U.S.: Avoid Oil Speculation Overkill?

President Barack Obama’s latest policy initiative to take a more aggressive stance against manipulation of oil markets received mixed reactions. The proponents of the measure, including Chairman of the Commodity Futures Trading Commission (CFTC), Gary Gensler, welcomed Obama’s proposal, noting that it “build[s] on progress the CFTC has made in making the unregulated swaps market more transparent and implementing new anti-fraud and anti-manipulation reforms.”  Other federal agencies, including the Energy Information Agency, pointed out the role of oil supply disruptions from unstable parts of the Arab world as well as temporary interruptions from Canada, China and Brazil due to technical problems were key factors in elevated crude and gasoline prices. 

A bigger argument against Obama’s policy initiative appears to be that high oil and gasoline prices are not because of the presence of financial investors in the oil futures markets and “there is no evidence that the bulk of the financial investors taking positions in oil futures markets since 2003 have engaged in such activities.” According to the Chicago Mercantile Exchange (CME) Group, which sets margins for the benchmark U.S. crude oil contract, “speculation should not be confused with manipulation.”  Still, it is interesting that “speculators tend to buy crude when there is a strong underlying reason to do so such as the loss of Libyan crude last year or sanctions and possible military action against Iran” this year.  In fact, higher oil price bets by speculators at times of an anticipated supply crunch from Libya and Iran increased prices by $15-$20 a barrel. 

At this point, a prudent approach for the Obama administration to understand the oil futures market may be to monitoring it better, particularly since it plans to increase access to CFTC’s data, before setting trading margins on the market.  The latter may carry unintended consequences, such as making prices more susceptible to swings by squeezing out smaller investors out of the market and giving more influence to bigger hedge funds and banks.

New Federal Emission Caps on Fracking: To Be or Not to Be?

The Environmental Protection Agency’s (EPA) new cap on emissions in drilling natural gas this week is the first federal ruling to tackle air pollution tied to hydraulic fracturing.  According to EPA, the new standards would reduce the release of toxic and carcinogenic chemicals such as benzene, hexane and methane.  Natural gas producers would have two years to comply with the new standards.  Although the American Petroleum Institute (API), which represents 500 oil and gas companies, argued that the new standards would slow down the production of domestic natural gas and cost hundreds of millions of dollars, some gas drillers did not think the costs would slow down the gas boom in the U.S.   Gas producers, such as Southwestern Energy Co. and Devon Energy Corporation, stressed that they already have technology in place to capture fugitive methane, an important greenhouse gas. 

Pollution related to drilling natural gas does remain a source of concern.  For example, emissions from gas wells in Wyoming attributed to the increase in ozone levels to the degree that the government may need to “declare parts of the state as an ozone non-attainment area.”  But drilling for gas has not been delayed in Wyoming or Colorado, “where technology to capture emissions has been required by state since 2009 and 2010.”  Development of shale gas in Arkansas’ Fayetteville Shale by Southwestern has been also relatively successful due to cutting costs of emission capturing from $20,000 per well to zero.

While EPA’s new environmental measure is a step towards improving environmental standards of the booming shale gas industry in the U.S., there is a potential for over-regulation of the industry or duplication of efforts already undertaken by the industry to control emissions.  Shale gas has completely transformed the U.S. energy landscape, making the country self-sufficient in natural gas.  The low cost natural gas is reviving the manufacturing and chemical industries in the U.S., shifting the heavily coal-based utility sector to gas, and bringing down the prices of heating and electricity to consumers.  Regulatory slowdown of the industry would have unintended consequences to the economy. 

At this point, addressing casing and cementing of shale gas wells as well as usage and treatment of the flowback water appear to be the most important environmental challenges facing the industry.  But before slapping a one-size fits all regulation to appease environmental groups, it is also crucial to look at functioning state regulations that already exist as well as voluntary self-regulation practiced by some gas producers to avoid major accidents.

U.S. Energy Independence: Optimism with Caution

A recent announcement by the White House that onshore drilling permit application reviews would be cut by 80 percent is good news of the month. According to the Secretary of the Interior, Ken Salazar, the measure will “make oil and gas permitting and production on public lands a reality [and] the automated permit application process, which is expected to be in place in early 2013, would be similar to a program already in place for offshore drilling permits.” The new automated processing of applications would reduce the permit review process from 298 days to about 60 days. With gasoline prices highest since 2008, Republicans criticized the Obama administration for foot dragging in issuing drilling permits and obstructing exploration and drilling in public lands. Simplification of the review procedure will further help usher the development of energy in the U.S., which has seen a renaissance over the past five years thanks to shale gas and oil supplies.

As access to federal lands for oil and gas exploration expands, some analysts optimistically predict that the U.S. is bound to significantly increase domestic oil production and reduce its dependence on foreign oil. According to Raymond James and Citigroup, U.S. oil imports will fall from 9.8 million barrels per day (mbpd) in 2011 to 4.5 mbpd by 2015 and reach zero net imports by 2020. Analysts in these companies believe that ramped up deepwater production from under the Gulf of Mexico and natural gas liquids output will account for such a dramatic change in the U.S. energy landscape.

This forecast seems to be overly optimistic. While increased domestic oil production is an important factor behind the growing U.S. energy independence, changes in the country’s hobbling economy, weak oil demand, increased physical supply, or the above average increase in crude inventories may carry implications on how the U.S. energy market would evolve. In other words, it may be too ambitious and misleading to put definitive timeframes by which the U.S. would be a zero net importer of oil. Another important factor that continues to impact oil prices is the role of energy market speculators, an interesting perspective on which is given by Forbes:

The U.S. oil production increased since 2008 from 4.95 mbpd up to 5.59 mbpd [but] is so small that U.S. supply increases have no discernible impact on the price. If oil prices were determined solely by supply and demand for oil, U.S. production might matter more to the price. But what matters most to the price of oil is the positions that speculators — who do not take delivery of oil – take. When oil hit $147 a barrel [in 2008], investigators found that those speculators accounted for 81% of the trading volume in the oil markets. There’s an easy way to take those speculators out of the oil price equation: raise the amount of capital they need to invest in their bets on the direction of the price of oil. And when the commodities exchanges require the speculators to increase the amount of their own capital — dubbed margin — into their bets, the price of oil seems to go down.

It is hard to imagine the U.S. energy market not to continue being impacted by global oil prices and by speculators in the future, given that it is already happenning at a time when the country has reduced dependence on foreign oil and boasts highest domestic oil production in eight years. Do correct if I am wrong.