Commodity Futures Speculation Causing Rise in Food and Oil Prices

Commodity Futures Modernization Act of 2000

We may never know for sure the combination of circumstances that brought on energy crisis of 2008. But one factor was almost certainly the Commodity Futures Modernization Act of 2000, which allowed unprecedented levels of speculation in oil futures by investment banks and pension funds, bringing the familiar boom-bust cycle home to the gas pump. [Drill Now? Try Regulate Now., Wall Street Journal, April 7, 2010]

To lower international food prices and protect our social interests, the Commodities Futures Trading Commission must use its authority to curb excessive speculation in commodities futures and re-establish strict position limits on speculators (which were successful until removed by the Commodity Futures Modernization Act of 2000). We must regulate and bring transparency to all trading. We can also removing damaging speculative influence on commodities prices by prohibiting participation in commodities markets by those who do not produce, manufacture, or take physical delivery of the commodities. We must create a solidarity economy that puts compassion and care for one another ahead of short-term profits, in the United States and around the world. [The world food crisis: what is behind it and what we can do, WorldHunger.org, October 23, 2008]

The surge in world food prices can be attributed to the “financialisation” of commodities due to the Commodities Futures Modernization Act of 2000. The game changed for commodities the minute the legislation passed -- ten years ago. That doesn't explain the surge this year but it does explain the increased volatility of the last decade. [Don't Blame Bernanke: Here's Who's REALLY To Blame For Surging Food Prices, Business Insider, October 12, 2010]

And what caused the huge spike in oil prices? Take a wild guess. Obviously Goldman had help — there were other players in the physical-commodities market — but the root cause had almost everything to do with the behavior of a few powerful actors determined to turn the once-solid market into a speculative casino. Goldman did it by persuading pension funds and other large institutional investors to invest in oil futures — agreeing to buy oil at a certain price on a fixed date. The push transformed oil from a physical commodity, rigidly subject to supply and demand, into something to bet on, like a stock. Between 2003 and 2008, the amount of speculative money in commodities grew from $13 billion to $317 billion, an increase of 2,300 percent. By 2008, a barrel of oil was traded 27 times, on average, before it was actually delivered and consumed. [Matt Taibbi, The Great American Bubble Machine, Rolling Stone, July 2, 2009]

The price of crude oil today is not made according to any traditional relation of supply to demand. It’s controlled by an elaborate financial market system as well as by the four major Anglo-American oil companies. As much as 60% of today’s crude oil price is pure speculation driven by large trader banks and hedge funds. It has nothing to do with the convenient myths of Peak Oil. It has to do with control of oil and its price. [F. William Engdahl, ‘Perhaps 60% of today’s oil price is pure speculation’, Global Research, May 2, 2008]

Food Commodities Speculation Causing Rise in Food Prices

September 24, 2010

Guardian News - The world may be on the brink of a major new food crisis caused by environmental disasters and rampant market speculators, the UN was warned today at an emergency meeting on food price inflation.

The UN's Food and Agriculture Organisation (FAO) meeting in Rome today was called last month after a heatwave and wildfires in Russia led to a draconian wheat export ban and food riots broke out in Mozambique, killing 13 people.

But UN experts heard that pension and hedge funds, sovereign wealth funds and large banks who speculate on commodity markets may also be responsible for inflation in food prices being seen across all continents.

In a new paper released this week, Olivier De Schutter, the UN's special rapporteur on food, says that the increases in price and the volatility of food commodities can only be explained by the emergence of a "speculative bubble" which he traces back to the early noughties [a cooler way of saying 2000s].

"[Beginning in] 2001, food commodities derivatives markets, and commodities indexes began to see an influx of non-traditional investors," De Schutter writes. "The reason for this was because other markets dried up one by one: the dotcoms vanished at the end of 2001, the stock market soon after, and the US housing market in August 2007. As each bubble burst, these large institutional investors moved into other markets, each traditionally considered more stable than the last. Strong similarities can be seen between the price behaviour of food commodities and other refuge values, such as gold."

He continues:

"A significant contributory cause of the price spike [has been] speculation by institutional investors who did not have any expertise or interest in agricultural commodities, and who invested in commodities index funds or in order to hedge speculative bets."

A near doubling of many staple food prices in 2007 and 2008 led to riots in more than 30 countries and an estimated 150 million extra people going hungry. While some commodity prices have since reduced, the majority are well over 50% higher than pre-2007 figures – and are now rising quickly upwards again.

"Once again we find ourselves in a situation where basic food commodities are undergoing supply shocks. World wheat futures and spot prices climbed steadily until the beginning of August 2010, when Russia – faced with massive wildfires that destroyed its wheat harvest – imposed an export ban on that commodity. In addition, other markets such as sugar and oilseeds are witnessing significant price increases," said De Schutter, who spoke today at The UK Food Group's conference in London.

Gregory Barrow of the UN World Food Program said:

"What we have seen over the past few weeks is a period of volatility driven partly by the announcement from Russia of an export ban on grain food until next year, and this has driven prices up. They have fallen back again, but this has had an impact."

Sergei Sukhov, from Russia's agriculture ministry, told the Associated Press during a break in the meeting in Rome that the market for grains "should be stable and predictable for all participants." He said no efforts should be spared "to the effect that the production of food be sufficient."

"The emergency UN meeting in Rome is a clear warning sign that we could be on the brink of another food price crisis unless swift action is taken. Already, nearly a billion people go to bed hungry every night – another food crisis would be catastrophic for millions of poor people," said Alex Wijeratna, ActionAid's hunger campaigner.

An ActionAid report released last week revealed that hunger could be costing poor nations $450bn a year – more than 10 times the amount needed to halve hunger by 2015 and meet Millennium Development Goal One.

Food prices are rising around 15% a year in India and Nepal, and similarly in Latin America and China. US maize prices this week broke through the $5-a-bushel level for the first time since September 2008, fueled by reports from US farmers of disappointing yields in the early stages of their harvests. The surge in the corn price also pushed up European wheat prices to a two-year high of €238 a tonne.

Elsewhere, the threat of civil unrest led Egypt this week to announce measures to increase food self-sufficiency to 70%. Partly as a result of food price rises, many middle eastern and other water-scarce countries have begun to invest heavily in farmland in Africa and elsewhere to guarantee supplies.

Although the FAO has rejected the notion of a food crisis on the scale of 2007-2008, it this week warned of greater volatility in food commodities markets in the years ahead.

At the meeting in London today, De Schutter said the only long term way to resolve the crisis would be to shift to "agro-ecological" ways of growing food. This farming, which does not depend on fossil fuels, pesticides or heavy machinery has been shown to protect soils and use less water.

"A growing number of experts are calling for a major shift in food security policies, and support the development of agroecology approaches, which have shown very promising results where implemented," he said.

Green MP Caroline Lucas called for tighter regulation of the food trade.

"Food has become a commodity to be traded. The only thing that matters under the current system is profit. Trading in food must not be treated as simply another form of business as usual: for many people it is a matter of life and death. We must insist on the complete removal of agriculture from the remit of the World Trade Organisation," she said.

• Food Commodities Speculation and Food Price Crises (September 2010)
• Speculation and the New Commodity Price Crisis: Separating the Wheat From the Chaff (August 2010)
  Agricultural swaps are per se violations even of the deregulatory Commodity Futures Modernization Act. If OTC wheat trading collapses as the result of a new rule on agricultural swaps, wheat and other agricultural commodity price volatility caused by so-called dark markets will greatly diminish. But the CFTC faces a tough fight to implement the Dodd Frank legislation, not only because of the massive Wall Street lobby against enforced regulation, but because of continued efforts to deny that financial speculation played a role in price volatility and to argue therefore that Bush administration rules suffice. The latest denialist gambit, by the Organization for Economic Cooperation and Development, to dismiss excessive financial speculation as a major commodity price driver in 2007-2008 has recently been demolished by a Better Markets Inc. study.
• Citizen Coalition Scores Victory Against Food Speculation (April 2010)
  Deregulation of the commodities markets in the 1990s and especially through the Commodity Futures Modernization Act of 2000 (passed by Congress after midnight of the last day of work) removed many of the common-sense laws established in 1936. The limits on speculation were lifted, allowing massive inflows of speculative money into the relatively small commodity markets. Speculation, per se, is not bad, but when speculators dominate the market instead of businesses hedging for legitimate business purposes, the excessive speculation damages the underlying purpose of the market. After investors lost money in the stock bubble in 2000 and real estate bubble in 2005/6, many decided to shift part of their investments into commodities. They were encouraged by an AIG-sponsored study that said commodities were a good long-term investment to help diversify an investment portfolio. The result was an explosion in speculation on basic goods. According to hedge fund manager Michael Masters, institutional investors (pension funds, university endowments, etc.) increased their investments in commodities futures from $13 billion in 2003 to $260 billion in March 2008, and the price of 25 commodities rose by an average of 183 percent in those five years.
• A Nation of Village Idiots (September 2008)
  A few days after the Supreme Court made George W. Bush president in 2000, Phil Gramm stuck something called the Commodity Futures Modernization Act into the budget bill. Nobody knew that the Texas senator was slipping America a 262 page poison pill. The Gramm Guts America Act was designed to keep regulators from controlling new financial tools described as credit "swaps." These are instruments like sub-prime mortgages bundled up and sold as securities. Under the Gramm law, neither the SEC nor the Commodities Futures Trading Commission (CFTC) were able to examine financial institutions like hedge funds or investment banks to guarantee they had the assets necessary to cover losses they were guaranteeing.

Oil is Traded as a Commodity Which Causes Fluctuation in Prices

Oil and gas are commodities, and their prices can change every second at the New York Mercantile Exchange and other trading hubs. Those far-off changes affect the cost of the next day's commute.

WikiInvest - Few inputs impact the world economy like the price of oil. As oil prices rise, costs go up for transportation companies, squeezing their profit margins and forcing them to raise prices, similarly affecting all the other companies that rely on them to transport products and people.

By contrast, most energy companies benefit from higher oil prices, either from higher revenues for oil, or because of increased demand for substitute energy sources such as ethanol and natural gas. 2007 and the first half of 2008 were good times for many energy companies; futures prices rose tremendously, peaking on July 3rd, 2008, at a record high of $145.85.

By early December 2008, futures prices plummeted, dropping below $50 per barrel, mostly in response to the recession caused by the 2007 Credit Crunch and 2008 Financial Crisis. The extreme volatility of this important economic input has piqued interest in issues like peak oil, speculation, and the world's rising energy appetite, and is leading to greater investment in renewable energy.

Spot Prices versus Futures Prices

Spot prices are the prices paid for oil here and now -- as in, the amount of money you would hand a producer in exchange for their tossing a barrel of oil into the back of your truck. Futures prices, on the other hand, are the prices paid for contracts promising the delivery of oil at a future date. Whether or not the prices of oil futures affect spot prices is one of energy economics' most prevalent modern debates.

Moreover, there really is no "true" spot market for oil, in the sense of that there is a "true" spot market for stock or other financial assets. A "true" spot market requires, as described above, the actual physical transfer of the goods, to the purchaser, directly at the time of purchase, and there simply are no large scale sellers of crude oil, that operate in such a fashion. The "spot" prices that are quoted, involve the transfer of 1000 barrels of crude oil, not one or two. That would require literally 5 of 6 tractor-trailer rigs to carry off back to your house: the transportation costs would approach the value of the oil itself. When one speaks of a "spot" price for crude oil, one is meaning the current trading price, of the next future contract that will come due.

Those that claim that futures prices (and, therefore, speculation) do not affect spot prices argue that people who purchase futures contracts do not actually purchase any real oil. When a fund purchases a futures contract and that contract comes due, it must sell the oil to someone who will actually use it, because that fund has no way of actually keeping the physical product. This means the oil must come to market -- no matter what the price.

If a firm buys a $150/barrel futures contract in June for July and the spot price in July is $140, the firm must buy the oil at $150, and then it MUST sell the oil at $140 as well, because it can't actually hold the oil. This means there is no accumulation of oil -- firms can't hoard oil, so they can't actually affect the present market. Therefore, it is argued, the prices of futures contracts have no affect on spot prices.

Those that believe futures speculation has an effect on spot prices (at least, those with a sound understanding of economics) argue that when oil futures are traded, oil purchasers, like refiners, try to buy oil at prices that will benefit their margins in both the short and long term. If it is believed that oil prices will rise in the future (indicated by futures prices being higher than present prices), purchasers will want to stock up on oil at lower prices today and put it in inventory; this drives up demand for crude in the present, forcing oil prices up in the present. Thus, it is argued, high prices for oil futures leads to high prices for oil in the present.

What Does the Oil Price Depend On

April 19, 2011

This is Money - The price of a barrel of oil is the result of a number of competing factors: How much oil is available, how much oil is demanded by consumers, how much it costs to get oil from the ground to the consumer, the price of dollars and the potential that oil speculators see for the price to rise and fall.

Many of the long-term global trends point to steady increases in the price of oil. Reserves are finite so the commodity is slowly becoming scarcer ' something that pushes the price up.

The explosion of development in countries like China and India has created more demand as those and other developing regions industrialise. They build more roads and increase manufacturing ' it all requires oil.

The bearish argument is that technological new energy developments - solar, wind, etc - should begin to reduce the world's dependence on the black stuff.

Supply is fettered by the countries that export it. The Organisation of the Petroleum Exporting Countries (Opec) meets regularly to set the amount they are willing to release onto the market. Opec oil accounts for approximately 35m of the 80m barrels released onto the global market each day.

Opec can reduce output as a means to push prices higher and can increase it to meet greater demand. It is tempting to think that all the producers are motivated simply by a high price. In fact, for some countries it may be beneficial to have a lower price if it means they can maintain, or increase, the volumes they sell.

Oil is priced in dollars so movements in that currency also impacts on crude. The weaker the dollar, the higher the dollar price of oil because it takes more dollars to buy a barrel.

There is one more factor that is thought to influence the price of oil. It is possible for investors to speculate on the price of oil by purchasing futures contracts. Investors ' they could include investment banks, hedge funds or pension funds ' will buy a quantity of oil to be delivered at a future date. If the price of oil has risen by the time the contract is delivered, the investor makes money. It became a contentious issue in 2008 when critics alleged that this type of speculation helped to push the price of a barrel to a record $147.

However, investors have defended the process, arguing that speculation does nothing to reduce the actual amount of oil on the market, which would push the price up, and that other commodity markets have shown greater increases than the oil market with no price speculation.