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Government Assistance
Bailing Out The Oil Market
By William Pentland
01/10/09 "Forbes" -- - 09.23.08, 11:35 AM ET -- While
everyone knows the U.S. government is looking to bail Wall
Street banks, few people realize that it's also bailing out
speculative oil and commodities traders in the process,
fueling a sharp rise in energy prices. Lehman Brothers (nyse:
LEH - news - people ) and AIG (nyse: AIG - news - people )
held enormous trading positions in commodities markets. If
those positions had been liquidated suddenly, the price of
everything from wheat to oil would have collapsed. The
Commodity Futures Trading Commission, the main regulator of
U.S. commodity markets, allowed Wall Street's investment
banks and trading companies to take control of massive
positions in commodities markets called swaps held by Lehman
Brothers and AIG.
The result: Oil prices spiked by a whopping $16 per barrel
on Monday, the largest single-day rise in oil prices ever.
"If speculators were forced to liquidate their positions,
oil would easily be $65 to $75 per barrel by the time the
liquidation was complete," said Michael Masters, the founder
of Atlanta-based hedge fund Masters Capital Management.
Tuesday, oil was trading at $108.74 in midday trading in New
York.
For all the talk of OPEC, the biggest threat to high oil
prices in the short term might be the implosion of Morgan
Stanley (nyse: MS - news - people ) or Goldman Sachs (nyse:
GS - news - people ), which would trigger a massive number
of low-priced oil-futures contracts to flood the market all
at once in search of buyers to liquidate those contracts.
"If either of these entities were to collapse, we believe
the downside for commodities would be tremendous as these
companies unwind positions," Valerie Wood, president and
owner of Energy Solutions, told Platts on Monday. "In
particular, we know Goldman Sachs has large investments in
crude oil and natural gas commodities because its own
Goldman Sachs Commodity Index fund [comprises] about 39%
crude oil commodities and about 6% natural gas commodities.
A liquidation of GSCI shares would directly result in the
selling of these commodities, and selling pushes prices
lower."
Ironically, the biggest losers turned out to be the traders
who bet that at least one of the victims from this month's
financial chaos would be forced to liquidate a major long
position in oil prices. When they avoided that fate, the
race to unwind those bets that oil prices would fall before
the end of the trading month caused a massive rally in oil
prices.
The market meltdown has revealed the full extent of Wall
Street's influence on commodities prices and, especially,
their role in energy markets. More than $40 billion in cash
has poured into commodity markets since the start of 2008,
according to a report by Standard & Poor's. The total amount
of investments in commodity indexes is estimated at between
$150 billion and $270 billion. In other words, new
investments in the market have climbed by 15% to 25% in less
than a year.
In 2006, the U.S. Senate's Subcommittee for Permanent
Investigations had already reported "there is substantial
evidence supporting the conclusion that the large amount of
speculation in the current market has significantly
increased prices." The trouble is that so much of the
trading happens in so-called "dark markets," unregulated
over-the-counter electronic exchanges where trading
companies buy and sell energy derivatives, that this role is
hard to document.
Investment banks make money off commodities speculation, but
are just conduits for hedge funds and institutional
investors that have taken large positions in commodities
markets as a long-term investment.
"The market dynamics induced more and more financial players
to move into commodities markets," said Fadel Gheit, a
senior oil analyst at Oppenheimer & Co. "It was a perfect
storm. The Federal Reserve was cutting interest rates and
people were running away from the dollar as it lost value.
Hedge funds, pension funds and mutual funds started pumping
money into commodities because they were the safest place
and the safest of them all was crude oil. There were too
many dollars chasing too few physical assets. That's the
bottom line."
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