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Thursday, April 26, 2012

Transcript 498: Michael Greenberger on Commodity Market Manipulation

Today it is wall to wall oil. In a few moments we'll begin the testimony of Michael Greenberger and Gene Guilford before the House Democratic Steering and Policy Committee on oil speculation and prices.

If you will recall we started off 2011 saying the rise in oil prices would trigger a general economic downturn, just as it had in 2008. Since we didn't believe we in the recovery in a business cycle sense, we could not call it a double dip, but we did suggest sub zero percent GDP growth by the onset of 2012. Growth was closer to zero than to the consensus 4.5 percent in 2011. Pending any revisions, we did not get below zero. We'll look into the reasons in future podcasts. Possibly the bite out of demand from the rise in oil prices was offset by the expansion of credit and to some degree by tax cuts. We assumed restrictions to credit would replicate higher interest rates. This is true for the mortgage market, but other consumer debt, student loans, and corporate credit continues apace.
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There's a lot we don't know about oil, oil prices, oil companies, the oil sector, Texas, and North Dakota, but some things we do know.
  1. An oil-based economy is a doomed economy, because oil is a dead end environmentally.
  2. Oil interests have an inordinate influence on public policy. That is, they own the place, along with finance.
  3. Oil prices are not supply and demand prices.
  4. Oil prices are a primary driver of what is termed inflation.
  5. As oil goes up in price, labor goes down, in real terms. Oil inflation is wage deflation.
  6. Oil extraction and distribution, from exploration to drilling to setting up infrastructure to the point of final sale produces fewer jobs per dollar than any other sector.
This final point deserves a bit of expansion. Why is it that oil prices have less effect on Europe where the price is higher per gallon, or liter? Part of the reason is that the transportation system of Europe is less dependent on oil. Part of the reason is that it is a smaller shock when a dollar is added to a gallon of gas and pushes it from seven to eight dollars. And part of the reason is that the price in Europe is high because of taxes and those taxes finance jobs and demand from those incomes. In the U.S., when the price goes up a dollar a gallon it is just a tax – in the Tea Party sense, a net loss – to the oil companies and speculators. Much is made of the fact that new oil drilling in North Dakota is creating jobs, or in Pennsylvania. Now these jobs that involve more intrusion into geological integrity may be different than the traditional drop a straw into a pool jobs, but traditionally, they do not last. They go away even as the cost of the oil they produce stays around. And North Dakota is a quarter the size of Brooklyn. So a boom....

If we taxed gasoline consumption as the Europeans do and returned that money in the form of jobs, or reductions in other taxes, or even in cash as the Cantwell-Collins Cap and Rebate plan from a couple of years ago, usage would go down, adjustment to the future would go up, and the economic impact of speculation would be far less.

Before we get to Greenberger and Guilford, there are some disturbing notes from Argentina, that the country has nationalized a major oil company there.

We abridge an article here from Mark Weisbrot off the Real World Economics Review blog, issued under the title
Argentina’s critics get it wrong again
April 20, 2012

The Argentine government’s decision to re-nationalize its formerly state-owned oil and gas company, YPF, has been greeted with howls of outrage, threats, forecasts of rage and ruin, and a rude bit of name-calling in the international press.

We have heard all this before. When the Argentine government defaulted on its debt at the end of 2001, then devalued its currency a few weeks later, it was all gloom and doom in the media. The devaluation would cause inflation to spin out of control, the country would face balance of payments crises from not being able to borrow, the economy would spiral downward into deeper recession.

Nine years later, Argentina’s real GDP has grown by about 90 percent, the fastest in the hemisphere. Employment is at record levels, and both poverty and extreme poverty have been reduced by two-thirds. Social spending, adjusted for inflation, has nearly tripled.

All this is probably why Cristina Kirchner was re-elected last October in a landslide victory.

Of course this success story is rarely told, mostly because it involved reversing many of the failed neoliberal policies – backed by Washington and its International Monetary Fund — that brought the country to ruin in its worst recession of 1998-2002. Now the government is reversing another failed neoliberal policy of the 1990s: the privatization of its oil and gas industry, which should never have happened in the first place.

Repsol, the Spanish oil company that currently owns 57 percent of Argentina’s YPF, hasn’t produced enough to keep up with Argentina’s rapidly growing economy. From 2004 to 2011, Argentina’s oil production actually declined by almost 20 percent and gas by 13 percent, with YPF accounting for much of this. And the company’s proven reserves of oil and gas have also fallen substantially over the past few years.

The lagging production is not only a problem for meeting the needs of consumers and businesses, it is also a serious macroeconomic problem.

The shortfall in oil and gas production has led to a rapid rise in imports. In 2011 these doubled from the previous year to $9.4 billion, thus canceling out a large part of Argentina’s trade surplus. A favorable balance of trade has been very important to Argentina since its default in 2001. Because the government is mostly shut out of borrowing from international financial markets, it needs to be careful about having enough foreign exchange to avoid a balance-of-payments crisis.


So why the outrage against Argentina’s decision to take – through a forced purchase — a controlling interest in what for most of the enterprise’s history was the national oil company? Mexico nationalized its oil in 1938, and – like a number of OPEC countries – doesn’t even allow foreign investment in oil. Most of the world’s oil and gas producers – from Saudi Arabia to Norway – have state-owned companies. The privatizations of oil and gas in the 1990s were an aberration – neoliberalism gone wild. Even when Brazil privatized $100 billion of state enterprises in the 1990s, the government kept majority control over Petrobras.

As Latin America has achieved its “second independence” over the past decade and a half, sovereign control over energy resources has been an important part of the region’s economic comeback. Bolivia re-nationalized its hydrocarbons industry in 2006, and increased hydrocarbon revenue from less than 10 percent to more than 20 percent of GDP (the difference would be about two-thirds of current government revenue in the United States). Ecuador under Rafael Correa greatly increased its control over oil and its share of private companies’ production.

So Argentina is catching up with its neighbors and the world and reversing past mistakes in this area. As for their detractors, they are in a weak position to be throwing stones. The ratings agencies are threatening to downgrade Argentina. Should anyone take them seriously after they gave AAA ratings to worthless mortgage-backed junk during the housing bubble and then pretended that the U.S. government could actually default? And as for the threats from the European Union and the right-wing government of Spain, what have they done right lately, with Europe caught in its second recession in three years, nearly halfway through a lost decade, and with 24 percent unemployment in Spain?
It is interesting that Argentina has had such remarkable economic success over the past nine years while receiving very little foreign direct investment and being mostly shunned by international financial markets.
And here we see that there have been questions about how oil prices are reported.

Price reporting agencies, so-called PRA's, are under scrutiny by the International Organization of Securities commissions, or IOSCO, at the behest of the G-20.

Articles from Reuters say
PRA benchmark prices are referenced by many key exchange-traded commodity derivatives contracts, clearing platforms and by a very significant number of OTC commodity derivative contracts. As such, PRAs have significant impact on the overall functioning of commodity derivatives markets, on the price discovery process and on risk management. They may also have significant systemic impact given the importance of oil to the global economy. These factors are central to IOSCO’s continued attention on PRAs.

PRA's are Media, such as Argus Media and McGraw Hill Cos (MHP)-owned Platts. Their journalists' surveys are used to settle billions of dollars worth of trade and help establish oil benchmarks used globally to set oil prices.

Fox business says
However, despite their importance to the oil market, PRAs aren't subject to third party regulatory oversight or a special degree of accountability and have come under increasing scrutiny amid attempts to better control oil market volatility following the spike and crash in oil prices of 2008.
"The range of potential approaches to PRA oversight may realistically lie between recommending a form of self regulation to recommending a direct governmental regulatory system for PRAs," IOSCO said in its consultation report.

Read more: http://www.foxbusiness.com/news/2012/03/01/iosco-consults-on-regulation-oil-pricing-agencies/#ixzz1svxK7Niw
Reuters says,
Price assessments for over-the-counter (OTC) oil trade and derivatives produced by industry reporters are used to settle billions of dollars worth of deals and to help settle trade on benchmark futures exchanges.
The International Organization of Securities Commissions said reported prices were at risk of being manipulated by submission to the agencies of selective or false prices.
Under pressure to curb speculation blamed for huge swings in oil markets, the Group of 20 (G20) top economies last year asked IOSCO to look at the role of price reporting agencies (PRAs). The lead agencies are Platts, owned by McGraw-Hill (MHP.N), and privately-held Argus Media.
IOSCO recommended a range of ideas for physical oil market PRAs, including a possible independent regulator, which could be a step towards greater supervision of over-the-counter oil markets that are now lightly regulated by comparison with derivatives.
The IOSCO report highlighted a number of possible problems with oil price reporting. Sometimes assessments of oil prices were based on a very small number of trades, it said.

"The number of transactions in certain benchmark assessments can often be less than five and not infrequently there are no prices submitted," the report said.

Journalists at reporting agencies assess prices by calling up as many traders as possible and contacting them via instant messaging to ask where they see the market, trying to avoid pitfalls such as reflecting only a buyer's or seller's view.

In some markets, such as the North Sea market which sets the price of global oil benchmark dated Brent, many of the day's deals are done in a 30-minute period known as the "window," aimed at increasing transparency.
Even so, many other physical and derivatives oil deals are done bilaterally and are not captured by the window process, making some corners of the market relatively opaque. Oil traders in the physical markets are rarely permitted to speak to pricing agencies on the record.

[One dealer quoted said] increased transparency would provide a better deal for consumers, and rules could help to encourage that.

"At the moment you get (major oil companies) trading a million tonnes of paper and it's completely invisible," the dealer said. "You need government legislation to get limits on size."
IOSCO members regulate more than 95 percent of the world's securities markets in more than 100 countries, including the U.S. Securities and Exchange Commission, Britain's Financial Services Authority and Japan's Financial Services Agency.

Now let's turn to oil prices and speculation.

Here with Michael Greenberger, Professor at the University of Maryland, formerDirector of the Division of Trading and Markets at the Commodity Futures Trading Commission (CFTC) where he served under Brooksley Born., and with him Gene Guilford, Executive Director and CEO of the Independent Connecticut Petroleum Association

Before they start, just a note on the question of whether oil prices are set in these derivatives markets. That is, Do futures determine the spot prices? Professor Krugman, among others, has said, no they don't. These witnesses make sure you know that in practice, they do.

As Yogi Berra said, "In theory there's no difference between practice and theory, in practice, there is. " Nothing more illustrative than the moment, when the rise in oil prices comes with the official excuse of Iran-Israel war breaking out any day. But storage is full. There is no war now. The spot price follows the futures price up, as the speakers say, in lock step.

That is the practice.

If you want a truly disturbing conspiracy vision, imagine the money that will be made if war actually does break out.

Enough of that, here is part one of Michael Greenberger, then Gene Guilford, appearing at a hearing led by Nancy Pelosi and Rosa De Lauro.


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