S.O.S. Now - Stop Oil Speculation Now - Answers to Common Questions

Answers to Common Questions

What is a commodity?
Commodities are raw materials purchased by manufacturers to make other products such as processed food, refined oil, jet fuel, automobiles and a host of consumer products and building materials.
What is the commodity futures market?
It is a marketplace where traders or businesses can buy or sell commodities for future purchase or sale. Those deals to buy or sell commodities are called "contracts" and they set forth the amount of the commodity, a price and a future date for the purchase or sale. For example, businesses highly dependent on oil – refineries, heating oil dealers, airlines and trucking companies – can reduce their risk of significant price fluctuations by purchasing future delivery contracts at predetermined prices at a commodity futures market. The two largest U.S. commodity futures exchanges are the Chicago Mercantile Exchange (CME) and the New York Mercantile Exchange (NYMEX).
What is the purpose of commodity futures markets?
Commodity futures markets provide two critical functions for businesses such as airlines and trucking companies that use large amounts of commodities. First, these markets serve as a means for price discovery. Second, they help businesses control for price risk and price fluctuations.
Which federal agency regulates commodities trades?
Congress created the Commodity Futures Trading Commission (CFTC) in 1974 as an independent agency. The CFTC regulates commodity futures and options markets in the United States and has authority to craft and enforce the regulatory framework that governs the trading of all commodity futures, including energy products such as crude oil.
Who participates in these markets?
There are effectively two categories of participants: financial players and physical players. Financial players include individuals, pension funds, university endowments, sovereign wealth funds and others. Physical players are those who produce or use the commodity being traded, such as airlines, trucking companies, etc.
What is a speculator?
Financial players with no intention of using the physical commodity often are referred to as "speculators." In other words, they do not have a business need to buy or sell the commodity; they simply want to trade futures contracts to make a profit. Speculators, for example, could buy large numbers of oil contracts and then sell them to each other again and again. In 2008, on average, nearly 12 times the volume of oil was traded on futures exchanges as was consumed globally. Without proper oversight, transparency and limits on futures positions, speculative trading unjustifiably can increase the price of energy or other commodities – with businesses and consumers picking up the final tab.
What is a hedger?
Hedgers use the futures markets to manage risk by minimizing their exposure to significant price swings in commodities. This means that they usually buy or sell contracts at an amount related to the volume of what they will produce or what they will need to sell or purchase (to use in their business). Businesses such as airlines, trucking companies, oil companies and refineries are examples of these forms of hedgers.
What does trading "on paper" mean?
"Paper trading" is when speculators buy contracts for oil or other commodities with no intention of ever using, producing or taking delivery of the commodity. Speculators buy and sell these paper contracts to each other again and again. A barrel of oil may trade 20 times or more before it is delivered and used. The prices may go up with each trade.
Has speculation contributed to unwarranted oil price increases?
From the beginning to the end of 2008, the price of a barrel of crude oil on the New York Mercantile Exchange (NYMEX) moved from $99.64 to $145.29 to $33.87. On the way up, it took just 103 days of trading for the price of crude to soar 67 percent (more than $58 per barrel) to its July 3 peak, followed immediately by a precipitous 77 percent decline (more than $111) in just 118 days of trading. It is difficult to explain that unprecedented price volatility by changes in supply and demand fundamentals. Fewer than six months after the December 2008 low of $33.87, oil prices settled north of $72 on June 11, despite adequate supplies and the sharpest year-over-year drop in global consumption in nearly 30 years.
Why has speculation increased in recent years?
Institutional investors (corporate and government pension funds, sovereign wealth funds and university endowments) have poured billions of dollars into the commodities markets. These speculative trades have helped to drive up the price oil because the majority of new contracts are betting on increases, rather than decreases. In effect, this swell in "artificial demand" for oil is upsetting the balance between physical supply and demand and, once again, fueling a price "bubble."
What is an index speculator?
An index speculator is a financial player, such as a corporate or government pension fund, sovereign wealth fund, university endowments or other investor, that buys (invests in) the 25 commodities that compose the Standard & Poor's-Goldman Sachs Commodity Index (S&P GSCI) and/or the Dow Jones-AIG Commodity Index (DJAIG). The value of the index depends on how well the commodities being "tracked" by the index perform in the futures markets.
Should institutional investors be prohibited (or limited) from investing in commodities futures?
The effects of institutional investors have been so great that they have actually altered the price discovery dynamics of today's futures markets. Index speculators buy without sensitivity for the supply and demand of individual commodities, which undermines the price discovery function of the markets. Active trading strategies should be allowed, but they need to be done in a transparent and limited way.
Why should the government intervene in free markets? Won't the bubble just work itself out eventually?
The markets will eventually work themselves out and this bubble will pop on its own accord, just like all other bubbles have in the past. Unfortunately, while we are waiting, the price of oil could easily double again. Businesses and consumers can't afford to wait for that to happen. For decades, we have had speculative limits in the commodities markets to reduce manipulations and price bubbles. Simply reestablishing these limits will greatly help solve this problem without unintended consequences.
What are position limits?
Currently, a handful of foreign exchanges, most notably the London Intercontinental Exchange (ICE), are trading energy contracts that are identical to those traded in the United States, but are not following U.S. regulations because they claim they are exempt from U.S. law. These exemptions should not exist because they are trading U.S. commodities using terminals based in the United States.
What is the London loophole?
Position limits were created in 1936 to keep speculators from hoarding contracts and manipulating commodity prices. Unfortunately, over the last 20 years, many of these rules have been weakened or removed altogether. This allowed speculators to dominate the market, dramatically raising prices for all consumers.
What are swaps trades?
Swaps trades (also known as "over the counter" trades) are commodities transactions that take place between two separate parties outside of the traditional markets. Since they do not take place within regulated markets such as NYMEX, these often secret trades take place without regulatory oversight. We believe these trades should be transparent and under the same rules as traditional markets, so that no price manipulation takes place.
What is the so-called "Enron loophole"?
In 1936, Congress passed tough regulations to reduce the possibility of price manipulations by speculators. However, in 2000, Congress passed the "Enron Loophole" as a result of lobbying from Enron and a few other companies. Passage of this measure removed CFTC authority to monitor speculative energy trading of secret swaps and foreign exchange transactions over "virtual" or "electronic" exchanges. This has allowed speculators to trade commodities with little or no oversight. In order to ensure fair and open markets and to prevent manipulation, all energy trades need to be regulated in a manner similar to those on regulated markets like NYMEX.
In addition to reducing speculation, what other actions does the Stop Oil Speculation Now Coalition support?
We need to increase domestic supply, exploration, alternative energy sources and conservation to further reduce the price of oil. Unfortunately, these are all more long-term solutions. Working Americans and businesses need immediate relief.