Monday, January 26, 2009

IER on Oil Speculation

60 Minutes Spectacle on Speculators
Institute for Energy Research, Jan 26, 2009


The January 11 edition of 60 Minutes featured a segment on oil speculation. Correspondent Steve Kroft interviewed hedge fund manager Michael Masters and others who blamed the run-up in oil prices on hedge funds and other investors. Unfortunately, Kroft failed to interview a single person who explained the benefits of hedging and even speculation on oil contracts. The 60 Minutes takeaway message—that government should increase regulation of commodities futures markets—could actually increase volatility in the oil market and hurt consumers.


The Benefits of Futures Markets

As we explained in an IER study issued last summer, the commodities futures markets perform a vital function by allowing parties to “lock in” a price of oil months or even years in advance. By removing their exposure to huge price swings, both oil producers and major consumers (such as refiners and airlines) can more confidently plan their future operations.

For example, the owner of an oil field might be willing to sink new wells if he expects oil prices to average at least $50 per barrel in 2010, while an airline might expand its service area to include a new city, but only if it can buy oil at less than $75 per barrel throughout 2010. If there were no futures markets, the oil producer and airline might decide to play it safe, rather than investing millions in projects that could prove unprofitable if oil prices move the wrong way. But fortunately with sophisticated financial markets, the two enterprises can hedge away this risk with futures contracts. The oil producer can sell (“go short”) futures contracts, agreeing to sell his output in 2010 for, say, $65 per barrel, and the airline can take the other side of the contracts. Both parties benefit by locking in the price of $65, rather than being subject to the volatile spot price of oil.

Successful Speculation Reduces Price Volatility

Just about everyone agrees on the benefits of futures markets when the buyers and sellers are those who physically deal with oil by the nature of their business. But even non-traditional “speculative” buyers—who plan on unloading their futures contracts before taking physical delivery—perform a useful service if they accurately forecast price moves.

The motto of the speculator is to “buy low, sell high.” (Or a more sophisticated version is to “short-sell high, cover low.”) But these actions reduce the volatility in the market, because the speculator’s buying pulls up prices when they are too low, while the speculator’s selling pushes down prices when they are too high. This is exactly what consumers want speculators to do. When the price strays from where they “ought” to be, an astute speculator comes along and knocks it back into line.

Now it’s true that many investors piled into commodities through the summer of 2008, thinking they would move ever higher—and then they had the rug pulled out from them in August and September. But we don’t need the government to impose penalties on such faulty speculation (which pushed prices the wrong way), because these investors lost their shirts! The market itself provides the appropriate reward and punishment for wise or foolish forecasts.

People often forget that for every speculator who “went long” on oil futures contracts, there was another party who had to go short. Indeed, after the 60 Minutes piece aired, investment manager Kevin Duffy reminded us of his warnings to clients over the summer that oil was overpriced. His hedge fund, Bearing Fund, shorted futures contracts and made money from the accurate call.

Another wrinkle in the typical complaint against speculators is that the statistical evidence shows the causality ran in the opposite direction. According to the CFTC’s analysis of confidential data, it was far more typical for a price change in oil to precede a change in investors’ holdings, rather than vice versa. Yes, big investors were enlarging their clients’ exposure to commodities in 2007 and 2008, but this was often because these sectors were outperforming others. So it wasn’t that a bunch of pension funds rushed into oil, and pushed up its price. Rather, the rising price of oil led to more and more investment in oil futures, by fund managers who were trying to shield their clients from skyrocketing energy prices. The process was mutually reinforcing, but the line between hedging and speculation is blurred. After all, soaring oil prices were hurting stock performance. By diversifying holdings to include commodities, fund managers were trying to limit the volatility in their clients’ returns.

A final point is that the presence of large, institutional investors provides more liquidity to the futures markets, allowing the traditional hedgers (such as producers and airlines) to use these contracts more flexibly. New regulations that restricted the ability of “speculators” to enter these markets would ironically hurt even the non-speculators because of higher bid-ask spreads.

Was It Speculators, or Supply and Demand?

A recurring theme in the 60 Minutes segment was that the price swings in oil weren’t due to the fundamentals of supply and demand, and so they must have been the fault of the insidious speculators [...].

The true situation is far more nuanced. Part of what happened on Sept. 22 was that the dollar fell sharply against other currencies; recall that these weeks involved the bailout of AIG and the collapse of Lehman Brothers. Because oil is traded internationally but quoted in U.S. dollars, a fall in the dollar translates into a higher quoted price for oil, which is perfectly consistent with “fundamentals.”

Moreover, Sept. 22 was the last trading day before the expiration of the October futures contracts. There were investors who had shorted oil—they were pushing down its price, betting that it would fall further—and they needed to unwind their positions, because they didn’t actually have physical barrels to deliver to the holders of the contracts. According to oil economist James Williams, the Nymex contracts had a delivery point of Cushing, Oklahoma, but the inventories in Cushing were low because of the hurricane drawdown. The situation led to a “short squeeze” where short-sellers were trying to buy back their positions and were scrambling for the unusually tight supplies. Thus the 60 Minutes piece is right that speculation was involved that day, but it’s the opposite of their interpretation: The people pushing down oil prices hit a temporary snag, caused by a physical bottleneck, and so the price popped back up briefly.

Masters’ analysis of the EIA data is also misleading. It is true that world oil supply had been steadily increasing every quarter since the beginning of 2007, while world oil demand finally peaked in the fourth quarter of 2007 and then began falling in 2008. But what Masters neglects to mention is that world oil demand was always higher than supply, up until April 2008, as the EIA data (XLS spreadsheet) show.

The market price of oil during this period did exactly what consumers would want. Starting in 2006, the world began consuming more barrels of oil per day than producers could deliver to market. The deficit was covered by drawing down on previously accumulated stockpiles. In this environment of a supply crunch, the market price needed to rise rapidly in order to call forth greater supply and curtail demand.

Even as late as the first quarter of 2008, on average there was more than a million barrel a day deficit, where world oil demand exceeded supply. Of course the “fundamentals” would drive higher prices in this environment. And then, after years of rising oil prices in this deficit environment, the situation finally reversed in April 2008. From that point on, world oil output had finally caught up with and overtaken demand. A few months later, the price of oil crashed back down. The presence of large investors definitely influenced the movement of prices, but ultimately the explanation based on supply and demand is accurate.

Even the sudden collapse of oil prices may be partially or completely attributable to “real” forces in the economy. The economic outlook changed considerably in the late summer of 2008, meaning that oil consumption will not grow nearly as quickly over the next few years as forecasters previously believed. The dollar has also strengthened tremendously because of the “flight to safety” by investors around the world. The rising dollar translates into lower oil prices, quoted in U.S. dollars.


Institutional investors rushed into the commodities futures markets as oil prices steadily rose from the fall of 2007 through the summer of 2008. This correlation led many analysts to conclude that the hedge funds were causing the prices to rise. But a more careful analysis shows that the situation was more nuanced, with price rises (fueled by legitimate, fundamental supply and demand) leading rational investors to diversify their holdings by gaining exposure to the energy sector.

In any event, it is wrong to assume that giving government bureaucrats more power will somehow make financial markets more transparent or efficient. Masters and the folks at 60 Minutes should read up on how the SEC ignored letters about Bernie Madoff’s Ponzi scheme that a suspicious analyst in the private sector began sending them back in 1999. In the private sector, speculators who make bad forecasts lose money, big time. In contrast, the SEC will probably see its budget increased even though it ignored a reputed $50 billion swindle for 9 years.

Many investors overshot the rise in oil prices, and the market punished them accordingly. But record oil prices really were driven by the fundamentals of supply and demand. Futures markets, and large institutional investors who use them, provide a valuable service to consumers by actually reducing volatility in the long run. It’s too bad that 60 Minutes seems to have overshot in their finger-pointing, but there won’t be any market correction for them.

U.S. Conventional Weapons Destruction Program in Afghanistan

U.S. Conventional Weapons Destruction Program in Afghanistan. Fact Sheet, Bureau of Political-Military Affairs
US State Dept, Washington, DC, Jan xx, 2009

The U.S. conventional weapons destruction program in Afghanistan aims to protect victims of conflict, provide life-saving humanitarian assistance and help provide security and safety for the Afghan people. Since 1993, the Department of State has provided more than $95,000,000 in conventional weapons destruction and humanitarian mine action assistance to Afghanistan. Direct funding to five Afghan non-governmental organizations has sustained clearance operations, developed host nation management and technical capacity and provided vocational training when a reduction in mine clearance activities increased the number of unemployed deminers.

The Conventional Weapons Problem

The widespread and indiscriminate use of mines, small arms/light weapons, ordnance and munitions since the Soviet invasion of 1979 has left Afghanistan heavily contaminated with explosive remnants of war (ERW). The United Nations Mine Action Program for Afghanistan (MAPA) estimates that 720 square kilometers of suspected hazardous areas exist, with more than 4 million Afghans living in 2,229 ERW-contaminated communities. Mines and ERW killed or injured more than 445 Afghans in 2008, an average of 37 victims per month. Additional conventional weapons and munitions hazards are reported daily. Although MAPA has cleared almost two-thirds of all suspected hazards discovered to date, vast amounts of areas remain contaminated due to on-going conflict and inaccessibility because of difficult terrain and deteriorating infrastructure.

The majority of ERW-contaminated areas are agricultural fields, irrigation canals, and grazing areas as well as roads and residential and commercial areas. Security belts of landmines also exist around major cities, airports, government installations, and power stations. An equally significant problem is the existence of large amounts of unexploded ordnance, which inflicted extensive injuries and destruction even prior to the on-going conflict. Still, mines and ERW and loosely secured or illicit conventional weapons and munitions persistently restrict access to valuable resources and important infrastructure, effectively making social and economic reconstruction in Afghanistan extremely difficult.

United States Assistance

In FY 2008, the Bureau of Political-Military Affairs’ Office of Weapons Removal and Abatement (PM/WRA) in the Department of State provided $18,000,000 for the Conventional Weapons Destruction Program in Afghanistan. These funds enabled Afghan non-governmental organizations, international non-governmental organizations, international organizations, and private and public sector partners to clear ERW-contaminated areas as well as to destroy or secure abandoned or otherwise at-risk munitions and explosive ordnance that might be used by insurgent elements to construct roadside bombs and other improvised explosive devices that target coalition forces, Afghan civilians, and international aid organizations. Slight increases in programmatic funding for FY 2009 will be used to increase national capacity development and conventional weapons destruction activities throughout Afghanistan.


Since January, 2006, PM/WRA-funded projects have destroyed or secured more than 9,000 metric tons of unexploded, abandoned, or otherwise at- risk munitions and small arms/light weapons, and provided explosive ordnance safety training to more than 65,000 Afghan nationals. This assistance removes explosive hazards that threaten civilian populations, and enables critical reconstruction and development projects central to economic growth, stability, and security. Department of State funds also play a vital role in the capacity development of MAPA, which consists of 20 Afghan implementing partners and international non-governmental organizations, and the UN’s Mine Action Center in Afghanistan, the coordinating body for MAPA management and operations.

To learn more about the Office of Weapons Removal and Abatement's humanitarian mine action and conventional weapons destruction programs, visit

Good and Bad Things At ILO

Can the ILO Be Saved from Itself?, by Charlotte M. Ponticelli
Heritage, January 22, 2009
Heritage Lecture #1106



One of my major responsibilities has been representing the Department of Labor--and, indeed, the United States government--in international organizations that deal with labor and employment issues. And, of course, the major international organization I have worked with is the International Labor Organization.

My bureau works closely with the ILO on a number of projects.

  • We oversee labor programs funded by the State Department and implemented by the ILO in the Middle East and Latin America.
  • We oversee numerous projects that are implemented by the ILO's International Program for the Elimination of Child Labor (IPEC). Over the past decade, the U.S. has funded nearly $370 million worth of programs in over 75 countries. As a result of these programs, we have rescued more than a million children from exploitive child labor.
On a regular, ongoing basis, we also represent the United States government at the ILO's annual conference and at its Governing Body meetings. We do this along with the AFL-CIO, which represents American workers, and the U.S. Council for International Business, which represents U.S. employers. Both of these partners, I should add, have been helpful and dedicated to making the ILO a strong and effective voice for democracy and rights.

I think this is an opportune time, with the current economic challenges, to talk about the ILO itself: to give you my perspective on what it does well, what concerns the U.S. government has had, and what we at my Bureau see as the road ahead.

The Mission of the ILO


The International Labor Organization was created in 1919, in the wake of World War I, with the purpose of creating an international institution that could bring governments, employers, and workers together to improve living and working conditions and help preserve social stability in the new post- World War I order. As the sole remaining component of the League of Nations, and as a member of the present-day U.N. system, the ILO has been a strong voice for worker rights, for helping to build democracy in Poland and South Africa, and build­ing strong, open-market systems in Eastern Europe after the collapse of the Soviet Union.

The ILO continues to be a beacon in promoting freedom in some critical places across the globe. For example:

  • In Burma, the ILO is the sole U.N. agency that plays a useful role on the ground. It has been directly responsible for enabling victims of forced labor to report on their treatment without fear of reprisal. The ILO's special adviser in Burma has helped people get out of jail, has helped rescue child soldiers, and has actually engaged the military in dialogue on forced labor.
  • In Belarus, the ILO's Governing Body has been in perfect sync with the Bush Administration's goal of pushing for democracy, both by condemning Belarus for its lack of freedom of association and by at the same time offering to work with the government to move forward.
  • In Zimbabwe, thanks to the workers and employers--and with no thanks to countries like South Africa or China--the ILO has been in the forefront of criticizing the atrocities of the Mugabe regime. In the labor area, this includes the systematic arrest, detention, and harassment of trade unionists. At its last session, the Governing Body decided to send to Zimbabwe a Commission of Inquiry, one of the highest-level investigatory missions available.
  • In regard to Iran, the ILO has regularly condemned the Iranian government for arresting and imprisoning independent trade union leaders and for its record on discrimination in the workplace.
  • And in Colombia, the ILO--largely at the behest of the United States--has established an office on the ground to help address key labor issues, including violence against trade union officials. The Colombian government, the busi­ness community, and the labor unions themselves supported the establishment of the office.
In addition to the tremendous work on child labor, forced labor, and trafficking, the ILO also supports U.S. efforts to bring about democratic reform in the Middle East, assisting the Department of Labor with State/Middle East Partnership Initiative-funded projects in Bahrain, Oman, Morocco, and Egypt, and work mandated by Congress that supports the CAFTA-DR[1] trade agreement. And in collaboration with the ILO, we've recently launched new projects in Tanzania and Haiti.

The Other Side of the Story

There's also another side to this story. Go to the ILO Web site or look at the Director-General's speeches over the past few years. You won't find very many references to all of the good work I've just described. What you will find are articles and speeches that deal with the ILO's role in:

  • Climate change and energy policy,
  • Reforming the international monetary system,
  • Changing the rules of the international trade system,
  • Addressing international investment issues,
  • Addressing the global food crisis,
  • Mandating social policy for individual countries, and
  • Suggesting that the ILO take the lead in addressing global social policy in the current economic crisis.
Here's an example: Speaking at the Vatican on Human Rights Day in December, ILO Director-Gen­eral Juan Somavia said, "We have a multilateral sys­tem that is underperforming. It is not delivering the type of policy coherence we need today. There is a profound need...for a new form of global gover­nance...a global community of multiple actors including, but going beyond governments."[2]

Here's another example: In November, the officers of the Governing Body issued a statement calling for six steps to be taken to address the financial crisis. I won't enumerate them, but among them were:

  • Ensuring the flow of credit to consumption, trade, and investment;
  • Supporting productive, profitable, and sustain­able enterprises, together with a strong social economy and a viable public sector, so as to maximize employment and decent work;
  • Maintaining development aid as a minimum at current levels and providing additional credit lines and support to enable low-income coun­tries to cushion the crisis.
I would note that in the discussion of the crisis at that Governing Body in Geneva, only one party not­ed the importance of the ILO working to ensure that basic workers' rights would not be lost in the shuf­fle: It wasn't the workers' group or the European Union--it was the United States.
In short, the key problem is that the ILO is seek­ing to become the world's lead institution in addressing the social consequences of globalization. This is not a conspiracy theory; rather, it's a point made regularly by the Director-General. The world of work, a challenging field unto itself, suddenly loses importance and instead becomes a platform for launching all sorts of social projects.

That's why we have been very concerned about a new instrument that was adopted by the organiza­tion's conference just this past June, called the ILO Declaration on Social Justice for a Fair Globaliza­tion.[3] The title alone suggests exactly what is wrong with the ILO at this time. What is worrisome is that it opens the door to efforts to attribute universal applicability to conventions that heretofore would be relevant only if a country formally ratified them. That means, for example, that select conventions on employment and social protection could conceiv­ably take on the status of agreed international prin­ciples without our consent.

Now we, of course, would not honor this. Suffice it to say, it would be appalling, both morally and in terms of economic efficiency, if an international organization were to determine the "right" balance between employment and social protection.


How well are these resources managed? In short, not well. The ILO fails to ensure adequate impact analysis of its programs. We receive reports from them on what they did and how they managed pro­grams, but we can't get answers to questions like, "What do we get for the $10 million spent on Project X?"

When our Secretary of Labor raised this with the Director-General, he replied, "You have to realize that it's sometimes very difficult for the ILO to mea­sure the impact of what we do. After all, we don't sell shoes. We hold seminars. We give advice. And how do you measure the impact of advice?"

Perhaps there is something to be said for that question, but for an organization that spends almost one-half billion dollars per year, that's not enough.


The ILO is the only tripartite organization in the U.N. system--that is, the only organization in which each country is represented three ways: by representatives of the government, employers, and workers. In my view, this tripartite nature is both the strength and the weakness of the organization. The good part is that it includes the private sector and civil society. But there are two difficult issues.

  • First, the ILO is disproportionately run by workers--and, to be exact, by trade unions. Workers see the ILO as their organization, but if its outputs are going to be useful, governments and employers have to see it as their organiza­tion too. This drove the International Organiza­tion of Employers earlier this year to stand up and demand that the ILO ensure "that employer priorities, objectives and resources are treated on an equal basis with those of the workers." This might not be easy: Just a year ago, during a discussion on "sustainable enterprise," the rep­resentatives of workers objected to any inclu­sion of the word "entrepreneur."
  • Second, governments are being marginalized. If workers and employers agree on an issue, the views of the governments--the funders of the Organization--become irrelevant because the worker-plus-employer majority is declared to be "consensus." Something must be done to address this issue.
At some point, the ILO's tripartite structure must be evaluated. Is it right that the 10 percent of work­ers in this country who are unionized should be allowed to speak for the entire American workforce? The same holds true for many other countries.

There are many times when the interests of orga­nized labor and the interests of other employees may differ significantly. Perhaps thought should be given to including other worker groups--maybe professional associations or entrepreneurs or non-governmental organizations--to better represent the real workforce. I don't have an easy answer to this, but it's something we will surely have to deal with in the future.

What Should the ILO Be Doing?

What should the ILO be doing? Here's what I would suggest. It may not be glamorous, but we think the ILO could--and should--focus its activi­ties on helping countries improve their capabilities in these areas:

  • Labor Law and Implementation. [...]
  • Building Capacity. [...]
  • Child Labor, Forced Labor, and Trafficking. [...]
  • Fewer International Meetings, More Work in the Field. [...]
  • Corporate Social Responsibility. [...]


As we look at the problems and the potential of the ILO, it's worth asking the question, "If the ILO disappeared tomorrow, would we need to replace it?" Or, as I said in the blurb for this meeting, "Can the ILO be saved from itself?"

The short answer is yes; the ILO could be a very useful tool in addressing many of the issues the world faces in the era of globalization. Both the United States worker and employer representatives agree on this.

Unfortunately, the ILO is veering further from, rather than closer to, being in a useful position. I hope that the new Administration, which has given much attention to labor issues, will use its influence to push the ILO to do its real job: to create better opportunities and better workplaces for working people, to promote job creation, to help provide businesses with the skilled workers they need, and to help boost economic development and prosperi­ty around the world.

Charlotte M. Ponticelli, at the time of this lecture, served as Deputy Under Secretary for International Affairs at the U.S. Department of Labor. She has also served in the U.S. Department of State as Senior Coordi­nator for International Women's Issues and Senior Advisor to the Assistant Secretary for Population, Refugees and Migration, and on the U.S. Commission on Civil Rights.

Full article w/references here