OIL SPECULATION

Oil speculation is a very interesting topic that relates to more than just aviation.  It affects the cost of heating many homes, and more importantly, the cost of transportation.  Of course transportation doesn't only include the population driving or flying, but the shipping of goods.

This post will try to explain what oil speculation is for those who may not know.  There is an article by Money Magazine that really does a nice job.

Oil speculation is the process of purchasing oil futures with the intent of making a profit.  This is usually done by people or investment companies that have very little to do with the oil industry.  Oil is a commodity that can be purchased just like grain or livestock.  When an investor purchases a commodity at a certain price, they are hoping the market price increases so they can eventually sell at a higher price.

The Commodity Futures Trading Commission (CFTC) was established by Congress in 1974.  Their purpose was to regulate the trading of commodities.  Enron, as well as others, lobbied Congress in 2000 to help reduce CFTC's powers.  Enron created specialized software for oil futures to be traded.  In the same year, a group of oil companies and financial institutions, headquartered in Atlanta Georgia, created the Intercontinental Exchange (ICE) in London.  It was an exchange set up to trade European oil futures, and since it was in London, CFTC did not have any regulatory power.

After this groundwork was done, investment companies and financial institutions heavily increased their oil futures trading.  Their buying and selling created a "false market" that was no longer dependent upon supply and demand.  Oil companies enjoy this type of trading.  As the price of oil futures increases, oil companies recognize that they can charge in elevated price regardless of supply.  They will stock pile oil and gasoline anywhere they can if production is higher than demand.  I have personally known gasoline distributors that fill empty tanks at gas stations that were closed in order to store some of the excess gasoline. 

Money Magazine featured a different article that discussed airlines' fuel consumption.  They estimated that fuel can consume up to 40% of an airline's budget.  It is easy to see how falsely elevated fuel prices can affect the airlines.  Fuel costs alone can determine if an airline makes a profit or not.

So what is the difference between oil speculation and fuel hedging?  Southwest Airlines has arguably had one of the best fuel hedging programs since the 1990's.  It has been the biggest reason for their financial success (unless you think people actually enjoy lining up like cattle to board without an assigned seat).  The biggest difference between Southwest Airlines pre-buying fuel, and an investment company buying oil futures is that Southwest Airlines will be using that fuel themselves.  An investment company is only hoping the price of oil increases so that they can sell for a profit.  It is now estimated that 60% of what is paid for fuel is due to oil futures trading!

It is very difficult for me to express how I feel about this topic.  I HATE paying the current prices for gasoline, and I would love to be able to purchase cheaper airline tickets.  I would also like to know that the airlines in this country could compete better in the global market.  However, I am an advocate of living in a free country.  I do not always think that more regulation is the answer.  I think that the free market should be allowed to work itself out.  The airlines continue to find new ways to earn income.  Delta has a large maintenance program (which performs maintenance on more than just Delta airplanes) that produces a nice profit for them.  UPS has become a large player in small business loan lending.  Maybe the airlines could create an organization that is somehow involved in the oil industry.  In my opinion there are many options to explore before trying to have the government pass more regulation and have more control.

There is a current bill that was assigned to a congressional committee on September 21, 2011.  Click here for a discussion about the bill, or to track its progress.  The part of the bill that could most impact the airlines would be the limit on any single trader to only be able to hold 5% of the oil futures.  This would prevent some of the excessive prices, but I do not feel it would eliminate the problem completely.  Investment firms will always find loopholes, and creative ways to get what they want.  In addition, every company involved in futures trading is attempting to make money, and can easily coordinate with other companies to continue making money.