How financial speculation in oil prices ruins airline profits

Reply Wed 17 Aug, 2011 03:51 pm
August 17, 2011
How financial speculation in oil prices ruins airline profits
By Kevin G. Hall | McClatchy Newspapers

ATLANTA — Although planes take off and land round-the-clock at this city's bustling airfield, Paul Jacobson isn't focused on flying, but rather on how much it costs to fly. As the senior vice president of finance for Delta Air Lines Inc., he must navigate volatile fuel costs, which he thinks that oil speculators are driving to punishing levels.

During peacetime Delta is the world's largest consumer of jet fuel, edging out the Department of Defense. So even a small move in oil prices has an impact on the bottom line of a company that flies at least 700 of its own large and regional airplanes and counts more than 1,400 aircraft under its companywide umbrella.

Delta and the Air Transport Association, the lobby for airlines, have been out in front among 98 companies and trade groups that banded together to create the Stop Oil Speculation Now coalition. It's pushing for curbs on financial players in the oil markets, which they believe are pushing fuel prices high to profit from trading rather than from any need to consume fuel.

"Given how much trading there is today in commodities, it warrants as much attention and scrutiny as the stock market gets, and deserves some checks on the power of any individual player so as not to unduly influence" pricing in oil markets, said John Heimlich, the Air Transport Association's chief economist.

Airlines argue that huge investment inflows from pension fund investors and Wall Street firms into the oil markets are driving volatility in world oil prices and distorting the price of crude oil and jet fuel.

"We don't want to be in a scenario where we have to 'right-size' the airline for fuel prices. We want stable fuel prices so we can go and run our business, grow and be a normal business," Jacobson said in an interview at Delta's global headquarters here, next to Hartsfield-Jackson international airport. "When we have to react with capacity reductions, all of this stuff is important."

Capacity reduction is a fancy way of saying that Delta and its competitors have to ground airplanes when oil prices get too high. Because of rising fuel prices, they must cram more passengers onto fewer flights in an attempt to control their costs.

Rising oil prices are out of sync with a weak U.S. economic recovery. Delta and its competitors, all job creators, struggle to remain profitable. The price of the jet fuel they need to fly Americans to and from destinations is as volatile as the prices motorists pay at the local gas pump.

"The way to think about that in our context is about $100 million to the bottom line; more profitability or less profitability, depending on which direction that shifts," said Jacobson, who's also Delta's treasurer.

The airline consumes about 95 million barrels of jet fuel, or 4 billion gallons, annually.

At any point in time, Delta is hedging about 50 percent of its fuel costs. It does so through purchasing contracts for future delivery of oil, called futures contracts. It also does so by entering into private bets with Wall Street banks and other players in the unregulated over-the-counter market, sometimes called the swaps or derivatives market.

For most of the last 30 years, end-users of oil — such as airlines, oil refiners and trucking companies — dominated the futures market. They traditionally composed 70 percent of the market.

Today, that ratio has been flipped on its head: Financial players with no intent of ever using a barrel of oil make up 70 percent to 80 percent of the market in any given week.

That's why Delta and the Air Transport Association are aggressively pushing regulators to rein in financial speculation. They want limits imposed on financial players across several oil-trading platforms, not just in the futures market. And they want to return to a market in which some speculation is encouraged but not to the point that it crowds out users of oil.

Futures markets are designed to bring together buyers and sellers, and through a process called "price discovery" they reach rational, mutually acceptable prices for the underlying commodity, in this case crude oil.

Since 2000, and especially since 2007, big institutional investors such as pension funds and commodity-investment funds have flooded into the commodities markets, taking positions in everything from coffee to crude.

This has led some analysts to argue that these financial players distort the price discovery process in the futures market and raise the price of oil.

However, Sarah Emerson, a Boston-based analyst for Energy Security Analysis Inc., disagrees.

"I think it is price discovery, but in a new and different world than we had 10 or 15 years ago. And it's a world, unfortunately, that the airlines will have to cope with," she said. "They consume a commodity that a lot of people want. It's in every country, in every economy, and it's subject to production problems. ... I would argue that price discovery is better than it ever was."

Emerson thinks that oil was priced too low for too long, and that traditional oil traders looked past real risks to global supply disruptions.

"The world is not perceived as safe as it used to be. Markets are all about perceptions," she said.

However, she agrees with airlines that speculation has raised the price of crude oil and that there needs to be greater transparency about trades to level the playing field.

"There is a premium, and I think that it is huge. There is a gray area for sure that the financial community is in, but I don't think we can say the current pricing is 'wrong.' It is what it is. It's a market where there is asymmetric information, and unfortunately Delta is on the wrong end of that," the veteran energy analyst said.

Delta starts with the assumption that it's always short of the fuel it needs, since it doesn't produce any itself.

"We're short 95 million barrels of jet fuel per year if we want to keep flying. That's a risky position to have, and if you think about it in a Wall Street context, there isn't a trader on Wall Street that would take that big a position ... because of the risk around that position, so we've got to find ways to mitigate that," Jacobson said.

The airline does so by trying to guess the direction of oil prices in the futures market, then making private bets, with supplier contracts and a host of other financial mechanisms designed to hedge against rising oil prices.

American Airlines also is concerned about the role of speculative money in oil markets and how that affects its bottom line. The airline used almost 2.5 billion gallons of jet fuel last year, and it tries to hedge anywhere from 35 percent to 50 percent of its fuel needs, going out as far as 24 months in an effort to smooth out the volatility in oil prices.

"We fully support the Air Transport Association's effort to curb oil speculation driven by those traders who have virtually no intention of ever using or refining the oil they trade," said Sean Collins, a company spokesman in Dallas, adding that hedging efforts have produced cost savings in eight of the last 10 years.

Critics contend that the huge inflow of investment money into oil amounts to a self-fulfilling prophecy, with investors betting that prices in the future will go higher, thus driving them up. Wall Street investment banks touted commodities over the last decade as a way to reduce risk and enhance earnings, since commodity prices often moved in the opposite direction of stock prices.

The rise of emerging economies such as China and Brazil, drivers of growing global demand for oil, has aided this sales pitch. There's no reliable global information about supply, production and consumption of oil. The opaqueness of data encourages speculation.

Speculation is primarily felt in the futures market. When the price of an oil futures contract is higher six months from now than it is for delivery next month, it's a typically short-lived phenomenon called contango. Today, airlines and other end-users lament what's now being called "perpetual contango." Futures prices continue to rise irrespective of weak demand for oil in the sluggish U.S. economy.

"The pension funds, the asset managers, the index investors are essentially saying, 'I just need a piece of the pie. I don't care if the price goes up or the price goes down, because I am doing it as a return-enhancer/risk reducer to my other asset,' " Jacobson said.

These investors care little about supply and demand, said Heimlich of the Air Transport Association.

"I think today a lot of people are playing in the oil market who don't know much about the fundamentals of energy markets, and they may not care much," he said. "It may not be malicious, but they may not be fully informed."

To appreciate what volatile prices mean to airlines, consider that when oil prices tumbled over a period in May, after a price spike, Delta saw the value of its hedges drop by $140 million. That big number is peanuts compared with the $1.2 billion that the top hedge funds invested in oil lost over those same days.

"When you look at the dollars invested and the magnitude of how these markets can move as a result of these non-consuming players that are in it, we think it's obvious that it has a pretty measurable and sizable effect," Delta's Jacobson said.

Oil historian Daniel Yergin has coined the term "financialization" of oil prices. In recent months, as investors fretted over whether Greece would default on its bonds, the United States would raise its debt ceiling and China would lose control of inflation, they flocked to oil futures to diversify their investment base.

"It's almost like oil is now the holy grail financial-vehicle proxy for the future," Heimlich observed. "If you are bullish on oil, buy Exxon Mobil stock. ... You can hedge currencies, play the gold market. But oil has become the choice, the vehicle."

As a consequence, airlines and motorists alike suffer.

"When the price of Apple (stock) goes up, the price of Wal-Mart (stock) goes up, a few people get hurt, but a lot of people benefit. When the price of a physical, widely used commodity like energy or food goes up, a lot of people suffer, and economies suffer," Heimlich said. "I think what we have at stake is far beyond the airlines' interest."

Read more: http://www.mcclatchydc.com/2011/08/17/121047/how-financial-speculation-in-oil.html#ixzz1VKEhavXv
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Reply Wed 17 Aug, 2011 03:53 pm
June 15, 2011
Meet the man with the power to crack down on oil speculators
By Kevin G. Hall | McClatchy Newspapers

WASHINGTON — Most Americans don't know who Gary Gensler is or the agency he runs. They should.

It falls to him as the chairman of the Commodity Futures Trading Commission to rein in the flood of speculative money flowing into financial markets that many experts fear is driving up the price of oil, gasoline and basic foodstuffs.

The obscure CFTC regulates markets in which more than $5 trillion in trades take place daily. Gensler is trying to implement legislation passed last year that requires first-ever regulation of some of the darkest, riskiest corners of these financial markets.

Gensler's also a man in the proverbial hot seat, trying to bring change amid attempts by some in Congress, doing Wall Street's bidding, to gut his agency's funding.

His task is to regulate the market for complex instruments called derivatives, where a lack of regulation nearly brought down the world financial system in 2008. The value of all assets represented in trades in these derivatives markets is more than $600 trillion.

Separately, he's also charged with capping how much of the oil and grain markets any single investor can capture.

It's a big challenge for a guy few have heard of, facing a task few would want, and who almost didn't get the job.

As a former partner in Goldman Sachs, Gensler came under scrutiny from liberal Democrats, and his 2009 confirmation was held up for more than five months because of concerns about his Wall Street past.

Republicans were wary of his other past: He served as a Clinton administration Treasury undersecretary. And consumer groups didn't trust him because during that time, complex derivatives were exempted from regulatory oversight. The exemption proved to be a rope with which Wall Street nearly hanged itself, and everyone else, in 2008.

After two years at the CFTC, however, Gensler appears to have won over most of his detractors.

"I think he undercut that distrust, but I think it is beginning to creep back again over the question of whether the commission will take a strong stance," said Michael Greenberger, a University of Maryland law professor who headed the CFTC's trading division in the late 1990s and opposed the Clinton administration's exemption of derivatives from regulation.

"Overall, I think he's done an excellent job," Greenberger said. He attributed Gensler's caution to making sure the new rules can stand up to legal challenge. "Those of us who want to see the markets thrive — supported with adequate capital and transparency_ are indebted to the CFTC in general and Chairman Gensler specifically."

Barbara Roper, the director of investor protection for the Consumer Federation of America, pointed to last year's Dodd-Frank revamp of financial regulation, in which Gensler criticized the Obama administration's position on complex financial instruments as too soft and convinced Congress to get even tougher.

"I've been quite impressed with Gensler, which doesn't mean we agree with every sentence in every rule proposal. But I think he has done a good job of getting the strongest possible package of rules through the agency, under extraordinarily difficult circumstances," Roper said.

If there's a dink in the glowing reviews, it's on the issue of position limits, mandated by Congress to cap how much of any commodity any one trader or company can control. It's intended to curb speculation. In January, the CFTC proposed a 10 percent cap and began taking input, but the agency has told lawmakers it may not take effect until next year.

That doesn't sit well with critics, who note_ as McClatchy did in a May report_ that speculators now make up more than 70 percent of the market in contracts for future delivery of oil.

"It appears that speculators have an even larger position in the market than ever before, and it is really only excessive speculation that can be responsible for the extraordinary volatility that we're seeing in the market," said Sen. Susan Collins, R-Maine, in an interview. "It's just been an enormous volume that seems divorced from any underlying fundamental of supply and demand."

Collins pressed for tighter regulation of these markets in last year's revamp of financial regulation and said she's "disappointed" in Gensler for falling behind on congressional mandates.

"It's troubling to me that these markets were really established for end-users (of oil) and producers to bring them together ... now they have become markets that appear to have become dominated by hedge funds, pension funds and other non-commercial users, and this isn't what the markets were established for," she said.

Collins and other critics argue that the price discovery function of these markets_ bringing together a buyer and seller to find a market price — is distorted by the huge influx in speculative money.

In comments to McClatchy on Tuesday following a public commission hearing, Gensler was cautious about embracing the view of critics.

"It's a very good question. The markets have changed dramatically. There are electronic markets, there are significant high-frequency traders in the markets now. Price discovery is a critical and essential thing to these markets — that people can come into the market and discover a price and meet in a transparent marketplace," he said. "They can't do that yet in the swaps market ... until we finish these rules, until we get the job done."

Gensler denied foot-dragging on capping how much any one investor can hold, noting there have been more than 12,000 comments filed to the CFTC about its proposed limits.

"I think the recent volatility in commodity prices reminds us as to why we have to get this job done," he said. "We are not a price-setting agency, but our core — we help promote the integrity of these markets. What does that mean to the public? It means you can see where people are buying and selling, that no one party is sort of concentrated in the market, the market is free of fraud and manipulation, and you've got an effective cop on the beat. All of these features are important to the market and recent volatility reminds us."

As CFTC chairman, he's just one vote on a five-member commission that must approve by a simple majority every new rule it's implementing. Wall Street banks and powerful hedge funds are lobbying the agency and Congress furiously.

"He and his small agency have probably come under more pressure than any other regulatory agency in the history of the country. A day does not go by when there aren't an army of industry lobbyists laying siege to the CFTC to get the rules bent to their favor," said Dennis Kelleher, a former Senate lawyer who now heads Better Markets, a nonpartisan group pushing for more transparent financial markets.

The stakes are high for ordinary Americans, Kelleher said. His group has documented the massive amount of speculative money now flowing into futures markets. These markets were originally designed for end-users of oil or farm products to hedge against price shifts. Today these markets resemble casinos, with financial players who have no intention of ever taking possession of the commodities they're investing in, far outnumbering the actual end-users.

"It's true that the CFTC's jurisdiction relates to some of the most complex products known to man, but they were also the very products that were at the center of the financial meltdown," he said. Kelleher called the CFTC "the most important agency that nobody in America has heard of," and said that Wall Street has reason for concern. "It's the highest profit-margin products they've ever created, and Wall Street and its allies want to protect these profits no matter what."

The Republican-led House of Representatives Wednesday debated an agriculture spending bill that would slash the CFTC budget by $30 million at a time when the agency is laboring to meet new regulatory mandates that greatly expanded its workload.

It's an anything-but-subtle attempt to thwart the agency's new powers.

"If you didn't have a House that was anti-regulatory-balance, it's likely that the derivatives reform would have moved further along," said Michael Masters, a hedge fund manager who has advocated tougher rules to limit speculation. "Ultimately, I think there will still be new regulations in a renewed regulatory framework, but I don't think there's any question that the folks in the House have done as much as they can to slow things down."

Gensler came into office saying there has been excessive speculation in financial markets, especially those for oil contracts. Crude oil prices ran up to $113 a barrel in May, despite a weak economy.

A McClatchy report in May, based on secret State Department cables, showed that Saudi producers told the Bush administration in 2008 — as crude prices raced to all-time highs — that oil prices were being driven by financial speculators.

Given all the evidence that speculators should be regulated more closely, Collins and 16 other senators are unhappy with Gensler, whom they otherwise give high marks.

"He seemed so committed to reform. He's clearly very knowledgeable. I'm just at a loss as to why he has not been more aggressive in this area," Collins said. "My constituents are being hit not only by high energy prices, but a spike in food prices, so I am disappointed that the chairman has not made this more of a priority."

Read more: http://www.mcclatchydc.com/2011/06/15/115875/meet-the-man-with-the-power-to.html#ixzz1VKFRNrK4
Reply Thu 5 Apr, 2012 10:27 am
April 4, 2012
Finance expert says speculators are behind high oil and gasoline prices
David Lightman | McClatchy Newspapers

WASHINGTON — Financial speculators are gambling on oil the same way they gambled on the housing market a few years ago — a frightening prospect for the fragile economy, a Democratic congressional committee was told Wednesday.

"It is similar to the gambling Wall Street did on whether or not people would pay their subprime (below-market rate) mortgages in the mortgage meltdown," said Michael Greenberger, a law professor at the University of Maryland and a former federal regulator of financial markets. "Now they are betting on the upward direction of the price of oil."

The housing industry collapse helped trigger the deep recession that began in late 2007 and whose effects are still felt today.

The economy is slowly recovering, Greenberger said, but it could come to a halt unless oil prices come down. Gene Guilford, president of the Independent Connecticut Petroleum Association, told lawmakers that the recent oil price run-up has cost consumers an additional $10 billion a month since mid-December.

The House of Representatives' Democratic Steering and Policy Committee, which consists of party leaders, called the hearing to spotlight Democratic efforts to promote lower oil and gasoline prices. No Republicans were present.

Today's routine $4-and-higher prices for a gallon of gasoline have nothing to do with conventional supply-and-demand forces, Greenberger said. He formerly directed regulation of market trading in futures contracts and derivatives for the Commodities Futures Trading Commission.

"It is excessive speculation, which is a fancy word for saying that gamblers wearing Wall Street suits have taken these markets over," he said.

Financial speculators such as investment banks and hedge funds account for at least 65 percent of purchases of contracts for future oil deliveries, more than twice their traditional share, while buyers who intend to actually take delivery of the oil and use it, such as airlines, make up only about one-third of demand. The speculators bid up contract prices, sending oil and gasoline prices higher and reaping them huge profits. The bidding is stoked by fear of possible violence in oil-producing countries, notably Iran.

Congress has tried to pressure the Commodity Futures Trading Commission to put limits on how many contracts anyone can buy, but financial interests have stymied CFTC efforts in federal court.

Greenberger suggested several remedies, including a strong Justice Department probe. He said the threat of a serious investigation can be enough to intimidate speculators.

"If there is a real investigation, just the appearance of it will cause these cockroaches to scatter," he said, "because the light will be turned on."

The Energy Information Administration said Wednesday that U.S. crude oil inventories "are above the upper limit of the average range for this time of year." Total motor gasoline inventories also remain in the upper limit of the average range. Both were as of March 30. That means supplies are plentiful; there's no shortage pressure driving prices up.

The EIA, the statistical arm of the Energy Department, also said that total products supplied over the last four-week period have averaged about 18.2 million barrels per day, down by 4.7 percent compared with the similar period last year. Similarly, over the last four weeks, motor gasoline product supplied has averaged nearly 8.6 million barrels per day, down by 3.8 percent from the same period last year.

That inventories are up and products supplied are down suggests that producers are stockpiling supplies on concern that prices could go even higher, when they could earn a premium, even as demand for oil and its derivative products such as gasoline is actually down. Inventories are often built up ahead of the summer driving season.

The benchmark U.S. oil price fell Wednesday to $101.47 in New York, its lowest level since mid-February, but still well above where analysts believe it should be with supplies up and demand down.

(Kevin G. Hall of the Washington Bureau contributed.)

Read more here: http://www.mcclatchydc.com/2012/04/04/144181/finance-expert-says-speculators.html#storylink=cpy
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