Speculation does not explain high oil and gasoline prices? Please!!
This post is a guest contribution by Dian Chu, market analyst, trader and author of the, EconMatters.
WTI (West Texas Intermediate) Crude Oil futures traded at its lowest in almost two months in New York on Thursday, May 5 in its biggest selloff in two years, plunging 8.6% on the day to below the $100 mark (Fig. 1). Brent crude on ICE also dropped as much as $12.17, or 10%, which was the largest in percentage terms not seen since the Lehman Brothers financial crisis, and the largest ever in absolute terms, according to FT.
The epic waterfall was partly due to the combination of a strengthening dollar after European Central Bank President Jean-Claude Trichet said he wouldn’t raise interest rates, and a surging U.S. first time jobless claim that sent oil, silver and other commodities plunging.
Big Speculators Moving Out
That is, some big players (i.e. speculators) decided to move out of commodities, either to take profits, or for risk off trades, as crude and gasoline market fundamentals have not changed much since the start of the year to warrant such a run-up of prices in recent months (Fig. 1).
Link Between Oil Storage & Speculation?
For example, in this article, Klein partly quoted Michael Greenstone, an energy economist at MIT, and concluded that:
“Speculators make money by pulling oil off the market, putting it in inventory, and selling it later…So if you’re seeing speculation, you should be seeing a massive run-up in inventory. And we are seeing a bit of an inventory bump, particularly in recent weeks. But not enough of one.”
Taylor and Van Doren also drew a similar conclusion in an article at Forbes stating that since there’s not a massive increase in oil storage to cause a physical supply shortage, so do ‘put away the torches and pitchforks’ as speculators are not to blame for the rise in oil and gasoline price.
Reality Check – Shorts & Paper Barrels
First of all, taking a long position, as in Greenstone’s ‘store then sell’ scenario, is not the only way to ‘speculate’ in the oil market. Another way is by placing short bets, or a combination of long and short positions. Short bets could cause huge price spikes and volatilities if those speculators have to cover their positions due to an unexpected and sudden rise of the underlying commodity price.
With the current price momentum, more short speculators will be piling in to put even more downward pressure on crude oil in the coming days, particularly after QE2 ends in June, and no more stimulous on the horizon.
As for the notion that the only link between speculative activities and oil market is with oil storge, here is a quick lesson on the modern art of speculation. From Bloomberg:
“Less than 1 percent, or 3,248 crude futures contracts, was delivered in 2010, compared with the average open interest of 1.34 million contracts during the same period, according to Nymex and data compiled by Bloomberg. There is no physical delivery against Brent oil futures contracts traded on the London-based ICE Futures Europe Exchange. “
While there are some long speculators (typically big players) doing the good old contango trade–‘store now and sell later’–as described by Greenstone, there’s a whole brave new world via oil ETFs such as USO and BNO to party in speculation.
These commodity ETFs are futures-based that takes no physical deliveries, but may accumulate huge long positions due to investment fund inflow, thus influencing market prices, particularly during their monthly contracts rollovers.
Everybody’s A Speculator!
So this is the New World [Paper] Order of Crude Speculation….no physical ‘putting in inventory’ necessary. Furthermore, there is this tip bit from FT.com dated May 5:
“CME Group, operator of the Nymex exchange, touted open interest records not only for crude oil but the dull world of natural gas, where a flood of new supply has kept prices listless. This, along with a plunge in silver this week, suggests a wall of investor money flowing indiscriminately into and out of commodities.”
In essence, Crude, along with almost all other commodity markets, has become such a huge paper palace that almost every participant is a speculator, long or short–where you can buy, sell, speculate, and could ‘own barrels’ without them being actually ‘stored’. And through that process, speculators bid up prices, take profits, on any kind of market event—be it real, hyped, or ‘rumored’–but no one has to really put anything in inventories.
Rising Crude Inventories
Well, on the supply side, that “bit of an inventory bump’ pushed inventory level at Cushing, Oklahoma, which is the delivery point of NYMEX WTI futures contracts, to around 41.9 million barrels the week ending April 08 (Fig. 2). That was the highest ever since the EIA started tracking Cushing inventory in 2004. Crude oil storage at Cushing remained close to the record high sitting at 40.5 million the week ending April 29.
Crude stockpiles are also rising in other U.S. regions as well. The latest crude inventory report from the government showed stockpiles rose 3.42 million barrels to 366.5 million the week ending April 29, the highest level since October.
Sliding Gasoline Demand
RBOB Chasing Brent
Brent is traded on ICE–a speculator haven–as it is essentially unregulated, relatively opaque, and a less liquid market (although this is in dispute between ICE and CME).
More Pain From RBOB To Gas Pump
QE2 Added Speculation
Speculation vs. Excessive Speculation
Saudi Arabia recently estimated that about $25 a barrel of speculation premium has been added to the current oil price. Separately, a study co-written by a CFTC commissioner, Bart Chilton noted that about 64 cents a gallon can be attributed to over-speculation, reported The Seattle Times.
Source: Dian Chu, EconMatters, May 6, 2011.
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