As the post financial crisis regulations begin to bite, the mortgage market attempts to revive and the financial sector indulges in its latest cyclical round of layoffs, attention is beginning to focus on the increasing financialization of a lucrative source of wealth: energy trading.
Though energy is a complex global market of a size sufficient to stymie even the most determined speculators, an increasingly rancorous debate has broken out about the role of futures trading and how it might be affecting supply and cost. The stakes are commercial, financial and political. JL
Les Leopold comments in the Naked Capitalism blog:
Gasoline prices have been falling in recent weeks, but they’re still close to their five-year high after climbing steeply for three years. For every penny increase at the pump, $1.4 billion per year leaves our collective pockets, creating a drag on the sluggish “recovery.” Where does it go and what caused the price explosion at the pump?
It’s a common belief that oil prices are set on the world market by supply and demand. Less supply and/or more demand causes prices to rise. Oil is getting harder to find; OPEC is holding back supply; China and India are guzzling it up; Iran is threatening to blow it up. And regulations are getting in the way of drill, baby, drill — end of story. But this fixation on blind market forces ignores the fact that Wall Street is financializing the commodities markets – especially oil
The same greedy swindlers who puffed up the housing bubble and then milked it dry are now hard at work doing the same with gasoline.
What is financialization and why is it coming to the oil industry?
Here’s a chilling definition provided by economist Thomas I. Palley (PDF):
Financialization is a process whereby financial markets, financial institutions, and financial elites gain greater influence over economic policy and economic outcomes…..Its principal impacts are to (1) elevate the significance of the financial sector relative to the real sector, (2) transfer income from the real sector to the financial sector, and (3) increase income inequality and contribute to wage stagnation.
In short, we’re talking about the spread and growing supremacy of financial gambling – the ability to bet on the prices of goods produced in the real economy without actually owning those goods.
The vital activities of manufacturing, resource extraction and agriculture are turned into financial instruments that can be rapidly bought and sold. More to the point, financialization allows financial gamblers to extract profits from the real economy to enrich themselves without producing any real economic value for our economy.
When markets are financialized, they offer a myriad of ways for Wall Street firms to bend or break laws to manipulate markets and haul in enormous profits. In effect, financialization extracts a hidden tax from the real economy which is then passed onto us in the form of higher prices, economic hardship and then government bailouts when it all comes crashing down.
The oil markets have become just another profitable Wall Street casino. Why? Because, as the infamous outlaw Willie Sutton said, “That’s where the money is.” Oil markets as well as other commodity markets require a certain number of speculators. Oil producers and end users go to these markets in order to lock in prices for the products they use or sell. From refiners to shippers to airlines, oil markets provide a way to obtain price certainty for a specified period of time. To make these markets function, speculators are needed to take the other side of those trades. For more than a century about 30 percent of these commodity markets involved speculators and 70 percent of the participants in terms of volume were real producers, distributors and users. That’s what a healthy commodities market looks like.
But once financialization metastasized, the proportions flipped. Now 70 percent of the action comes from speculators, while only 30 percent comes from those who really produce, distribute and use the actual commodities. The casino has taken over.
This speculative invasion is why gasoline prices are climbing rapidly. The only question remaining is how much of the price rise is due to excess speculation. Here’s what the experts say:
•The St. Louis Federal Reserve (not exactly a Marxist institution) claims that 15 percent of the rise in gasoline prices is due to Wall Street speculation (PDF).
•A report from the House Committee on Government Oversight claims that up to 30 percent of the rise may be due to speculators.
•Even experts at Goldman Sachs, of all places, say that “excessive speculation is causing oil prices to spike by up to 40%.”
•And Saudi Arabia, ”the largest exporter of oil in the world, told the Bush administration back in 2008, during the last major spike in oil prices, that speculation was responsible for about $40 of a barrel of oil.”
This flip in the balance of real economic activity and speculation is precisely what John Maynard Keynes warned us about more than 75 years ago:
"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism…."
Who are the speculators?
Senator Bernie Sanders released classified documents revealing the names of the largest speculators in the oil markets as of 2008.
A look at the top 20 speculators reveals that only five are actually involved in producing, shipping, refining and consuming oil (Vitol, CMA, ENA, Semgroup and Emirates Oil). The other 15 are banks and investment houses – a virtual who’s who of Wall Street firms that puffed up the housing bubble and took down the economy. Goldman Sachs, Morgan Stanley, JP Morgan Chase, Merrill Lynch, Citigroup — they all make the list.
A tale of two casinos
It’s stunning to compare the similarities between the housing bubble and the rise in oil prices. Just take a look at the two charts below. The first shows the price of a barrel of oil after eliminating the impact of inflation. You can see the price spike in the 1970s during the Iranian oil boycott, and then in the 1990s during the Persian Gulf War. Clearly, those significant geopolitical events disrupted supplies and had a real impact on the price of oil.
But look what happened when the Wall Street big boys jumped into the oil speculative business right around 2002-’03. The price of oil went bonkers. The gyrations were far more extreme than any of the previous geopolitical events. There is no rational supply-and-demand explanation that accounts for that dramatic rise. Sure, after the economy crashed in 2008 prices declined. That makes sense. But up again goes the price of oil even though we’re facing nothing like the supply and demand shifts caused by oil boycotts and wars. Then again, maybe it does indicate a new war – Wall Street versus the rest of us.
Now take a look at the housing bubble graph – similar shape, similar timing. And that’s no coincidence. When Wall Street turns a market into an enormous casino, prices skyrocket and the economy is threatened. Wall Street did it to housing and now they’re doing it again to commodities — especially oil.
When Wall Street jacks up gasoline prices through its speculative activities, it has two job-killing impacts. First, it sucks money out of our pockets to pay for gasoline, which in turn means we have less money to spend on other goods and services in the real economy. It’s the equivalent of an anti-stimulus tax. As gasoline prices go up, economic demand falters and workers in the real economy are laid off.
The second impact is more complex but just as real to unemployed oil workers on the East Coast where several refineries in the Philadelphia area are being shut down even though the price of refined gasoline is rising.
Here’s where it gets tricky. The East Coast gets its oil primarily from the North Sea. That’s called Brent oil. The rest of the country gets most of its oil from the Gulf Coast. That’s called West Texas. The two kinds of oil are very similar in content and traditionally were similarly priced. Not any more.
As the chart below illustrates, a gap has emerged so that Brent oil is now significantly more expensive. This means that the oil coming into East Coast refineries is more costly to refine. But the increased cost can’t be passed on at the pump because the national prices are mostly set by the lower cost West Texas oil (and from European refineries that are dumping gasoline in the U.S. as Europe switches more and more to diesel). As a result, East Coast refinery profits are squeezed, which in turn leads to the shutdowns.
But what accounts for the split between the two prices of oil? Some experts say Brent oil is becoming more expensive because other oil supplies coming into Europe from the Middle East are more vulnerable and uncertain due to the Iranian situation and the Arab Spring. Maybe so. But speculation also is at work. Because oil speculation regulations are more lax in London, it is likely that Brent oil is the raw material for a more profitable casino. As Wall Street money pours in, up go the prices…and down go the refineries and thousands of refinery workers.
But wait, isn’t Wall Street helping the environment by driving up gasoline prices?
Without question the rise in gasoline prices moves the nation toward more fuel-efficient cars, which in turn will reduce greenhouse gas pollution. But relying on Wall Street to cause this dynamic is ridiculous, foolish and grossly unfair. First, because Wall Street speculators not only drive up prices they create price instability – rising prices followed by rapid crashes. If a recession follows, gas prices will crash and the incentive to purchase fuel-efficient cars will disappear. Second, rising gas prices without offsetting credits for low-income people are very regressive – meaning lower-income people pay a higher share of their income on fuel costs.
But more galling is the fact that Wall Street speculators are pocketing what amounts to a gas tax as if they were the duly-elected government of the United States (maybe they are the government, but not duly-elected).
If we want to tax carbon for the sake of the environment (and we should), then the government should do so and collect the revenues, not Wall Street. And if we think that Wall Street’s nefarious way is better than nothing at all, than heaven help us.
How do we rein in the speculation?
President Obama recently called for $58 million in order to put “more cops on the beat” at the regulatory agencies that police the commodities markets. Supposedly these extra cops would be able to prosecute more cases of price manipulation and other blatant violations of the rules and regulations that govern commodity trading.
This effort, while laudable, doesn’t go nearly far enough. The best way to check speculation may be through a financial transaction tax that makes it less profitable to speculate in commodity markets. A relatively small tax on all financial transactions would likely reduce the number of bogus speculators. That’s the only message they understand. Enforcement of weak rules matters little to those who spend all their waking hours playing and dreaming up new financial casino games. The only way forward is to take away their chips.
Unfortunately, the Obama administration opposes any and all financial taxes for fear they will upset financial markets. Well, this market is already upset by financial greed and corruption. Hopefully, the administration will learn before it’s too late that the American people are sick and tired of being fleeced by Wall Street.
In the meantime, next time you fill up your tank, remind yourself that something like $10 to $25 is going right from your pocket to Wall Street. Maybe that will get us to join the fight for a financial transaction tax. It’s long overdue.
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