Free Market Proponents Call for Regulation on Speculative Oil Futures Trading: Define Irony

Analysts say speculative oil trading is to blame for gas prices at $4 a gallon. Congress considers regulation and legislation. What happened to market forces of supply and demand?

In the 2005 movie Syriana an oil company executive quotes Nobel Prize winning and renowned economist Milton Freedman: “Corruption is government intrusion into market efficiencies in the form of regulations”, he says. Freedman, one of the strongest proponents of the free-market, promoted the view of minimal government intervention in the markets as a means of creating political and social freedom.

We are born and raised according to the theoretical concepts of the free market and we are diligently taught the rules of the ‘vanishing hand’ and market forces at work. Our economic upbringing and formal academic education teaches us about market efficiencies and perfect competition only to face, later in our lives, a very harsh and different reality.

Gloating isn’t the best of qualities, yet I couldn’t avoid it when I read about a recent congressional panel regarding rising oil prices. Four senior analysts testified before congress claiming speculators are to blame for $4 a gallon gas prices.

The four senior analysts are: Michael Masters, who heads up Masters Capital Management, Fadel Gheit of Oppenheimer & Co., Edward Krapels of Energy Security Analysis and Roger Diwan of PFC Energy Consultants.

All four analysts agreed limiting speculators’ participation in energy markets will lead to sharp drop in oil prices to the economically reasonable level of $65-$75 derived by supply and demand.

Apparently Congress is looking to revise legislation to do just that. There are several bills at work trying to limit or even remove speculation from energy markets.

More than 63% of oil futures owned by speculators

According to the Energy and Commerce Committee speculators now control overwhelming amounts of the oil futures market.

The economic function of a future contract is to enable any corporation to hedge its business and fix the price of oil in a future business deal, either paid for or sold. Imagine oil companies who wish to raise the level of certainty behind their revenues. They will offer future contracts to buy oil in certain prices in a future given time. Should a trucking company find those prices reasonable a deal is closed today with known prices for both enabling them to smoothen out uncertainties in future business.

The level of contracts owned by speculators rose from 37% of the contracts in 2007 to 63% in 2008 with the rest owned by oil refineries, trucking companies, wholesalers and other end users.

Imagine all that speculative money removed from the market. Suddenly an overwhelming over-supply is created and prices drop sharply.

The following are more charts presented before the committee. They are real eye openers:

The massive increase in speculative investments is evident from the charts. Another important observation is the level of relative growth in speculative investments:
More regarding economic theory, free markets and reason

Projecting the case of speculative investments on Milton Freedman’s entire economic philosophy is a huge over-simplification and I won’t be going that way. I only wish to illustrate the delicate balance that need be between the freedom of markets and government regulation.

Lack of proper regulation enables speculators to take advantage of market failures. Sadly it’s not a perfect world and there’s no real ‘vanishing hand’, perfect competition and market forces. There are opportunities and opportunists grabbing what is left open for grabbing.

There’s no doubt speculative activities contribute to market efficiency. The price of a lack of proper regulation and supervision can be very high.

Ayn Rand, the noted author and philosopher who wrote the infamous book “Atlas Shrugged” believed and promoted, wholeheartedly, the concept of freedom and objectivism. She is quoted for writing, much like Milton Freedman that “Every government interference in the economy consists of giving an unearned benefit, extorted by force, to some men at the expense of others”.

As an idea these words echo strongly. The problem is they are often correct the other way around. A Lack of government interference in the economy might give unearned benefit, extorted by force, to some men at the expense of others.
If we’ve sunk deep into philosophy than we may also recall Thomas Hobbes and Jean Jacques Rousseau’s words regarding the government:

“That a man be willing, when others are so too, as far forth as for peace and defense of himself he shall think it necessary, to lay down this right to all things; and be contented with so much liberty against other men, as he would allow other men against himself” (Thomas Hobbes)

“As soon as any man says of the affairs of the State "What does it matter to me?" the State may be given up for lost” (Jean Jacques Rousseau)

Related Posts :

• Is There an Oil Price Bubble Evolving?
• Higher Gas Prices: A Blessing in Disguise or America's Wakeup Call
• Spontaneous Observations on Commodity Prices - Will Prices Remain so High?

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Higher Gas Prices: A Blessing in Disguise or America's Wakeup Call

Higher gas prices have got Americans driving less and public transport has never been this busy - A blessing in disguise?

Gas prices have been too low for too long. The American public demanded and received cheap gas and is slowly undergoing an adjustment process as the result of dramatically increasing gas prices which can no longer be held at bay by any means.

With oil prices climbing to $130 a barrel, and with no end in sight, the economy suffers as higher gas prices take their toll in the form of higher transportation, manufacturing and energy costs.

Gas prices at $4. $5 and maybe $6 a gallon are now very significant to any household’s budget and considerations.

However, I can help but notice the many blessings and advantages higher, or more real, gas prices will have both in the long and short term.

Higher gas prices carry significant advantages

#1 Reduced Waste

The NY Times reports more and more drivers are abandoning their cars in favor of public transportation or mass transit. Apparently buses are getting crowded and so are the parking lots near railway stations and bus stops.

In cities like New York and Boston where the mass transit systems are developed there has been a registered increase of over 5% in passengers. In South and west cities an even more dramatic increase has occurred (the NY Times reports an increase of 8% in passengers in Denver with increases registered also in Minneapolis, Seattle, San Francisco and Dallas).

Furthermore, February was the fourth month in a row that Americans registered a decrease in car travel distance according to the Federal Highway Administration. Apparently 60% of Americans are intent on lowering their gas consumption.

Gas prices in the USA are amongst the lowest in the world. The following chart lists gas prices from around the world:

$4 a gallon seems less expensive now, doesn’t it?

#2 Reduced pollution

The immediate result of increased use of mass transit and fewer distances traveled by car will be a reduction in pollution. It might not be significant but I believe it will surely be felt in the bigger cities and urban centers.

Hopefully, higher gas prices will also result in a new trend encouraging American drivers to switch their cars to more efficient, and regrettably smaller, cars.

US vehicles have ranked bottom in world fuel efficiency for years now. According to Reuters: “U.S. fuel-efficiency requirements for passenger cars have been stuck at 27.5 miles per gallon since 1985, while the standard for pickups, minivans and other light trucks will increase from 20.7 mpg in 2004 to 24 mpg in 2011. That puts the United States behind Canada, South Korea, Australia, China, Europe Union and Japan in vehicle fuel economy. The Senate earlier this year passed a bill raising America's car and light truck requirements to 35 mpg by 2020.”

There are more pickup trucks and SUV’s to be held in the US than anywhere I’ve ever been. I haven’t been able to find any of the smaller cars anywhere in the US.

#3 Increased economic feasibility of alternative energy sources

The biggest problem with alternative energy sources is their price. Solar, wind, geo-thermal and bio-diesel are costly and require massive investments in research and development. With increasing gas prices the economic feasibility of alternative energy projects has risen dramatically.

We have only our government to blame for the lack of alternative energy sources today as only a government truly sees the real economic value or cost of oil usage its alternatives. It seems the market forces are demonstrating their powers yet again with higher gas prices an excellent motivator for both governments and private investors to act on alternative energy projects.
These projects, in turn, will hopefully result in lower pollution levels, higher efficiency, less waste and a more balanced approach towards our planet.

#4 Reducing dependence on oil producing states and reducing the power of dictators in those countries

It’s no secret oil producing countries usually have corrupt regimes with many characteristics of dictatorships. These regimes evolved using the immense power oil offers as the single most valuable energy resource available to us today.

This dependence has caused many counties to make painful compromises and dubious decisions when it comes to oil and the counties that produce it.

Hopefully, higher gas prices and the alternative energy resources to come will help lower our dependence on these countries significantly. Another desired affect maybe the weakening of these regimes as their one source of power will slowly diminish.

Image by: Greg Woodhouse

Was Israel's decision to unilaterally withdraw from the Gaza Strip wise?

As "Kasam" rockets continue to rain on the Israeli city of Sderot and the kibutzim near by and as the radical Islamic Palestinian terror group "Hamas" and "Islamic Jihad" take control over Gaza asking whether the unilateral withdraw from the Gaza Strip was wise is ever more justified. To answer this question I believe we should look at the bigger long term picture.

The Israeli settlements in the Gaza Strip housed over 1,400 families. These settlements were strategically located and enabled the Israeli army to maintain some control over the Gaza strip and the refugee camps within it which house terror infrastructure and are used a base for terror activities and terrorists.

The Israeli public opinion regarding the settlements in the Gaza strip where mixed. Many objected to the heavy military presence required to defend these settlements, the price paid in human life, the suffering of the Palestinian civilian population and the enormous budgets that had to be invested in civilian and military infrastructure.

There was little doubt of the settlements strategic contribution and, by looking back, the contribution of the Israeli military presence to sustain the Palestine moderates in power but the price to be paid was high. Israel was on low moral ground, the supposed oppressor of 1.5 million Palestinians. The defense of these settlements took it's toll from the Israelis and Palestinians in life, suffering and budgets. Justifying the presence of 1,400 Israeli families among 1.5 million Palestinians was nearly impossible for the word public opinion justifiably tends to emphasize the civilian suffering regardless of circumstances such as terror activities carried out in its name. Another, very important aspect, was the military presence as perceived by the Palestinian population having to face roadblocks and ID checks constantly perpetuated the notion of occupation.

The logic and rational behind the unilateral withdraw is still sound. Israel is on higher moral ground having withdrawn with out conditions from the Gaza strip and allowed the Palestinians full control over it. Road blocks and military outposts vanished from the population's sight and envying Israeli settlements as well will allow a generation of Palestinians to grow independently.
It is true the Palestinians, as always it seems, have missed yet another chance to establish a foundation for a nation based on growth and success and have chosen, it seems, to wallow in the hatred manifested by radical Islamic organizations. The taking over of Hamas over the Gaza strip has enabled Israel to demonstrate to the world it's impossible position and day to day struggle with terror.

Israel has failed to convince the public opinion of the lack of its responsibility for the Gaza strip and continues to provide it with gas, electricity, water and food ironically keeping "Hamas" in power. Israel is facing increasing military build up in the gaza strip and the import of weapons and munitions to the gaza strip which is slowly but surely on its way to become another southern Lebanon. However, the unilateral withdraw will prevail to be one the better more justified decisions taken by Israel for the moral basis on which it stands.