FNC
Mike Norman
It’s time to speak the truth. No more disingenuous questioning and wondering. No more exasperated resignation. We know the reason why oil prices are high, and it’s time to admit it and do something about it.

Oil prices are high because of speculation, pure and simple. That’s not an assertion, that’s a fact. Yet rather than attack the speculation and rid ourselves of the problem, we flail away at the symptoms. High gasoline prices? Oh, let’s use hybrid cars, or drill in the Rockies or off the California coast. How about doubling the use of ethanol, even though it costs more to produce than the energy you get out of it? Then again, we can go to Alaska, or build more refineries, or triple the number of nuclear power plants. Sound good?

Tune in to "The Cost of Freedom" business block, Saturday at 10am ET, for more with Mike Norman and the entire FNC business team.

What if we just stopped the speculation?

No, you can’t do that! That would be interfering with the “free” market.

Hey, the “free” market is starting to get awfully expensive.

Tell me, how is it free when speculators rule the roost? It’s one thing when they do what they do with pieces of paper called stocks, but it’s another when they do it with a vital commodity like oil. We saw the devastation their behavior wrought in the 1990s, and we’re witnessing it again right now.

Moreover, it would be one thing if they were right and buying oil for all the right reasons. But they’re not.

Recently we saw crude oil supplies rise to a six-year high. Gasoline stockpiles were at a three-year high. Distillates have come back from a steep deficit to inventory levels that are now above where they were last year. Natural gas inventories reside well above their five-year average.

Yet prices go up and up and up.

Still not satisfied?

Okay, OPEC is producing at levels not seen since the early 1970s — and that doesn’t even include Iraq, which is struggling to achieve pre-Gulf War production levels, but will soon be there. Furthermore, global production still outpaces consumption, even accounting for China’s unsustainable economic growth rates.

In short, there is nothing in that equation that says oil should cost what it costs today. Nothing! With one exception — speculation.

The New York Mercantile Exchange is the preeminent energy futures market in the world. It has become the price-setting mechanism for oil. Even OPEC refers to NYMEX when it sets its price targets. Right now it costs exactly $3,375 for anyone to control 1000 barrels of crude oil valued at roughly $67,000. Three grand to control nearly seventy!

The NYMEX sets that margin requirement, or “good faith” deposit, based on a number of factors like volatility and price. Yet despite the fact that crude and gasoline prices have doubled in the past year the exchange has only raised the margin requirement once, and by a token amount. I might add. The reason I remember it so well is because I think I had something to do with it.

Last August I happened to run into Senator Chuck Schumer (D-NY) outside my office here on Wall Street. I asked him why more pressure wasn’t being placed on the NYMEX to raise margin requirements given the high level of prices and the known fact that speculation was adding anywhere from $10 to $15 to the price of crude. His answer to me was, “That’s a good idea.”

One week later I ran into Speaker of the House Denny Hastert at FOX News. I posed the same question to the Speaker; he turned to his assistant and said, “We’ll have Snow make the call.” That was a reference to Treasury Secretary John Snow.

I followed both of these meetings up with a story that I wrote for the New York Post, which discussed the ambivalence of the NYMEX in the midst of surging oil prices.

Two weeks later, NYMEX raised margins by that token amount. There was a price pullback, but it didn’t last long.

Some might argue that higher margins don’t help, and in fact may even exacerbate the problem by not allowing price to ration supply, which is the normal function of markets. I say, hogwash. The problem is not with supply; it’s with demand — speculative demand.

If you don’t believe me check the most recent Commitment of Traders’ Report from the Commodity Futures Trading Commission. It shows large speculators net long crude oil and commercial hedgers net short. In the gasoline market this standoff is even more pronounced.

There have been many times in the past when exchanges used margin policy to impact prices. It’s within their mandates. In 1980 the Commodity Exchange Inc. in New York declared a “liquidation only” market in silver. This move was designed to break the back of a corner that was being engineered by a group of speculators. That policy worked. Prices eventually fell to $10 and the specs were ruined.

Moreover, the Federal Reserve can also raise margin requirements on stocks and it has, 23 times since 1934.

As more and more speculative funds buy into the crude, gasoline, and heating oil markets, their price structures are getting distorted. Deferred contract months are selling for big premiums over spot or nearby contracts. Normally that would not be the case in situations of tight supply, as so many say we are in. This tidal wave of speculative buying is fostering the artificial hoarding of oil. It is dangerous, and it should be stopped.

History has shown that sometimes markets can be distorted by manipulation and mania. In my opinion, those times justify intervention. The New York Mercantile Exchange has not shown any responsibility in this regard, but we shouldn’t expect it to: It makes its money off the trading of oil contracts listed on its exchange.

However, pressure should be put on the NYMEX to raise margins high enough to significantly reduce the amount of speculation going on in their markets. Leave the bona-fide hedgers (those who produce or sell the stuff) alone, but for the good of the economy, and for the long-term integrity of the markets, we must make it too costly for funds to play the spec game.

This weekend our Business Block has much more on the price of oil. Tune in Saturday at 10am ET and Monday at 4am ET.

Mike Norman is the founder and publisher of the Economic Contrarian Update and a frequent guest on the Business Block.