Features and Interviews
All this week, the Commodity Futures Trading Commission (CFTC) has conducted hearings investigating the role of speculation in the energy markets. And while the end results remain to be seen, one thing seems certain: Position limits are coming to an exchange near you - maybe even as early as this fall.
But position limits won't solve a thing, says oil expert Chris Cook. As the former compliance and market supervision director at the International Petroleum Exchange back in the 1990s, Cook is no stranger to market regulation or the often obtuse energy scene. And while many in Washington are pointing their fingers at commodities ETFs, Cook has taken the opposite stance, instead blaming the financial "middlemen," and accusing the market of having become "entirely sociopathic."
Earlier this week, HAI associate editor Lara Crigger chatted with Cook about how to best rein in energy speculation, including the relevance of the Brent Complex, the controversial "hedge exemptions," and the "submarines running the convoys."
Lara Crigger, associate editor, HardAssetsInvestor.com (Crigger): Many people in Washington are blaming speculators for the volatility in the energy markets, especially for last year's run-up. So are speculators to blame for high oil prices?
Chris Cook, former IPE compliance director (Cook): I'd say that speculators are to blame, but it depends on how you define "speculator." I don't regard the exchange-traded funds as speculators; I believe the real speculators are the middlemen who buy oil and sell it for profit, or who act as market markers in the derivatives markets with the view of making profits. Now, there's nothing wrong with either of those things, but it is inherently a speculative activity.
Crigger: Who are these middlemen, and how do they influence the markets?
Cook: You've got these financial institutions, the so-called Wall Street refiners, that really got moving in the early 1990s: Goldman Sachs, JP Morgan, Citigroup. Their participation is purely financial, and they're in the market to make a profit. They have a financial interest in volatility, as that's where they make their money. The more volatile the market, the more money they make.
The whole purpose of derivatives markets is to allow producers and consumers to hedge their price risks. Unfortunately, the volatility is so excessive. And it's not generated by the futures exchange. That's a big misconception: The futures exchanges are the visible tail; but the physical market, that's the dog.
That is, an exchange-traded fund is physically unable to make and take delivery. It's only the people who can actually make and take delivery who can affect the physical market price. That's what's being missed here. So the real problem isn't from exchanges. It's from this complex of contracts - the Brent Complex, the BFOE contracts.
Crigger: How do you mean?
Cook: Well, this month there's only something like 53 cargoes coming out of the North Sea for the BFOE. That's worse than it's been in years. So it only takes about $2 billion to buy them all and control them. So for someone like a BP or a Goldman, it doesn't take too many forward contracts to actually support the price.
Crigger: So is the Brent Complex still a relevant benchmark for oil pricing?
Cook: It's better than the alternative. North Sea oil has been in decline since I was on the exchange back in the 1990s. But the same is the case in Dubai and in the States (only worse). So the North Sea is the "less worse" solution.
Back in 2000, U.S. Senator Levin's Subcommittee on Investigations sent two staffers over to interview me about the Brent market. I think that not only should they dig that out again, but that the U.S. Senate and the House of Parliament should do a joint investigation of the Brent Complex.
Because what's going on right now is a waste of everybody's time. It's going nowhere, and if they do manage to limit exchange positions, it's just going to drive away people who should be on it.
Crigger: There was a recent report from the Financial Services Authority [Britain's financial regulatory body] absolving speculators of any blame for the high volatility in oil prices. What are your thoughts on that?
Cook: I think it comes back to defining what we mean by "speculators." The funds, the ETFs, the long-only people who've been in there all this time, like GSCI - those guys are not like the hedge funds. They're people who are genuinely interested in hedging inflation; they're prepared to take on energy risk and offload the risk of holding money, because they think money will depreciate.
To me, that's not speculation. That's the opposite of speculation. The true speculators are the middlemen who operate in the physical market. They're the ones causing the volatility.
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