How Oil Futures Trading Affects Prices
To understand how speculating in oil futures drives up the cost of oil, we will use a simple example. Let us say that an island nation receives a shipment of oil once every three months, and that that supply is enough to satisfy the demands of the local market. What would happen if an organization had enough money and clout to purchase and hold half of the supplies? Naturally, it would create an artificial shortage in the market and consumers would be forced to pay more as the remaining reserves are rationed. This is the effect that oil futures-trading has on the market.
It is not a big issue when a few small traders start to buy futures contracts, but when traders or institutions purchase large contracts the price has no where to go but up until there are real signs that consumers are unwilling to accept the new prices, or other market events force futures traders to abandon their long positions.
In part, it is the failure of other markets that has cause a flood of money to enter the oil futures markets. When traders and financial institutions started diversify the portfolios by pulling money from real estate and stocks they looked to next hot market, if that happens to be oil, prices will naturally rally on the back of the artificial demand.
The government did take steps to regulate the future market from excessive speculation by setting up the Commodity Futures Trading Commission (CFTC) in 1974. Unfortunately, the CFTC was limited to overseeing trades on the New York Mercantile Exchange (NYMEX). Companies and consortiums found their way around this regulatory framework by establishing other exchanges and systems such as the Enron loophole and the Intercontinental Exchange (ICE).