conservatives with an interest in denying the reality of peak oil. "Traditionally, denunciations of speculators come from the left of the political spectrum. In the case of oil prices, however, the most vociferous proponents of the view that itís all the speculatorsí fault have been conservatives ó people whom you wouldnít normally expect to see warning about the nefarious activities of investment banks and hedge funds. The explanation of this seeming paradox is that wishful thinking has trumped pro-market ideology."

No matter what the facts of the matter may be, a lack of transparency will make them more difficult to determine. According to CBS, "It's impossible to tell exactly who was buying and selling all those oil contracts because most of the trading is now conducted in secret, with no public scrutiny or government oversight. Over time, the big Wall Street banks were allowed to buy and sell as many oil contracts as they wanted for their clients, circumventing regulations intended to limit speculation. And in 2000, Congress effectively deregulated the futures market, granting exemptions for complicated derivative investments called oil swaps, as well as electronic trading on private exchanges."

This deregulation of the futures market was originally enacted for the benefit of Enron and made it possible for that firm to manipulate the California electricity market, driving prices up by as much as 300%. It has since been exploited far more widely, and the incoming Obama administration has promised to address the regulatory loophole.

The full CBS story is available here.

This video is from CBS' 60 Minutes, broadcast Jan. 11, 2009.

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