Air Date: Week of September 19, 2008

The price of oil reached a record high of $147 a barrel in July. (Photo: Mattias Barthel)

The price of oil has been on a wild ride this year, and some say physical supply and demand can't explain the dramatic ups and downs. Hedge fund manager Michael Masters talks with host Bruce Gellerman about the role commodities futures traders play in pricing petroleum.

Transcript

GELLERMAN: The price of petroleum has had America over a barrel. First it was soaring, then sinking, and now who knows where it’s heading, or why? Over the past year Congress has held more than three dozen hearings on the price of oil. At the latest, this past week, hedge fund manager Michael Masters told a Senate subcommittee that supply and demand can only explain a part of the volatility. Masters says the real reason is market manipulation, not necessarily by a small group of Dr. No evildoers, but by institutional investors, who funneled hundreds of billions of dollars into what are called commodity index funds.

MASTERS: Crude went up and crude went down. And just coincidentally, it tracked exactly the money going in and the money going out. To really understand supply and demand, you can’t just look at supply and demand in the physical market. You have to look at supply and demand of investors’ dollars as well.

GELLERMAN: So these companies – these institutional investors – were buying these index funds in commodities and part of that index was petroleum and it was pushing the price up and up and up and up.

MASTERS: That’s right. The most popular index, which is the Goldman Sachs S & P index, petroleum consist - and petroleum dry products – consist of roughly 70 percent of the index. So in effect, every time they put in a dollar into one of these indexes, three quarters of that dollar roughly went into petroleum products. And thus, you had an increase in the price. And there’s a big difference between the capital markets and the commodity futures markets. Commodities represent inventories.

GELLERMAN: So people can buy and sell everything from pork bellies to petroleum.

MASTERS: They can, but again, they’re just inventories. Now when you buy a bushel of corn, it doesn’t provide any interest. It is a much different animal than a stock or bond. When someone buys a stock or bond, they don’t expect to take it home and have it for breakfast. So, the price of a crude oil barrel is determined by the supply and demand in the physical markets and the supply and demand in the commodity futures markets of investor dollars. Collectively, they determine what the price is. Unfortunately, you know, when you have an influx of investors into these markets, you have significant distortions. And the issue that makes them dangerous, if you will, is this whole mentality of “buy and hold.” Commodities are meant to be traded. Just buying and holding what you look like in the commodity futures markets is a giant consumer.

GELLERMAN: In January 2000 the price for a barrel of oil was about $24.

MASTERS: That’s right.

GELLERMAN: In July of this year it was about $147, nearly $150.

MASTERS: Right.

GELLERMAN: Now it’s below $100.

MASTERS: We noticed a very significant amount of dollars flowing into index funds really starting around 2003. In fact, in 2003 the amount of index investment from large institutional investors in the commodity futures markets was roughly $13 billion. And by July of this year, that figure had grown to $317 billion. And we found that in excess of $60 billion of inflows had happened between January of this year and May of this year. And then, from July 15th of this year to just recently, September 2nd, $39 billion of outflows. And so, the price of crude and the price of petroleum products and indeed all commodities actually correlated very well to the inflows and outflows of these large institutional dollars.

GELLERMAN: But that’s correlation, that’s not causation.

MASTERS: Well people say that but it’s pretty strong evidence. I mean, we’re not saying that it’s the only reason, I mean, there are supply and demand factors in the marketplace. But how any economist could explain a more than $50 increase from low to high and then a $50 subsequent decrease from high to low in the space of six months just on supply and demand factors is beyond me.

GELLERMAN: I was looking back over the last twenty years or so and the world’s supply of oil was about equal to the demand. It hasn’t been out of balance. And yet, every time we heard the price was going up it was because something was happening in Nigeria or there was a tropical storm that might hit the Gulf.

MASTERS: You heard about those issues in the first half of this year, and then you know you’ve actual other issues since July. In other words, Russia invaded Georgia, you had two hurricanes, and yet the price went down anyway. In fact, this year inventories from data published by the EIA, the Energy Information Administration, have been stable all year. And the interesting thing about this whole issue is that these large investors, they had the intention of staying for a long period of time. And I think the only reason they did come out was because of Congressional scrutiny.

Congress said, “Wait a minute. You know, we may re-regulate this industry. We may change the rules.” And I think some of these large investors said, “You know what – we don’t want to stick around for this. We’re coming out of this quote unquote ‘asset class’ and withdrawing our money.” And we didn’t expect it to happen so quickly, but, you know, $39 billion coming out – that necessitated the selling of 127 million barrels of crude oil in the futures markets over a six-week period.

GELLERMAN: Don’t we have laws against market manipulation?

MASTERS: We do have laws against market manipulation. We used to have better laws against excessive speculation. Unfortunately those laws over the past seventeen years or so have been changed. Wall Street has lobbied to remove many of the restrictions that used to exist. The real issue with this particular, you know, bubble – this has very dramatic effects on citizenry around the world. I mean, it’s one thing if someone drives up the price of pets.com or an internet stock and then back down, you know that affects the shareholders of that company, but it’s a much different issue when you start driving up the price of crude oil. The amplification of prices causes by Wall Street investment is a social justice issue. And so, having position limits, which is something that worked for a long time in the commodity futures markets, and worked well, put in again, would work well to help the price more reflect what true supply and demand really is and not the whims of Wall Street investors.

GELLERMAN: Well, Mr. Masters, it was good talking to you.

MASTERS: Thank you very much.

GELLERMAN: Michael Masters is founder, and manages, the hedge fund Masters Capital Management.

[MUSIC: Mike Castro De Mari “Car Groove” from Sweet Sugar Lounge ( Supersonic Studio 2006)]

GELLERMAN: Just ahead, putting a price on carbon to save the planet. Keep listening to Living on Earth!

 

Links

The Commodities Futures Trading Commission regulates commodities speculators and says they aren't behind price spikes in commodities. Read the CFTC's report here.

Download Michael Masters’ report here ….

…and an update here.

To learn more about index speculation, check out Michael Masters’ blog