Fadel Gheit Can Fix the Oil Crisis

Between oil speculators, price volatility, over-zealous regulators and an antagonistic government, the oil industry faces a challenging environment. Some might even argue that the environment itself is an impediment to the extraction and production of the fuels we all need to operate the modern economy. To an outsider, the problems look daunting. There is talk of dwindling oil supply, which, combined with increased demand from growing economies, threatens to drive oil prices parabolic. There are concerns that pollution from combustion engines, a chief end-user of oil, is irrevocably harming the environment. Lastly, there is the reality that oil prices, for a variety of reasons, drag down the economy just as it starts to improve and work out of a negative state. Is all hope lost? Not according to Fadel Gheit, Managing Director and Senior Analyst at Oppenheimer & Co. Inc., Research Division. He recently spoke with Benzinga Radio about his field of expertise: the oil industry, and specifically why things are the way they are with oil prices around the world. If you've been following the commodities market the past couple of years, you've noticed wild swings in prices, along with higher-than-expected prices for oil. Gheit lays the blame where many experts do: unchecked speculation. "Over the past five or ten years, the speculators have really controlled the market," Gheit said. "There's a lot of volatility in oil because there is a lot of speculation on the direction of the price. Although the government regulators have been trying for years unsuccessfully to cool off the speculation, they have not really been successful. That will continue unless and until the government means business and puts their foot down." The harm that comes to the overall economy from speculation in the oil market is two-fold. First, speculators have an interest in a volatile market. It allows them to make money on the up and down side of the price as it moves. The further the deviation from the current price, the more money there is to be made. This turns the market away from its original intent (allowing consumers of oil to hedge their risk to higher prices over time) and toward a casino model, where folks who don't intend to ever take hold of the commodity drive up its price as a means to make money. Gheit specifically names financial institutions, like investment banks and hedge funds, as the primary drivers of this phenomenon. He's not a big fan of their involvement in the commodities market. "All financial players should get out of the speculation of commodities," Gheit told Benzinga Radio. "They should leave it only for the principals — the people who use the commodity itself. In the case of oil for example, airlines, chemical companies, power generating companies, oil and gas companies, they have the right to hedge their positions using all the financial instruments available," he said. "I don't want to see investment banks getting involved in the commodity market because volatility is the name of the game and they want to keep the market very volatile." How would removing speculators from the market affect prices? Not as much as one might hope, sadly. Considering upwards of 25 percent of the price of a barrel of oil comes from speculation, one might expect a 25 percent drop in prices. That might not be the case, said Gheit. "It might not change the price of crude, but it will definitely narrow the range of the volatility. So we would not see oil prices going up thirty or forty percent and then in four or five weeks, going down thirty or forty percent. There would be real players who either produce the oil or use the oil. When you see a financial player electronically trading barrels, they have no intention whatsoever of receiving these barrels or handling these barrels. If we keep the speculators out, life will be a lot easier." Easier for everyone, it seems. Companies, particularly companies that rely on the commodities market to hedge their, say, fuel costs (trucking companies, airlines, etc) need some degree of price stability to budget for the quarter, or for the year, or even five years out. With the current volatility, they cannot get anywhere near that price certainty. Throw the speculators out, Gheit argues, and they can have that normalcy returned to the market. When you think about it, there's really no reason NOT to kick the speculators out of the market. They're not utilizing the commodities market as it was intended; they're just siphoning money off the people who are. "All you have to do is look at where the money is and who is making the money. The people who are making the money are the financial players that have a vested interest in pulling the wool over the regulators and convincing them of their side of the story. I do not see why an investment bank would hoard copper or silver, and renting warehouses around the world to keep copper and silver, or renting ships to store oil. It's pure speculation." Speculation isn't the only problem facing the oil industry. Regulation, particularly striking a balance between effective regulations that help the environment and loose regulations that allow oil companies to do what we need them to do — get oil from the ground into the marketplace — can be tricky. Gheit thinks it has been made more difficult over the years because regulators and business see themselves as opponents, rather than as partners. Changing to a more partnership-based stance would go a long way toward helping both the environment and all of us get what we want. This cooperative regulatory stance had better come soon, Gheit argues, because the oil industry is on the verge of some technological breakthroughs that will require new regulation and new thinking between government and industry. "I believe in technology, and I think five years from now we'll be doing things completely differently. We will probably have more discoveries than we ever thought possible. I am not at all in the camp of peak oil and all this other nonsense. I think technology is our way out of this squeeze that we are in right now. The Arctic is going to open up. It's a question of when, not if. I think we are probably going to expand our footprint in the existing areas, like the Gulf of Mexico for example," he said. "We will probably double our reserve in the Gulf of Mexico in the next five to ten years. But the government has to do the right thing and make sure the industry conducts itself in the most environmentally responsible manner. We need honest competent regulators, not to give the industry a hard time. The government and the industry have to be on the same side."