Friday, May 13, 2011

Boost The Oil Margin Requirements

It's the term "speculator" that raises all the hackles, as in, "I blame the speculators for the price of oil and how much you pay at the pump." When you say that, you always sound naive, as if the "speculators alibi" is just sour grapes and what's really at stake is simply true supply and demand.

After all, the market -- any market -- is too big to be influenced by non-commodity producers or buyers, right? But time and again we have seen the financial buyers overwhelm those who need to take delivery. Just a fact of life. At any given moment, only so much of a commodity can be brought to market, and if that marginal amount can be snapped up by a group of hedge funds, it is completely reasonable that they can move the market up until we reach a level of substitution; or if there is no substitution, then demand destruction.

In fact, the notion that the financial buyers have no real impact was totally dispelled in 2008 when oil reached $147. Did anyone think that was really demand from actual buyers who needed fuel? Only a moron would think that. The simple truth is that a small amount of money relatively, the money a smallish hedge fund might have under management, can easily control $5 billion (as we know from a fund that lost $500 million in the oil collapse last week). If you do the math, you know that the money put up that was lost was nowhere near how much was actually purchased. Given the total groupthink of this hedge fund business, it is reasonable to presume that others were doing the same strategy, playing keep-away from those who needed the oil. When you couple in the $2 billion front-month buying that Dan Dicker from talks about, you have the possibility of $20 billion, easily, buying up oil in the financial markets with no intention of using it.

Given that the actual markets aren't that deep -- it is totally reasonable that the price at the pump is NOT set by the users and producers at all. Why else would the biggest oil producer withdraw from the market if we weren't in actual glut but artificial height for the commodities themselves? In fact, can you think of a situation where commodities became dominated by financial buyers that a bubble didn't form, from tulips, to gold in the '70s, to silver in the '80s, to housing (through CDOs) in the 2000s, to oil in 2008? It's the nature of the bad beast, and is not only ludicrous to say that's NOT what is happening but it is empirical!

I think that commodity allocation for funds is vital. They should own oil. It's a great asset that has appreciated long term. They can participate through the futures market, that's fine. But oil, unlike every other commodity, has national implications. The market has to be truer -- meaning more responsive to increased production -- than it is.

The president should sell futures against the Strategic Petroleum Reserve to knock down the phony price to more reasonable actual prices. In other words it is the futures, which are priced at the margin by the financial buyers, that simply need to be overwhelmed by an organization that is NOT trying to maximize its wealth. You get a government operator who actually wants to make less on oil and cares more about the health of the nation than the profit, and that institution can knock things down for certain. The president has a strategic imperative to keep the country safe from an oil embargo. But he can also avoid a recession by beating the financial buyers back. Think of it. The oil companies sure don't. They get to piggyback off the speculators by simply not taking the other side of the futures trade.

That's what they did in 2008. They just didn't bring any futures market pressure to bear.

Oil's not cotton. It's not even corn. Reasonable prices levered to actual consuming customers should be a national imperative. Either have the government raise the margins to drive these marginal buyers out, or sell futures against the Strategic Petroleum Reserve. In no way am I advocating that financial players shouldn't be involved. I am simply saying that if we make it so there's so little money that needs to be put up, the potential to want to corner or at least have mindthink to move prices up is too great.

We don't need as many buyers of oil if we can avoid it. The best way to do it is to make people put up a lot of cash, as the actual physical buyers have the capability of doing (they are not using leverage).

Just like in 2000, when the Federal Reserve could have used its power to control margined buying of stocks -- something that would have avoided the dot-com bust that hurt so many -- if the government steps in now and says it thinks it's prudent to see margin rates reach 50% of use, we wouldn't lose any of the true financial allocators and the market would be returned to actual physical demanders versus the financial demanders. And given all of the supply out there, the price would be dramatically reduced, which would eliminate a proximate cause of a dynamic slowdown.

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