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Are Oil Prices Rigged?
Ari J. Officer and Garrett J. Hayes Friday, Aug. 22, 2008
We've all read that speculators are driving oil prices artificially high a
claim that gets more interesting in light of oil's recent fall below $115.
But maybe we're looking at it from the wrong perspective. Suppose that major
suppliers in the oil industry are these manipulative speculators.
Is it possible that oil prices are rigged? You bet. Here's how:
Just how would you raise prices if you were an oil supplier? Controlling
the supply as in the 1973 OPEC embargo has become less effective with
more sources of oil worldwide. And oil suppliers clearly cannot raise
prices by controlling demand in the physical oil market; ultimately, they
need to sell their oil, not buy it. However, with the market inefficiencies
that we expose here, oil suppliers can regain the upper hand by artificially
inflating demand using a different market. To understand this mechanism, we
must take a glimpse into the future the futures market, that is.
The price of oil reported in the news is actually the price of oil in the
futures market. In this market, traders do not exchange physical barrels of
oil, but instead trade contracts which obligate them to exchange oil at a
quoted price at a specific date in the future, usually months in advance.
Such a contract allows companies to hedge positions by locking in prices
early. Airlines might buy futures contracts to reduce their exposure to
rising fuel prices. Conversely, oil companies might sell futures contracts
to assure a profit against future price drops. It's all about reducing risk
and uncertainty. But what if oil suppliers were instead buying oil futures,
compounding their own risk and reaping enormous profits from the explosion
in the price of physical oil?
The futures market has become the public driving force in pricing oil. But
the vast majority of oil consumed in the world is purchased through private
deals, given the massive undertaking of physically delivering millions of
barrels. However, a series of private deals cannot establish a market
price. Because pricing in the futures market is transparent, in that trade
activity is publicly available, it establishes the widely accepted benchmark
for the price of oil. In other words, the futures market serves as the
price discovery mechanism for the oil the world consumes.