Crackdown on commodity trading abuses needed

Financial players in commodity markets are turning the laws of supply and demand on their head

THERE ARE more than 50 tankers anchored off the UK coast at present, full of oil. Many are owned by financial “investors” who have bought spot oil and are waiting for higher prices in the futures market to crystallise. They will then make a killing.

This activity is part of an explosion in commodity trading within global financial markets, something that is harming consumers, economies and Ireland. It requires urgent political and regulatory attention that eliminates the abuse of real supply and demand.

Worldwide industrial production has collapsed by 14 per cent in the past 12 months, yet oil prices have bounced 26 per cent from spring lows. In 2002, oil prices averaged $25 per barrel. Today, in the midst of the worst global recession since the 1930s, oil prices are almost $80 per barrel. Some believe this is because the world is running out of oil but a series of mega discoveries (eg in Brazil and the Emirates) and an inexorable shift to alternative forms of energy (nuclear, wind, etc) threaten that cosy thesis. Others talk about rebounding economies yet actual demand stays depressed. No, the answer to this conundrum lies in financial markets.

It is estimated that activity by financial players in commodity markets dwarfs the actual volume in the underlying product. In value terms, the amount of trade is over five times the value of the real commodity.

So, if the physical market for a product such as oil or wheat is, for example, $10 billion, financial markets trade $50 billion worth of the stuff. This is courtesy of an explosion in derivatives trading and echoes what happened in mortgage markets in the last 10 years.

Turning bog-standard mortgages into so-called “sophisticated derivatives” ultimately destroyed the western world’s property and banking markets. Turning bog-standard oil and wheat into a plethora of derivative products is equally dangerous.

The development of commodity trading has been eye-popping. Global investment banks have committed tens of millions of euro to establishing trading desks, funds, sales teams and analysts to exploit the commodity space.

Many of these twentysomething analysts could not tell the difference between a bullock and a heifer but can write volumes about why grain and meat prices are inevitably going to rise. They have, funnily enough, a vested interest in talking up prices. It generates more commissions, and rising commissions generate higher bonuses. There is a real and natural bias in what these investment banks spin out towards inflating prices. The effect of that on real people is, as they see it, someone else’s problem.

By real people we mean farmers in west Cork, rice growers in Asia and consumers on Grafton Street. By artificially jacking up prices for oil, grain or rice, financial traders distort the real economy. You and I have to pay more for petrol, plastic, food and other everyday items that depend entirely on commodity production. These product prices should be determined by real, physical demand and supply, not a bunch of geeks in front of computers.

There are many good examples of this financial farce. In 2007, as grain prices shot through the roof we read “research” notes explaining why that trend was ever upwards. High birth rates, the lack of water and economic prosperity were rolled out to explain a linear projection. Yet they utterly missed the ability of farmers to turn on the taps when prices rose. Ukrainian and US farmers responded by boosting production and puncturing the financial market’s bubble. If the world is really running out of food, which some of these jokers argue, why is Ireland, with its lowest-cost grass-based milk production system, unable to create economic returns for farmers at present?

Oil is more tricky to analyse. Not only do financial traders cloud reality, the Opec cartel is forever trying to use supply as a manipulative force on price. This year, for example, it has reduced supply in an attempt to shore up demand. Despite their efforts to stuff the world’s consumers with high-priced oil, we have the spectacle of loaded tankers off the UK coast with nowhere to go. It is estimated that almost 10 per cent of the world’s tanker fleet is occupied in the same way at present. Some have been rented by household global banking names to store positions their traders have purchased. These are the same heroes who were given billions by taxpayers like you and me during the credit crisis.

Ireland should be at the forefront of a campaign against these harmful practices. We are net importers of commodities, especially oil. Irish consumers and companies remain woefully dependent on oil-driven energy prices as we sidestep the nuclear agenda. Our agricultural output prices have been hugely distorted by games in the commodity markets too.

Instead of going on about the environmental end of the world, why won’t Irish Ministers tackle something tangible, distorted and manipulated – like the virtual commodity world created by bankers?

Joe Gill is a director of equity research with Bloxham Stockbrokers