Happy National Pancake/Leap Year/Week before Super Tuesday Day, all. It has been a turbulent past few months and not just in the oil market. I will get into why very shortly but, for now, let’s just say that after a long and dark winter, I am once again available for dancing in the streets. Without any further cryptic remarks, I’d like to share an interview I just did with The Global Journal, based in Geneva, which rang me up to discuss ‘The Asylum’ and what the future holds for the energy market and gas prices during this, our illustrious Election Year.
(Q portions courtesy of Janine Huguenin-Virchaux, the magazine’s books and culture editor.)
Your book mentions that “the market is no longer reflecting supply and demand.” What is the use of a market that does not reflect the true price of oil? Do we need new hijackers?
That’s a great question – do we need new hijackers? If we could get some hijackers that could take back the market so that it does reflect supply and demand more clearly, then I would say yes, we do! However, I would also say that there is a serious debate going on about the extent to which price does reflect supply and demand. I think there is very good reason to believe that the price does not reflect it anymore. There is also a very technical reason for what has been going on that has not really been acknowledged or understood by many people. And that is the relationship between speculation and price discovery. A lot of the information that I get is from people who read the book and then they come to me and bring me stuff that nobody seems to really know about.
A lot of these guys are just regular traders who trade physical oil and feel that supply and demand is not reflected in the price correctly anymore. Whereas their entire lives – some of these men and women have been trading oil for thirty years or more – they feel the price did reflect it. So they believe there’s a huge difference in what they are seeing today in terms of the market fundamentals versus the price. And what they used to do was see price and fundamentals fit together better. They see a lot of distortion happening now. A lot of these people are concerned with that. I want to say, it’s not all about making money for these people: some of them look at this and say “Oh my God, it’s not acting the way it used to anymore and it doesn’t look like it’s headed anywhere good.” And that is aside from the fact that trading has become so ferocious that it is more about preserving a global casino than about supplying oil to people who need it.
That’s the problem. The casino aspect overshadows everything. Most of the people who play this game don’t want oil. They just want to play the game.
What is the alternative? I mean, these are the people who are speculating on the price of oil. Is there anything that can change to make it different? To make it less casino-like?
Yes, I think so. I am considering writing about this much more, the nature of speculation…I believe that speculation is an amazing thing. When you consider the wonderful things it has done for markets, moving supply to where it is needed the most in this world, it can be extraordinary. However, as we all know, there is such a thing as too much of a good thing. And speculation, while it can do wonderful things, can also do bad things. And I think that is often what we are seeing today. When you look at, for example, the market for water in the United States, and for most of the world, it is one of the last very highly regulated markets and one of the reasons that it remains sound in our country is that you cannot trade it unless you are actually going to take supply of water.
So, if you are not going to handle physical water, literally, you cannot just bet on its price. You cannot get a contract for real water and then buy and trade it for fun. It’s a process. You must be someone who is in this market to actually take delivery or sell it to someone. And you will go to jail if you are found to be doing differently. The problem with speculation in some of our other important resources is, we do not have these kinds of safeguards in place that we have for water. So, water does not have a problem, oil, of course, does.
But do you think we could do the same with oil? Or is this so out of proportion that it is not possible?
I think anything is possible. Certainly we could control who gets to participate in the market, as with the water example. A lot of this is also about leverage. Right now, for every real dollar of cash you see going into this market you see a lot of borrowing going on. You can change a lot of those rules if you want to.
The big problem with that is, this market has been developing for decades. You have a lot of people whose jobs now depend on the trading community and its health. People with families who are oil traders, who thought that speculation would always be the way it is. These people draw their livelihoods from consultancies, banks, hedge funds. Many people in Washington have strong ties to this industry. To take an entire industry apart is something I have never seen done as a writer. I have never seen a large group say, “This is no good, let’s just tear it down and rebuild it.”
The incentive to keep things the way they are is much greater because the rewards are much greater. To bring this back to something that makes sense means a lot of people will have to give up a lot of rewards and people are not good at that. To really address it is to actually take a lot of money off the table.
With the renewable energy resources coming into the game… because of the way the market works, everybody wants to make money as long as they can, do you think that anyone will even invest in alternative energy?
I do think that a lot of people in this market are open to making investments in projects that look like they are going to have some legs. The big problem is, a lot of this technology is what I would call a science experiment. I mean, you can come up with some really great options for small regions, sustainable solutions that can be applied to several counties or states, or part of a state. But a lot of the smart money wants a silver bullet. They want something that can save the entire country’s energy problem in a way that is green.
I do believe that, just looking at the smaller projects and talking to people, the real solutions are mostly going to be highly localized – meaning energy based on the resources of each region of the country. So, maybe one region has more water, one region has more sun…a lot of these projects have to be specific to the region to be truly sustainable and tailored to the region’s needs and resources. And those projects seem to be very doable. The problem is a lot of the people who want to fund these kinds of things only want to fund something extremely high-wattage. So these smaller projects – which are provable and could work – get overlooked because the smart money is still enthralled by the concept of a big silver bullet. And I don’t know if there is one. I believe probably not.
These smaller projects we could start funding immediately and use as models and say, “Look at this entire community, several counties that are completely self-sufficient and sustainable and green.” Hold them up as examples. I think people would be a lot quicker to say, “Oh, I want to have that in my community too; let’s figure out a way to do it here.” You don’t need a silver bullet. But you do need to have people who are willing to take a chance, start small and think big.
I think a lot of these people have an old-world-way of looking at things; they just want to drill more oil. They are living in the past. Or they only want to create some kind of new whiz-bang technology that will fix everything.
When the Emir of Qatar says that they are willing to look into developing renewable energy resources and that they would be behind something like that, do you think he speaks the truth or is this just paying lip service?
In the end, they are making more money off of selling oil. I think the Middle East may be one of the best places to look to get information about where we should be headed going forward. The reason why, as my time in the Middle East taught me, is that they are very aware of the fact that liquid oil is not going to be around forever. And they are already planning for the eventuality of oil running out.
But nobody is releasing information on how much oil there is left. That is the sense I got from reading the book: everyone is hiding how much they have left.
You mentioned Daniel Yergin. In an editorial in The Wall Street Journal he said that everyone should be happy that oil is here to stay because for every one barrel of oil consumed 1.6 barrels have been added to oil reserves. It sounds very comforting, but the problem is that oil reserves are very dicey numbers and they get adjusted all the time – not in a way that can be independently verified for the most part. So Saudi Arabia might say “Don’t worry, we have X amount of barrels so everyone calm down.” But the problem is that no one can check to make sure it is true. Not really helpful.
To go back to NYMEX, Goldman Sachs is blamed for a lot of the mistakes that were made in NYMEX. Do you agree? Where did things go wrong and if you could change anything, what would it be?
Good question. First, I would say that the leverage in this market is outrageous. For every barrel of oil that actually gets consumed, dozens of barrels are traded. I don’t need my barrel of oil to be traded that many times when I know that each time it trades, somebody is looking to take profit. Let’s say we have one barrel and it’s traded 50 times before it’s actually consumed. I don’t really need to pay for all those middlemen, it’s not very interesting. I don’t want to buy a car that was sold and bought that many times right before I bought it. It is not a persuasive pricing model.
In addition, you have these people buying and selling oil frequently without actually putting any money into their trades. If you are a day trader in this market, you don’t have to put any money down at all during the day that you are trading. You can trade a huge amount of oil without any money down, but you have to reconcile those trades at the end of the day. The ease of being able to just trade up a storm is a little too easy, I think. And that developed over time; there was not just one event that led to that. The barriers to enter over the years became lower and lower and lower. It was hard to get into this market in the beginning, it was a club, and now you have computers.
Then there is the fact that banks like Goldman, a bank that is known for being very aggressive, has been very, very smart at trying to look at the rules, while not breaking them, and effectively finding ways around the rules. Goldman wants to be aggressive, but they are not looking to break the law. It is not in their best interest to actually break the law. They are just looking to work the system and sometimes bend it in the cleverest ways possible. And they do it very well. So, in 1991, a group of Goldman traders who felt that they were not able to trade as much of the commodities in the U.S. as they wanted attempted to bend the rules. There were limits in place after the Great Depression on how much you could trade of a given commodity. Washington basically said, “We don’t want someone controlling too much supply” – in today’s terms, “We don’t want to have a single bank trading 89 million barrels a day of oil contracts because that is the total consumption of the world.” This group of traders at Goldman got together and said in a note to the Commodity Futures Trading Commission – which is the watchdog agency for this market in Washington – “We would like to trade a greater amount of products and we feel we should be able to, because we represent a lot of companies that use physical products and we are representing them and, even though we don’t care about physical products ourselves, we’re doing this on behalf of others who hire us to trade for them. So can we have an exemption?” And they got it, they got an exemption.
They knew who they were asking; they were asking Wendy Gramm who was a laissez-faire type of CFTC chairman. And her husband was a Senator who was also very free-market. So you can say that those two should have known better, that Wendy Gramm, the chairman, and Phil Gramm, the Senator, should have been more careful, but I think they really felt strongly that they were doing the right thing for the market. It turns out that what was created was an unbelievable casino. But that’s the point. At the time, it was unbelievable. At the time, a lot of people did not know what was going to happen. A lot of what you can see in this market – a lot of the experimenting with the different rules and regulations – some of it is genuinely done in hopes that things will go well. Some of it is done by people who don’t care about causing problems, because the money is just so good. But there are a lot of different people involved. It is not just one kind of person.
In terms of global governance, what should be learnt from the NYMEX story? in terms of the impact it had on the global level?
It is hard to boil it down to just one thing, but if there is one important thing, something that needs to be looked at in the future real closely, it is that we do not have a legal superstructure, or market regulatory superstructure, or an environmental superstructure on a global scale that will allow us to truly solve our deepest problems. All our laws, rules and regulations are very specific to the country you are talking about. Because things are getting increasingly interlinked – oil, the dollar, the stock market, all sorts of triggers related to supply and demand, credit, commodities and the fundamentals of those – we require a global solution. Something that can be applied across the entire planet. We don’t have a financial or legal superstructure in place to do that. We don’t have it with the environment, either. But these are things that from a very high level are being looked at by very smart people. Because right now in the market – and we can see it with the NYMEX oil story – you have regulatory arbitrage, where the market tries to go wherever there is the least amount of rules. So if you think you can have fewer rules in Cyprus, you go to Cyprus and set up everything there. It is definitely a situation where as long as we can arbitrage our way out of following rules and regulations by changing our base of operations, different parts of the market that really need to be protected will go unprotected.
Global governance can address some of this. What happens right now in the U.S. is that we are trying to put new rules in place for our markets, but other places – including the UK and Europe– are quite keen to use it as a way to compete with us. So it’s almost a game of the least protected market wins, which is bad. In market parlance, it is what is commonly called a race to the bottom. If you want to change something, then someone else will come along and take away what you’re trying to change and make it bad somewhere else.
The U.S. keeps forgetting that the reason so many people took us seriously in the first place is that we were considered a safe place to do business. We are now becoming increasingly less safe, because of all the loopholes we have created and the slipshod ways in which we are trying to fix them. It is not good for the long-term financial health of the country, of any country, to allow for this because it will be seen as a less and less safe place and people are going to look for places that seem to offer something more.