The Truth About Rising Oil Prices
June 2008
Introduction Crude oil now trades above $125 a barrel, more than double its selling price at the end of 2006. Rapid expansion in global demand for crude oil and other commodities has driven up prices, and U.S. consumers are feeling the pinch at the gas pump. Pundits have begun debating the underlying cause of these trends. Oil executives blame “speculators.” Hedge funds blame pension funds. American consumers blame all of the above. The simple answer is that there is no simple answer. The truth is: 1. Rapidly rising global demand for energy combined with slowing growth in supply are causing increases in the price of oil. 2. Because we are a net importer of oil, this trend has been magnified in the United States by the 40% decline in the value of the U.S. dollar since 2002. 3. Oil markets are global, and world trading in oil contracts will not disappear. Misguided domestic legislation could produce negative consequences and actually force trading to exchanges in the Middle East and Asia that list crude oil contracts. Many of these venues do not have information sharing agreements with the Commodities Futures Trading Commission (CFTC). 4. IntercontinentalExchange (ICE) has demonstrated a strong track record of creating orderly, transparent and regulated markets. ICE Futures Europe is a fully regulated market and is subject to an enhanced information sharing arrangement between CFTC and the U.K. Financial Services Authority (FSA).
1. World Oil Prices are Driven by the Fundamentals of Global Supply and Demand
“We see that fundamentals seem to be driving the majority of the prices across the board of commodities.”
Acting CFTC Chairman Walter Lukken, speaking to CNBC on May 30, 2008
The U.S. is the dominant consumer of oil
U.S. China Japan Russia Germany India Canada Brazil South Korea Mexico 0 5 10 15 20 25
Consumption, Million Barrells Per Day
World oil production is slowing down
120
Consumption, Million Barrells Per Day
100 80 60 40 20 0 2003
OPEC
2010
Unconventional
2015
Russia/Caspian
2020
2025
2030
OECD
Non-OECD (exc. Russia/Caspain)
Energy Information Administration via Securing America’s Future Energy (SAFE)
DOE, EIA, IEO via Securing America’s Future Energy (SAFE)
Page 1
“This is not about blame; this is about supply and demand. Supply is tight and there’s concern that supply is going to have trouble keeping up with demand over the longer-term. All the research I’ve done is that speculators, short-term investors have had very little impact on this.”
Treasury Secretary Henry M. Paulson, speaking to CNBC on May 22, 2008
“Right now the oil market is tight and there isn’t a lot of additional supply that can come on at very short notice and the market looks like it’s going to remain under pressure for some time to come.”
International Monetary Fund Chief Economist, Simon Johnson, May 31, 2008
“Stuck for answers, politicians have been looking for scapegoats. Top of the list are the speculators profiting from other people’s hardship. Some $260 billion is invested in commodity funds, 20 times the level of 2003. Surely all that hot money has supercharged the demand for oil? But that is plain wrong.”
The Economist, May 31, 2008
“What’s happened is that we’ve hit a plateau in world oil production and that has been ongoing since about the middle of 2004.”
Dr. Robert Hirsch, author of Peaking of World Oil Production: Impacts, Mitigation, and Risk Management, speaking to CNBC on May 20, 2008
2. A Weakened U.S. Dollar has Exacerbated the Impact of Higher Oil Prices
“I think one of the key problems with the economy is the weak dollar. It started in 2004. That’s when commodity prices went up like a rocket. It was made worse in August of 2007, last summer, when the credit crisis hit. The Federal Reserve has been throwing money from a helicopter, flooding the monetary system with liquidity in order to deal with the immediate credit crisis. Commodities took another surge upward. Oil went from $70 a barrel to about $120-130 that we see it at today.”
Steve Forbes, speaking to Bloomberg Television on June 2, 2008
Dollar Decline
Average world price of barrell of oil in dollars and in euros, 2002-2008
120 100 80 60 40 20 0 2002 2003 2004 2005 2006 2007 2008* Euros Dollars
• In particular, the weak dollar is responsible for “at
least half” of the increase in gasoline prices paid by U.S. consumers.
* 2008 price is weekly price of May 16, 2008 Source: U.S. Energy Information Administration
“The collapse of the dollar exchange rate, alone, explains at least half of the increase in the pump price of gas over the past five years. If it wasn’t for the falling value of the dollar, the price of gasoline wouldn’t be an issue.”
David T. King, former chief of the New York Federal Reserve’s Industrial Economies Division, in a Wall Street Journal Op/Ed published May 23, 2008
Page 2
3. More U.S. Regulation Could Drive Trading in Oil Contracts Overseas – Beyond the CFTC’s Jurisdiction or View
• Overregulation may already be driving markets overseas.
“Europe has a 56 percent share of the $52 billion global revenue pool from derivatives; it has a 60 percent or greater share of revenues in interest rate, foreign exchange, equity and fundlinked derivatives (the U.S. leads only in commodity derivatives). Many of these businesses grew from nothing in the past 5 to 10 years and could be located anywhere.”
Sustaining New York’s and the US’ Global Financial Services Leadership, January 2007
• Trading in oil derivatives is here to stay; the market demands it. The only question is where, and given the global reach of the Internet, electronic trading can easily move overseas. o Eliminating cash-settled contracts by requiring market participants to be able to take physical delivery eliminates a valuable hedging option for thousands of companies and entire industries, leaving oil companies and producer nations free to set the price. • Legislating margins rates is also misguided. o In the past year, margin requirements for the ICE WTI contract have risen over 140%, yet crude oil prices continue to rise. Margin requirements are, and should continue to be, used solely to ensure prudent risk management via a clearing house and not to attempt to establish artificial price controls.
“I think to use [margin requirements] to try to quash [a] type of speculative activity would be dangerous and may send a lot of this business offshore or into unregulated markets. I think that’s dangerous precedent… If we become too draconian, we will send [oil trading] either overseas or into darker markets and we don’t want that. We want to keep this in the sunshine and that’s what we’re attempting to do.”
Acting CFTC Chairman Walter Lukken, speaking to CNBC on May 30, 2008
• The move overseas may already be occurring. NYMEX is launching a new WTI contract on the Dubai Mercantile Exchange that will be subject to oversight by the Dubai Financial Services Authority. In addition, on May 30th, the Dubai Gold and Commodities Exchange (DGCX) launched WTI and Brent crude contracts. $370 million in WTI and Brent contracts traded the first day. The DGCX does not have a foreign board of trade status with the CFTC.
4. ICE has a proven track record of maintaining orderly, transparent markets, and supports information sharing between international regulators
• As an exchange, ICE does not set the price of any contract, nor does it benefit whether the price of any contract goes up or down. • ICE Futures Europe is located in London because that was the location of the market when ICE acquired the International Petroleum Exchange in 2001. At that time, ICE Futures Europe was a Recognized Investment Exchange, subject to oversight by the U.K. Financial Services Authority, and it remains so today. • Calling ICE Futures Europe an “unregulated” market is blatantly untrue. Since 1986, it has been regulated by the FSA and its predecessor. • The expansion of the regulatory information sharing agreement between the CFTC and the FSA, announced on May 29, 2008, makes ICE’s WTI (West Texas Intermediate) crude contract the most monitored and transparent oil contract in the world.
Page 3
Recent Agreement Strengthens ICE’s Global Leadership in Market Transparency
• ICE, together with the CFTC and the FSA, has facilitated the development of a cross-border program to provide enhancements to its energy market data reporting. • The MOU included the provision of large trader reports by ICE to the FSA and subsequent reporting of that information to the CFTC. The enhanced information sharing agreement is comprised of five key components: 1. 2. 3. 4. 5. Expanded information-sharing to provide the CFTC with daily large trader positions in the UK-listed WTI crude oil contract; Extended trader information sharing to provide crude oil trading data for all contract months in the WTI contract; A commitment to provide trader information to permit more detailed identification of market end users; A commitment to provide modified data formatting so trading information can be seamlessly integrated into the CFTC’s surveillance system; and In addition to the established position management program that FSA currently requires of ICE Futures Europe, ICE Futures Europe will notify the CFTC when traders exceed position accountability limits in the WTI crude oil contract that have been established by domestic contract markets.
Conclusions
• There are many factors at work that have driven up world oil prices. Most experts agree that rapidly growing global demand for oil, without a commensurate increase in supply, is the primary driver of higher oil prices.
• Market regulators are aggressively working to uncover any possible market abuses, and anti-manipulation laws already exist to address this. • Working with the CFTC and FSA, ICE has forged a cross-border information sharing agreement to make it easier for regulators to monitor oil futures markets and detect signs of manipulation. • Passing ill-conceived legislation may both adversely affect a properly functioning market and send trading volumes to venues outside the jurisdiction or view of the CFTC.
Page 4