Op-Ed: Oil Speculators Playing Two-Headed Coin

The energy loophole in the commodities trading regulations is rightly named after Enron.

In 2000, Enron exploited the lack of transparency in the energy market to cause a meltdown in California's power grid. After 100,000 businesses and residential customers went without power for two days, Enron had the nerve to sell contracts at inflated prices to these same businesses seeking to hedge future costs of power. Enron's "dark" trading practices harmed businesses, investors and consumers alike.

Sound familiar?

After months of questions about oil speculation, the Commodity Futures Trading Commission, with public prodding, found that the Swiss energy firm Vitol had secured 11 percent of the oil contracts on the New York Mercantile Exchange. The CFTC data infers that financial firms comprised more than 80 percent of the oil contracts on that exchange. We will never know the full extent of participation by traders. The Enron loophole had been exploited once again. Artificial shortages created fear, causing companies to hedge their bets and buy oil futures at inflated prices raising the cost of oil higher. The "pay now or pay later" dilemma is like a bet with the district attorney holding a two-headed coin in the Batman movie, "The Dark Knight." Heads he wins; heads he wins. Trading companies created artificial demand by bidding up oil contracts. Actual consumers of oil then attempted to hedge their fuel costs by buying oil futures, perhaps from the same traders.

Few industries are as vulnerable to fluctuations in the price of oil as the airlines. Fuel as a percentage of airline operating costs has doubled over the past two years, while the average ticket price has increased only 20 percent.

Airlines are speculating in oil futures too. Hedging allows a carrier to purchase fuel at set prices for a contracted period. For the next quarter, American Airlines is hedged at $95 a barrel for 35 percent of its fuel, 24 percent of Continental Airlines' fuel requirement is hedged at $114 and Southwest Airlines, an early winner in the hedging game, has 80 percent hedged at $61 a barrel. Southwest has hedged its fuel costs so successfully that Morgan Stanley's William Green called Southwest a good "oil play." Southwest has, in fact, benefited from fuel hedging for years.

Airlines that bet right on oil futures win; airlines that do not bet or bet wrong lose. We experience the results of their losses in user fees, reduced service and the schedule reductions to our cities. Like betting with a two-headed coin, hedging also can also be a lose/lose proposition.

The results of hedging are far worse once speculators enter the game. A good forecast for the cost of fuel can be turned on its head by traders manipulating the market. Artificial demand raised the cost of fuel for more than three months before prices retreated from a high of $147 per barrel. Airlines also lose when their hedges are higher than the falling price of oil. Swings in the cost of oil are not only vulnerable to manipulative trading but also to geopolitical events. Oil shot up $6 per barrel on news of the Russian invasion of Georgia, then declined more than $6 on the repair of the Turkish pipeline. The best managers cannot forecast the cost of oil when trading, manipulation and political events cause unpredictable swings.

The airlines are on the bleeding edge of oil speculation. Our proudest American carriers have been stripped of profits needed for new planes, better seats, employee training and a pleasant flight experience. In many respects, they are losing the global Olympics to offshore competitors.

America's airlines are like canaries singing in the cage that warn coal miners of danger. Other oil-dependent industries are at risk. The increased costs for transportation, materials and agriculture are now working their way through the economy to the American consumer.

We are all participants in the same economy. As stocks responded to the inflated cost of oil, how much equity was wiped out in people's 401Ks? How much more did we pay for gas to drive to work or to take the kids to school? Like the airlines, our equity and income have been diminished due to dark trading. We cannot have a free market with dark corners that tolerate market manipulation.

The problem of oil speculation is now beyond speculation. Legislation to end dark trading failed to pass before the congressional recess. The parties went into gridlock as amendments to expand offshore oil drilling were tacked on to legislation that would make energy trading transparent.

Speculation and drilling are important issues that require prompt but separate consideration. Congress can act to end dark trading. Political parties and legislators who are not seeking a solution are surely part of the problem.