Speculation behind global commodity price rise

By Ramgopal Agarwala

03/08/08 "Economic Times' -- - There is now a growing discomfort about the
role of speculative finance in the US, the capital of global finance. In an
open letter addressed to all airline customers, leaders of airlines in the
US have recently requested the passengers to join them in pushing
legislation to add more transparency and disclosure in the oil markets.

They argue that "twenty years ago, 21%% of oil contracts were purchased by
speculators who trade oil on paper with no intention of ever taking
delivery. Today, oil speculators purchase 66%% of all oil futures contracts,
and that reflects just the transactions that are known. Speculators buy up
large amounts of oil and then sell it to each other again and again. A
barrel of oil may trade 20-plus times before it is delivered and used; the
price goes up with each trade and consumers pick up the final tab. Some
market experts estimate that current prices reflect as much as $30 to $60
per barrel in unnecessary speculative costs."

Speculators have indeed sharply increased their allocation to commodity
markets from $13 billion in 2003 to $260 billion in 2008 and at present they
are not adequately constrained by rules about margin requirements and other
regulations about buying and selling which apply to equity trades. In fact,
there has been further deregulation in the US in recent years with respect
to speculative futures trading in oil and commodity indices covering a wide
spectrum of commodities including food and metals.

Eminent financiers such as George Soros and powerful US senators, such as
Joe Lieberman, are arguing that commodity index speculators are a big part
of the increase in commodity prices. Michael Masters, a hedge fund manager
in his testimony before the US Congress, has said that gasoline prices could
fall to $2 a gallon, half of today's price with legislation barring
commodity index funds. There are now more than 10 legislative proposals
before the US Congress calling for better regulation of commodity index
markets.

At the same time, there are powerful forces in the US against regulation of
such transactions. Investment funds managers and investment houses such as
Morgan Stanley are benefiting from these speculative activities and they are
mobilising public opinion against increased regulations. California's public
employees' pension fund, the world's largest, earned a 68%% rate of return on
its investments in commodity futures and other investors are rushing in
commodity markets.

The vested interests are trying to divert the attention from regulation by
arguing that other factors, including growing demand from emerging markets
such as China and India, is responsible for commodity price increases. This
game of blaming emerging economies in which the President of the US has also
joined is patently absurd because the rapid growth in India and China has
been going on for more than a decade with no increase in commodity prices
even in nominal terms and cannot explain the sharp increase in last two
years.

Other factors such as drought in Australia and switch of corn to biofuels
can explain part of the increase in food prices but none of them can explain
increases of more than 100%% in many commodity prices in a single year as it
has happened in 2007 and 2008. There is little doubt that speculative
finance is a key factor in sudden price increases in oil, food and metals in
the last two years. Amartya Sen in his classical work on famines pointed out
that even when supply situation for food is healthy, famines can occur
because of collapse of purchasing power of the common man. Today we are
witnessing a phenomenon of food riots caused by food price increases due not
to demand-supply imbalance but to greed of speculators facilitated by lax
regulatory system in the key trading centre of the world.

Given the play of vested interests in US Congress it is not clear which way
the legislation on regulating speculative finance in commodity futures will
move. Policymakers in developing countries in which price increase in fuel
and food are matters of life and death for the poor cannot remain silent and
accept vulnerability to the price fluctuations originating in developed
countries' financial markets. This must reflect on what they can do to
safeguard their people against the onslaught of the speculators in foreign
lands?

Over the long-term, the dominant role of a few commodity markets in the West
must be reduced. As the centre of gravity of the world economy shifts to the
South and South is becoming a dominant source of both demand and supply for
commodities, it must develop its own markets with its own rules.

However, in the short run when the contagion effects of the markets in
developed countries are still strong, the South must stake its claim in
contributing to reform of the regulatory systems in the developed countries
because its vital interests are involved. It should not remain silent when
the contagion from developed economies is leading to mass starvation in its
economies. It should demand, perhaps through international forums such as
G-20, proper regulations in the developed countries so that the greed of the
few in developed countries does not lead to misery of the many in the
developing countries. It should also use its leverage through institutions
such as Opec to persuade the developed countries to check the excesses of
speculators which could have adverse effects in the long run on both
producers and consumers of oil.

(The author is with RIS, a New Delhi-based research organisation)

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