Oil price volatility has assumed center stage. It is on the global radar screen – albeit with a difference. Consensus seems finally to be evolving into supporting a price that is detrimental neither to the consumers nor to the producers. Reigning in speculation is also becoming a priority, but all of this is easier said than done; there are many pitfalls to be confronted.
Producers have been insisting on price stabilization for some time, though with a different perspective. At the producers’ level there has been stress on a fair-price regimen with increasing hints that a price around $75 is fair. At a point in time, even President Nicolas Sarkozy had seconded the idea. This is indeed a very interesting and encouraging development. After all, consumers and producers rather desperately need each other.
Two interrelated issues are now up on the global agenda. Wild swings experienced by the oil markets over the last 18 or so months, and the pain and anguish that it has caused to a vast majority, has finally caught the attention of the mighty few. Heavyweights on the global stage are now conceding that the ongoing price volatility is “defying the accepted rules of economics.”
Others agree.
“Crude oil prices appear to have been divorced from the underlying fundamentals of weak demand, ample supply and high inventories,” Deutsche Bank cited in a recent report.
All this has sprung the world into immediate action. It is now one of the major tasks being taken up by the Riyadh-based International Energy Forum (IEF) secretariat. While talking to me earlier this week, Secretary General Noe van Hulst said his organization is focusing on resolving the issue.
The High-Level Steering Group established as a follow-up to the London Energy Meeting (which took place in December 2008) seems to be getting seriously involved with looking at the causes of volatility, including the links between the financial and energy markets. The outcome and recommendations will be presented at the next IEF Ministerial in Cancun, Mexico next March. The subject was also one of the major issues at the just held G-8 summit on Monday, where British Prime Minister Gordon Brown and French President Nicolas Sarkozy agreed to present a joint front for action on oil.
Demanding an investigation into how oil is being impacted by speculation, both the leaders went on to say in a joint statement that “governments can no longer stand by” and asking regulators to “look again into the question of whether trading activity is amplifying erratic price movements,” underlining that, “volatility damages both consumers and producers.”
There have also been some talks of putting in place a price band. “The Expert Group of the International Energy Forum should take the lead in establishing a common long-term view on what price range would be consistent with the fundamentals,” Brown and Sarkozy insisted in their joint statement.
These experts should also consider any measures that could be put in place to reduce volatility. And they should look again at whether trading activity is amplifying erratic price movements, they insisted. However, despite the issue of price band mechanism under intense focus, it seems very unlikely any such price-fixing mechanism will be put in place. BP chief economist Christof Ruehl, who was in Riyadh earlier the week, does not favor the idea, saying, it would economically lead to an inefficient allocation of resources, it would be a bureaucratic nightmare, and practically it would not work.
Brown and Sarkozy also called upon the International Organization of Securities Regulators to consider improving transparency and supervision of the oil futures markets in order to reduce damaging speculation.
And they had ample ammunition for the suggestion that extreme fluctuations in price are encouraging energy users to reconsider their reliance on oil. Producers are in danger of finding their key national resource loses both its market and its long-term value, the two leaders emphasized.
Volatility has forced Washington into action too. Earlier this week, federal regulators in the US announced they were considering new restrictions on speculative traders in markets for oil, natural gas and other energy products. The move is a big departure from the hands-off approach to market regulation of the last two decades.
The US Commodity Futures Trading Commission said it would consider imposing volume limits on trading of energy futures by purely financial investors and that it has already adopted tougher information requirements aimed at identifying the role of hedge funds and traders who swap contracts outside of regulated exchanges like the New York Mercantile Exchange.
“My firm belief is that we must aggressively use all existing authorities to ensure market integrity,” said Gary Gensler, chairman of the commission, in a statement. He said regulators would also examine whether to impose federal “speculative limits” on futures contracts for energy products.
Gensler appears focused on two basic goals. The first is to limit the volume of trading by purely financial investors, the “speculators,” as opposed to businesses like airlines or oil companies that consume or produce oil and want to minimize their exposure to big changes in price. According to data compiled by the Commodity Futures Trading Commission, other non-commercial traders accounted for almost one-fifth of the activity in several major oil and gas products for June.
The commission also announced that it would pull back part of the veil on the oil and gas markets, publishing much more detailed information about the aggregate activity of hedge funds and tapping into new information about traders who swap energy contracts outside of traditional exchanges.
The world seems converging on a more stable path from here – the route though, is still to be decided. Yet this is a major step in the right direction and the energy fraternity needs to welcome the initiatives.