Oil above $70? Making sense of the nonsense

High unemployment, excess supply and reduced demand for oil, gas and all the byproducts would lead one to believe oil must be around $35/barrel right?

Actually, oil prices have risen over 70% this year without a gasp or pull-back. Sound strange? Sound manipulated? Who is to blame?

Instead of placing blame or using the proverbial bazooka to kill a fly, a simple rule change could bring a market based solution to the inability of the oil trade to align itself with the "true" market for oil, gas, and all the byproducts. If one doesn't believe me that the current market for oil doesn't reflect true economics simply read the stories perpetuated about why prices have increased. "The economy is showing signs of recovery," "Concerns over policies in the middle east geared to reduce supply," "Dollar weakness," are all nonsensical parodies to deflect a reasonable person from understanding the true nature of these remarks.

Such remarks are signals between the world of speculators, traders and market manipulators to validate why prices change. This is not signaling in the sinister sense of the word, at least I hope not, but rather agreed upon inferences about price increases. Since these stories tend to be correlated to price increases, traders, speculators and market manipulators perpetuate that reality by buying in unison making them de facto causal. The only causal connection between any of these "stories" is that the purchasers of oil futures contracts understand them to mean something. It's literally "Morris Code" for the market.

The stories aren't "causing" anything, the traders, speculators and market manipulators are causing the change. The world has more oil than it can process on ships currently anchored at sea, demand is nearly nonexistent, except it may possibly be shrinking, and the economy has made no significant change. Also, the dollar has little to no impact on the price of oil in a "true" sense as in the last oil crisis of 2008 oil had appreciated against the Euro by 245% that same year. Like the other stories, the dollar rationale exists because the market participants make it exist (either by electronically linking oil and dollars inversely or in some other similar transaction)

The simple fact is: The price of oil increases when more individuals or entities purchase the futures contract for that commodity than individuals and entities that sold it. That's the only, absolute only, 100% factual conclusion one can scientifically deduce from an increase in the price of oil. The stories are fuel to the fire and are collateral to the scientific proof.

MARKET BASED SOLUTION:

If you buy it, you own it.

The oil market is a small market comparatively to the NYSE or NASDAQ in total capitalization. In fact, it is so small that many publicly traded companies have a larger market capitalization than the oil market. As such, it is a breeding ground for speculators, traders, and market manipulators, as well as, investors as they can effectively move the price. Also, the oil market, like all commodity markets, is different from other financial markets because it contains users, or individuals and entities that need it for a business input or consumption. More specifically, because oil is a necessity for sustaining life as we know it, it is quite inelastic in price (at least its most fundamental volumes) and thereby users are further pigeon holed. The combination of these facets creates a dangerous situation where disinterested parties can hold prices hostage because they know the users must purchase and the market is restrictively small.

Users would like to buy oil for as cheaply as possible, and then be able to buy it again and over again as cheaply as possible. Sellers of oil would like to sell it for as much as possible and then be able to sell it again and over again for as much as possible. BUT, speculators, market manipulators and traders want to do both and within the same offering. In other words, nonuser purchasers, or nonusers, will buy or sell oil on credit for a fraction of the closing price to enter and exit their position before the offering for a future contract closes. They are able to enter the market on terms that allow them to bid prices up with no obligation to buy and a very small, five percent (5%) of their total commitment, amount of capital at risk. The issue is that users have to buy a certain quantity regardless and have additional costs to factor, while nonusers act without recourse, restriction or quota.

The fix is to require nonuser purchasers of oil to incur the same costs of transportation, holding, warehousing etc. as users, to create a true market. A bid to purchase oil should include a duty to receive that oil, and hold that barrel of oil for a minimum of 45 days prior to that purchaser being given the lawful right to resell that barrel. Further, as oil is a necessity for the benefit of human kind, stored oil by both users and nonusers shall be callable by a any bona fide end user at the current market rate, but not to exceed the price paid by the holder plus an increase of Libor, in the case of a shortage. This second criteria ensures that users and nonusers alike do not starve the market by hoarding oil.

This concise framework would allow a true market to exist without barring the liquidity that investors offer. Don't buy it, unless you are willing to accept delivery and pay in full. Let users and sellers find an equilibrium based on market facts (consumption, demand, and supply), instead of signaling between non users and supply and demand for contracts. Finally, let prices reflect reality. This policy has a use it or lose it flavor, while encouraging those who have no business buying oil (hedge funds, retirees, college endowments) to put their capital to use in a productive, rather than destructive investment.