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The Speculation Question

I have grappled over the past year with the question of just how much speculation is playing a factor in runaway oil prices. I think it is primarily a supply/demand issue, but I feel that such a large flow of money into commodities is also driving the surge.

Not so, says a new article in Fortune:

Hunting for oil villains

NEW YORK (Fortune) — Atlanta hedge fund manager Michael Masters has been a star witness in two recent Congressional hearings on how speculators are supposedly driving up oil prices. Masters and I don’t see eye-to-eye on this issue, so I was surprised to get a call from him after my “Don’t Blame The Oil Speculators” column went up on Fortune.com last week.

Masters contends that without speculators, the price of oil would be $65 or $70 a barrel. He points out that the amount invested in commodities index products has risen from $13 billion to $260 billion in five years, a fact he thinks is key to understanding oil prices.

It certainly makes sense to me that large flows of money into a sector should impact the price. But the author argues that unless the speculators are taking physical delivery and taking product off of the market, then they won’t impact the price:

My own view is that speculators can’t materially impact prices if all they’re doing is making bets on the direction of oil prices by trading futures and not taking delivery of actual oil – hoarding stuff that would otherwise go to consumers.

Masters did pose an interesting question about how the Hunt brothers attempted to corner the market on silver:

In the end, Masters and I simply agreed to disagree. But there was one thing he said that really piqued my interest. “What do you think would happen,” Masters asked, “if the market went into liquidation-only mode [i.e. if speculators started unloading their futures contracts], like we saw with the Hunt brothers in 1980?”

I won’t give away the ending, but the author reviews the history of the Hunt brothers’ dealings. There was one key difference between their silver dealings and most oil speculators.

So, what do you think? Can speculators have such a huge impact on the price? And if not, what of JD’s suggestion at Peak Oil Debunked that it isn’t a supply/demand issue? Somebody is badly wrong here, or oil wouldn’t have broken through $145/bbl this morning. (I just noticed that JD also took on the article on speculation; will need to read it when I get a chance).

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July 3, 2008 - Posted by | investing, oil prices, speculation

35 Comments

  1. It seems to me the suppliers are the key. If they believe that the price rise is due to speculation and that the market clearing price is $50, then they know that at some point the market will break for that price and they want to sell all they can before that point. The signal that this is happening would likely be a significant rise in inventories, which isn’t happening. At that point, it seems to me that the upside speculators would start bailing to limit their losses, leading to a sharp price drop.

    Comment by Anonymous | July 3, 2008

  2. If U.S. demand is down 800,000 bpd,and the Saudi’s recently began pumping another 500,000 bpd,where did all that oil go? There weren’t any supply shortages before,so there should be an excess on the market now. Unless demand ramped up 1.3M bpd elsewhere,or someone(s) quit producing a like amount. It’s downright comical how Chavez or Ahwannajihad will say something stupid after oil prices drop a few bucks. Those two clowns are working the markets like violins.

    Comment by Maury | July 3, 2008

  3. Re JD’s “it’s not supply/demand” – he’s making some odd comparisons. He’s comparing a US demand drop in April 2008 to the Chinese increase in all of 2007.

    I ran some numbers, and came up with the following:

    12 months, through April, drop in US consumption: 310,000 bbls/day (not the 811,00 he claims – that’s for April alone)

    2007 vs 2006 US consumption (to match with the 2006/07 Chinese increase he cites) – UP 10,000 bbls/day

    1Q 2008 comparison (I couldn’t find Chinese data for April 2008) – Chinese consumption up 303,000 bbls/day, US consumption down 483,000 bbls/day.

    Bottom line, he has a point, but he makes an apples/oranges comparison in an attempt to magnify it. 811 vs 325 just sounds better than 483 vs 303, but those aren’t the numbers he should have used.

    Comment by Anonymous | July 3, 2008

  4. If the *psychology* of the market si that oil prices will be substantially higher in the future, then producers will be incented to reduce their production…or, at least, to avoid taking short-term actions to expand the production. It probably doesn’t matter whether the psychology is caused by speculation or by political events.

    If there is a number X which reflect the maximum world output possible with existing wells & equipment–just opening the valves flat out…and another number Y which reflects the maximum output possible with relatively easy short-term additions to capacity (more powerful pumps or something of that nature) then I wonder how current world output compares with X and with Y?

    Comment by David | July 3, 2008

  5. Disclaimer: no inside knowledge, and not to be taken as investment advice.

    I think the answer is likely that both explanations have some bearing. There is an underlying shift in the supply and demand curves creating upward pressure on prices. The falling stock market and the negative real yields on bonds have sent investors looking for any way to preserve their wealth from the ravages of taxes and inflation, and they’ve latched on to the only asset class that’s still in an uptrend, exaggerating its move.

    As for the mechanism of price effect vis-a-vis the physical market, my understanding is that most contracts for physical are written as $X/bbl above/below some relevant futures contract. No physical delivery need take place, the only requirement is that two parties (a buyer and a seller) must agree on a price, and the marginal price at which a seller can be tempted off the sidelines to go short becomes the price for every barrel whether traded or not. The very interesting question is, if all this money has come in long on oil futures contracts, who’s short? My guess is that as a group, financial players are long and oil producers are short as a hedge.

    We seem to be well beyond the point where owning oil futures is a good inflation hedge because, in effect, the market has “priced forward” many years of high inflation already. This is exactly analogous to the market pricing a stock with high earnings growth prospects at a higher multiple than one with lower prospects, the price rises until the two stocks offer similar returns. Of course, any time the price is largely built in expectations, a small change in expectations can bring the price down in a hurry. It remains to be seen if that’ll happen with oil. The parabolic charts have bubble written all over them, but as we’ve seen with past bubbles, the market can stay irrational longer than you can stay solvent. There are fewer and fewer traders willing to stand in front of this train (on the short side).

    Comment by Anonymous | July 3, 2008

  6. There are some facts that seem irrefutable to me:

    1. Oil-producing nations want higher oil prices, it is in their national interest. 2. Sovereign funds are huge, especially those of oil-producing nations. We are taking hundreds of billions of dollars. 3. We can expect oil-producing nations to act in their national interests, and use sovereign fund wealth to play the futures markets and increase oil prices by any and all means.
    4. Sovereign funds can be “cloaked” behind hedge funds, commodity funds, private equity funds, or could finance (again through cloaks) any number of “analysts,” websites etc.

    So, I dare say one would have to be naive to not EXPECT that powerful financial interests (oil-producing nations) to at least try to manipulate the crude futures markets, and to cloak their identities while doing so. We have to EXPECT that, if we agree OPEC nations will act in their national interests. It behooves them to do so.

    Okay, so I think we can agree that either 1)OPEC nations and financial quislings are trying to manipulate the crude futures markets to make money, or 2) OPEC nations believe in free and open markets, and are not trying to manipulate futures markets.

    This still leaves open the question as to whether they can in fact manipulate the oil futures markets.

    Evidently the Hunt Bros. with a comparatively miniscule pot of money, were able to manipulate silver markets for while. It collapased when they stopped, or ran out of money.

    The crude futures market is much larger, but OPEC sovereign fund wealth is also vast.

    Since we can safely assume oil-producing nations are at least trying to manipulate futures markets, my guess that oil futures markets are in fact being manipulated.

    Oil demand is waning, production is increasing, and yet prices keep going higher.

    I also think we are seeing Peak Demand in 2008, and we will see gluts in three to five years.

    Comment by benny "peak demand" cole | July 3, 2008

  7. Benny, no doubt that OPEC can and do influence prices. They could easily drive prices to $200 within the week by taking enough barrels offline.

    The question is more about the hedge funds and individuals buying oil contracts. Are they driving up oil prices? The article I linked to said “No.”

    Cheers, Robert

    Comment by Robert Rapier | July 3, 2008

  8. Peak Oil Debunked links to a bunch of articles today. If I had a day or two, I might be able to read and understand them. He says speculators are affecting oil prices.
    My main point is that we have to EXPECT that sovereign funds, and their financial quislings, will attempt to push crude futures prices higher, and that they will also plant “analysts” and blogs to carry water for them too. It is in the interest of OPEC to have higher oil prices.

    In fact, my guess is that OPEC and their financial quislings have pushed prices as high as they can go — we are getting immediate demand destruction now, and will see accumuluating demand destruction in years ahead.

    Comment by benny "peak demand" cole | July 3, 2008

  9. Having reviewed all the evidence, I have to put the “it’s the speculators” theory into the same irrational category as UFOs, 9/11 etc.

    There is nothing concrete to the idea which stands up to scrutiny, but still some people have this gut-feeling that it is intuitively obvious.

    I expected that PO whenever it arrived would be greeted with widespread denial, and suppliers would make any excuses to explain production decline. One of the main proponents of the speculation meme is OPEC, it’s proving to be an effective smokescreen.

    Having said all that, perhaps it is best to have an air of FUD about the whole thing, than OPEC stating something like “our oil is running out”. That could well cause some severe panic.

    Comment by bc | July 3, 2008

  10. In fact, my guess is that OPEC and their financial quislings have pushed prices as high as they can go — we are getting immediate demand destruction now, and will see accumuluating demand destruction in years ahead.

    This doesn’t begin to make sense. Why would they push up prices in the short term knowing that this will cause a crash in the long term? I don’t believe oil producers are insane.

    Comment by bc | July 3, 2008

  11. I believe the case for speculation is overblown (but reserve the right to be wrong).

    Some extracts from recent studies…..

    Deutsche Bank:

    Analysts qt Deutsche Bank looked at the price of commodities that do not trade in a futures market. The prices of several commodities that are not traded on any exchange, and are therefore much harder for speculators to invest in, have risen even faster than that of oil. Deutsche Bank calculates that cadmium, a rare metal, has appreciated twice as much as oil since 2001, for example, and the price of rice has risen fractionally more.

    “The rally in non-exchange traded commodity prices since the end of 2002 has been similar if not greater in magnitude,” the bank’s analysts wrote in a research note. “We believe this refutes the claim that speculators have been the primary drivers of rising commodity prices during this cycle.”

    The International Energy Agency, CNN Money, July 1, 2008:

    “There is little evidence that large investment flows into the futures market are causing an imbalance between supply and demand, and are therefore contributing to high oil prices,” the report said.

    Instead, the IEA put the blame for higher crude prices squarely on strong growth in demand coupled with limited growth in supply.

    The IEA argues that if speculation drives prices too high, the market would be unbalanced. Either demand would fall off, or stockpiles would rise. Neither has happened.

    In fact, global demand for oil products has surpassed supply in every quarter since the fourth quarter of 2006, according to the U.S. Energy Information Administration.

    The IEA also made the argument that many commodities – such as coal and rice – are showing similar price increases, even those without the possibility of speculation.

    Barclay’s Bank:

    The total value of index funds and other similar investments are estimated at $225 billion. That is less than half the market capitalisation of Exxon Mobil, and a tiny fraction of the $50 trillion-odd of transactions in the oil markets each year.

    Comment by armchair261 | July 3, 2008

  12. “Oil-producing nations want higher oil prices, it is in their national interest.”

    But, as they learned in the 1970’s and early 1980’s, excessively high prices are NOT in their interests. OPEC knows that the higher prices go, the more incentive there is for competing energy sources (western oil or alternatives), and the greater the risk of a lengthy drop in demand (conservation measures, dropping sales of Hummers).

    It does no seller any good if he destroys the demand of his buyer.

    Comment by armchair261 | July 3, 2008

  13. It’s not speculation or supply/demand, it’s just the belief that oil prices will continue to have upward pressure from buyers, sellers and speculators.

    If everyone believed oil prices were going to have continual downward pressure, the price would drop. Buyers and speculators wouldn’t buy futures above what they believe the price will be when the contract comes due, and the future price would be forced to drop.

    That’s all there is to it: belief

    I personally think exponentially increasing oil price is a good thing and will spur an age of innovation, which is a lot more interesting than driving a Hummer around and watching American Idol that cheap oil allows now. The sad thing is that along with innovation, starvation and war will come too.

    If you want to point a finger at high oil prices, start with The Oil Drum for inflicting the belief that we are running out of oil next Tuesday and we should all live in pole barns with a kitchen garden.

    Comment by Bob Rohatensky | July 3, 2008

  14. The sad reality is how little Joe Sixpack seems to understand of this important issue. Some argue that it can’t be supply and demand, “because there are no gas lines”. No shortage, see? Ignoring the little supply-and-demand principle that it is $4.50/gal that is avoiding those gas lines. Hint: gas lines were the direct result of Nixon’s efforts to control prices.

    The problem is aggrevated by the non-thinking MSM, who seem to look for the most uneducated layperson they can find, and then question them in depth about their opinions. Or worse, find somebody to word their premeditated opinions.

    Benny, keep repeating the Peak Demand BS, son. Eventually you’ll be right. Don’t expect any applause from here. Even a broken watch is right twice every day…

    And, no, there is no large anti-American conspiracy. Just incredible incompetence all round. Expect OPEC to keep exploiting that.

    Comment by Optimist | July 3, 2008

  15. bc and armchair-

    Since even before the days of the Texas Railroad Commission, oil producers have connived to keep prices higher, not lower. I contend you have to at least EXPECT that oil producers will connive to boost prices.

    Is it in the long-run interest of oil producers to have higher oil prices at any given time? Well, if they believe oil demand is relatively inelastic, then yes.
    We have seen that a 1400 percent increase in the price of oil since the nadir in 1998 has but dented demand a little bit. Even if demand falls in half, they make more money than at $10, or $30, or even $60 a barrel. That’s not refutable.

    I do concede that demand will start falling from here, and more rapidly in the years ahead. But in the meantime, OPEC will have made so much money, they are ahead. The present value of money, and all that.

    They can also ramp down production, as needed.

    For now, I think they have hit on a terrific formula: They can produce more, and use futures markets to maintain the price.

    Maybe OPEC is unable to manipulate futures markets.

    But you have to EXPECT that they will, that financial quislings will help them, and that they can mount a PY campaign make it all ring true.

    Comment by benny "peak demand" cole | July 3, 2008

  16. I think the really interesting link that you posted was the JD post talking about how contract prices are determined. From what I can gather, and I read it this morning, and not tooo carefully, so correct me if i’m wrong, but that futures prices actually determine contract prices. So even though speculators don’t actually take physical posession of oil, they can still run up the prices…

    Comment by Wako | July 3, 2008

  17. Benny,

    “Since even before the days of the Texas Railroad Commission, oil producers have connived to keep prices higher, not lower.”

    Given that Exxon, the largest publicly traded company, has only a 3% global market share by production, and since oil prices are set globally, how can American companies hope to directly affect global prices? They have no excess production to dampen prices, and they can only raise prices by massive collusion to halt production. Extreme courage is required while they forego cash flow.

    No sane manager is going to curtail production. He knows that prices could just as easily go down while he plays this game, and he knows he’ll be looking for a new job if he loses, and for all but a select few, he knows that he doesn’t have enough production to have an impact anyway. Given the highly fragmented nature of the US oil industry, the incentive to cheat on any collusion of this kind would be overwhelming.

    It’s clearly in the government’s interests to have low oil prices. And with 6% of the world’s production and about 2% of its reserves, I don’t think the US oil industry has much control at all over oil prices.

    Comment by armchair261 | July 3, 2008

  18. “So even though speculators don’t actually take physical posession of oil, they can still run up the prices…”

    But I keep coming back to the idea that there has to be something fundamental to support speculators. There can’t be, for example, used tire speculators driving up the prices of old tires via hype.

    Is there a URL where you can see net futures contract positions? I don’t think ALL speculators are going long.

    Comment by armchair261 | July 3, 2008

  19. June 2008
    “Khelil, Algeria’s energy minister since 1999, insisted that there was no current need for OPEC to increase its oil production. “OPEC’s statute asks the organisation to satisfy the needs of the international oil market. We have always done that… now, it’s very difficult to find a market… I put my oil on the market, but I don’t find any buyers.””

    This is a quote from france24, a website, late June 2008.

    add this to the problem Iran is having, in finding markets for their oil and they are filling up oil tankers.

    Does this strike anyone else as fishy? Oil shooting through the roof, and countries with no markets for oil?

    Armchair–

    you misunderstand me, I do not think American oil companies have any control today over oil prices. I think it is being set in the futures markets.

    Comment by Benny "peak Demand" cole | July 3, 2008

  20. Working as an oil market analyst, this is exactly the type of question that keeps me up at night.

    For the record, I believe that fundamentals are the key driver of the price increase. The key factor I point to is the decline in net oil exports – something that isn’t evident if you look at world production and consumption.

    Growth in consumption in the Middle East – not surprising when fuel prices are subsidised and you’re flush with oil revenues – has constrained exports. Net exports fell in 2006 and 2007.

    The US, China and Japan – all big net importers of oil – have competed for less freely traded oil – driving the price higher.

    As for speculation – I think its main impact has been to increase the volatility in crude prices. There is no question that these markets are more volatile than five or ten years ago.

    But when push comes to shove, speculators are out of the market – having purchased counter contracts – before the settlement date. At settlement, the price is that which balances supply and demand.

    Speculators aid price discovery, but I don’t think they can push up prices on a sustained basis. Unlike the Hunt brothers and silver, you can’t corner the oil market.

    Comment by Anonymous | July 3, 2008

  21. “We have always done that… now, it’s very difficult to find a market… I put my oil on the market, but I don’t find any buyers.”

    I’ve wondered about this too. If Iran has oil it can’t sell, then why not offer it at a $5 discount to market? Surely that would attract buyers. And would seemingly be better than letting it slosh around in idle tankers.

    Where is all the extra oil? Is there any evidence of rising inventories in the Middle East?

    Comment by armchair261 | July 4, 2008

  22. Seems simple to me how speculators can drive up the price- they are middlemen. Middlemen do not reduce prices.

    Comment by gc | July 4, 2008

  23. isn’t the only important thing–what happens in the cash market. that is the only true exchange of real money for real oil. all else is money spent on “what if” for every “what if” on the upside there is someone spending money on the opposite “what if”on the downside. the true price is what someone with the pickup truck pays the at the oil pump,leaving real money and driving off with real oil. this only happens when all the “what if”s[next month contracts] no longer exit. if the pickup truck doesn’t need the oil at the requested price, he leaves or waits for better deal. the oil owner has to find a hungry buyer, drop price or keep the inventory. for each contract period the cycle repeats–the “what if” players keep betting up/down.

    life could have scads or very few bettors. the higher the need, the more momentum, the bigger the betting crowd

    fran

    Comment by Anonymous | July 4, 2008

  24. Has anyone looked at the commitment of traders report from last Tuesday?

    Unless I’m reading it wrong, it looks like the non-commercial positions are net short.

    How can speculators be blamed on rising oil prices when they’re net short?

    Comment by Anonymous | July 4, 2008

  25. Another question….

    If there’s a pretty good case that speculation is driving up prices, then why aren’t pure refiners like Valero screaming? I imagine Valero has a pretty savvy staff of analysts studying this issue, and oil markets in general, to death. It’s their business, after all.

    If Valero thought that something was wrong with the market, and they’re buying on the order of $140 billion worth of crude annually, and their share price is dropping, and they had a 1Q2008 ROS of 0.5%… why aren’t we hearing more from them?

    This suggests to me that the world’s largest buyers of crude are saying “It’s the market price; it’s not artificially high.”

    Comment by armchair261 | July 4, 2008

  26. Has anyone looked at the commitment of traders report from last Tuesday?

    Unless I’m reading it wrong, it looks like the non-commercial positions are net short.

    How can speculators be blamed on rising oil prices when they’re net short?

    Those stats are cooked, and the CFTC has been called on it. At present, the incoming tsunami of hot money from investment banks, swap dealers, index investors and ETF investors is all classified as commercial, non-speculative. Furthermore, those stats don’t cover the huge volume of trades occurring off the radar screen either OTC (Over-The-Counter), on the ICE, or via linked trades involving other exchanges. Congress has already sniffed out that fraud.

    From Senator Bingaman’s letter to Walter Lukken, acting Chairman of the CFTC:
    “In particular, I remain concerned that the Commission’s assertions to date — discounting the potential role of speculation in driving up oil prices — have been based on a glaringly incomplete data set. Increasing trading activity in U.S. crude oil takes place on foreign boards of trade (FBOTs) and in over-the-counter (OTC) markets, for which the CFTC has limited data and oversight authority. Similarly, I am concerned that CFTC analyses classify so-called “swap dealers” — including large investment banks as “commercial” market participants, along side physical hedgers such as oil companies and airlines, rather than as “non-commercial” participants. The practice of including investment banks in the commercial participant category calls into question the CFTC’s continued assertion that non-commercial participants, or speculators, follow rather than lead oil price movements.”
    Link

    I find the continual reliance of the “no speculation” camp on such obviously bogus data to be lazy, if not downright deceiptful. Is it any wonder? Most of those defending speculators are speculators themselves, invested up to the gills in commodities.

    Comment by JD | July 4, 2008

  27. The International Energy Agency, CNN Money, July 1, 2008:

    “There is little evidence that large investment flows into the futures market are causing an imbalance between supply and demand, and are therefore contributing to high oil prices,” the report said.

    The International Energy Agency, OMR 11April08(P.1):

    “The impact these [investment fund] flows have had in recent years also remains unclear. An IEA Expert Roundtable in March discussed the many aspects that feed the current oil price. There were vastly different views on the effects of money flows on the oil market. In the IEA’s opinion, the limited information available makes it impossible to account meaningfully for the cross-market interactions that routinely take place between different futures exchanges and over-the-counter (OTC) markets. Further, what information there is fails to capture the true split between commercial and non-commercial activity.

    However, while the weight of money debate remains open, there is an almost unanimous agreement among analysts that the oil price has recently been compensating for the weakness of the US dollar – indeed, stripping out the currency impact since 2007 shows a much closer fit between oil prices and global balances.”Source

    Comment by JD | July 4, 2008

  28. I personally think exponentially increasing oil price is a good thing and will spur an age of innovation

    I agree that high prices have beneficial effects. But if you personally believe that oil will exponentially increase, then do you have every spare dime invested in the oil market? If not, why not?

    I mean, if we all know that oil will continue to skyrocket in price from here on out, isn’t oil the holy grail of investing? The 100% sure thing? Shouldn’t we put all of the world’s trillions upon trillions of pension funds, savings etc. into oil futures on the NYMEX? If not, why?

    Comment by JD | July 4, 2008

  29. JD- Because speculators (like we’d be putting our spare trillions into the market) lead to bubbles?

    I don’t know if this was a local phenomenon or not, but here in leafy suburban Chicago, the real estate market bubble was driven by speculators. You had the “natural” demand for homes- people wanting to sell, and the “natural” supply- people looking for a new place to live, which seemed to work pretty good. But speculators got in the mix and drove up the prices to their (intermediate) benefit. Guys who were looking to buy fixer-uppers for renovation or rebuild, to resell at a profit.

    That’s part of the “natural” demand, to some extent. I don’t doubt that there are more dumps on the market than there are fixer-upper-buyers. But as the lure of “free” money gained traction, anyone with the ability to splash some paint on the walls and replace the kitchen cabinets was getting no-money-down loans and buying these places up. By reducing the “natural” supply of lower priced homes and converting them into higher priced homes, these specualtors shifted the curve. As soon as the market topped, these guys were stuck with properties they had to unload, because they couldn’t get more supply and because the low-end buyer was marginalized by their actions. The market corrected itself.

    Like in the oil market, they were able to own a portion of the supply without (really) having to pay for it, distorting the natural order of things. This is a broad comparison, but apt enough, I think.

    Speculators distort supply and demand simply by the effect of drawing cash out of the process. If supply and demand is mostly matched, the cash that speculators draw off MUST come from higher prices to the ultimate consumer.

    Comment by gc | July 4, 2008

  30. jd,

    I’m not very well informed about the whole futures business, but I’m still troubled by a few observations that seem to defy the importance of speculation to crude oil prices.

    1) The prices for some commodities that have no futures exchange have gone up by amounts comparable to oil recently. For example, here
    are iron ore spot fines prices since 1/1/07
    ———————
    Spot prices based upon reports of buyers.

    2007-01 75 USD per metric ton or tonne, 2204.83 pounds.
    2007-02 82
    2007-03 91
    2007-04 95
    2007-05 100
    2007-06 102
    2007-07 102
    2007-08 125
    2007-09 151
    2007-10 170
    2007-11 180
    2007-12 185
    2008-01 missing
    2008-02 196 (mostly contracts with Chinese firms)
    ——————-
    That’s up 139% in 14 months. By comparison, WTI was up 75% in the same time frame.
    http://www.econstats.com/rt_ironore.htm.

    Also, as the Economist reports in its current issue, “The market for nickel provides a good illustration …. Speculative investment in the metal has been growing steadily over the past year, yet its price has fallen by half.”

    2) Where are the protests from the big buyers of crude, in particular buyers who don’t produce crude, like Venoco and Tesoro? A search of Venoco’s 2007 annual report does not find the word “speculation.”

    3) Money in the futures market seems small relative to the total crude market. From Barclay’s “The total value of index funds and other similar investments are estimated at $225 billion. That is less than half the market capitalisation of Exxon Mobil, and a tiny fraction of the $50 trillion-odd of transactions in the oil markets each year.”

    Can you reconcile these observations?

    gc,

    “Like in the oil market, they were able to own a portion of the supply without (really) having to pay for it, distorting the natural order of things. This is a broad comparison, but apt enough, I think.”

    But unlike crude speculators, those housing speculators actually did buy the commodity from the seller and take legal and physical possession of it. They removed commodities from the market, even if they were bought with borrowed money and shortly thereafter sold. Isn’t this different from the crude oil situation, where the speculator is not removing or consuming any physical oil from the market?

    I am not being critical here, just trying to make sense of a subject that isn’t my specialty.

    Comment by armchair261 | July 4, 2008

  31. Seems simple to me how speculators can drive up the price- they are middlemen. Middlemen do not reduce prices.

    This illustrates the core of the misunderstanding. Speculators are NOT middlemen!!

    This is typical of the arguments used to blame speculators. It’s easy to debunk, because it is plain wrong.

    They don’t buy oil and sell it on, they buy (or sell) a paper contract, which are often cash-settled and do not result in delivery. The vast majority of oil is traded directly from producers to refiners. Speculators are more like gamblers on a horse race, they affect the starting odds, but the don’t determine who wins the race.

    Comment by bc | July 5, 2008

  32. Please explain this “cash settlement” thing to me, because I guess I don’t understand it completely.

    (Here’s what I imagine happens, upon further review- I create a future contract that says I’ll sell you a barrel of oil in December for $100. Somebody buys that contract, and then in December, oil is really $150 a barrel. I give him $50 and he goes away. If the price drops, he gives me the difference. Is that it?)

    How does the market “know” the difference between buyers who intend to consume and buyers who intend to cash-settle?

    Comment by gc | July 5, 2008

  33. Does Mr. Masters have a conflict of interest perhaps?

    July 1, 2008 9:38AM
    Who is Oil Speculator Expert Michael Masters?
    By Elizabeth MacDonald
    More on the oil speculators in later blogs, I need to report the following to you first.

    Michael Masters, principal and founder of the hedge fund firm Masters Capital Management LLC, achieved near rock star status after his recent testimony before Congress about the impact of oil speculators on oil prices.

    The hedge fund manager said speculators are largely responsible for jacking up crude oil prices to new heights. A supposed Wall Street insider was finally coming clean, making for great sound bites. Masters reportedly said he is not currently involved in trading the commodities futures markets, that he is not representing any corporation or lobby group, but merely came forward as a concerned citizen.

    Recently, the U.S. House of Representatives approved a bill directing the Commodity Futures Trading Commission to invoke emergency powers to “curb immediately the role of excessive speculation” in the oil futures market, partly due to his testimony.

    Masters introduced in testimony the data point that some $250 bn has been invested in commodity index funds, up from $13 bn in 2003, a stat that’s used to argue oil speculators are causing prices to soar. How a hedge fund manager arrived at that $250 bn figure, and what data sources he used and how it was calculated, hasn’t been appropriately challenged. It may be right-it may be wrong.

    And Masters, more than regular citizens, apparently has a lot of skin in the game when it comes to getting oil prices lower. Credit Greg Newton at Naked Shorts for diving into filings with the Securities and Exchange Commission to figure out what Masters’ hedge fund invests in.

    Newton testified that he has been managing a long-short equity hedge fund for over 12 years and that he has extensive contacts on Wall Street and within the hedge fund community.

    But Newton dug into the most recent Securities and Exchange Commission 13F-HR filings for Masters Capital and found that the hedge fund portfolio “is at least knee-deep levered long in US airline stocks and General Motors,” which is “doubtless contributing to Masters’ distress at crude oil prices.” Didn’t see that in testimony, did you?

    As of March 30, Masters’ fund had call positions in AMR Corp (AMR: 4.83, +0.21, +4.54%), the parent of American Airlines, Delta Air Lines (DAL: 4.95, +0.05, +1.02%), General Motors (GM: 10.12, +0.14, +1.40%), UAL Corp., parent of United Airlines (UAUA: 3.86, -0.15, -3.74%) and US Airways (LCC: 2.40, +0.03, +1.26%). About 30% of his fund’s portfolio was in companies that feel the heat from oil price spikes. In the first three months of this year, says the total value of the portfolio declined 35 %, from $1.38 billion to $905 million. BusinessWeek has been on this story too.

    Masters has since said that this math “way off,” in part because it did not account for offsetting positions, and other options and derivatives not reported on the SEC forms.

    But more to Masters’ argument, that futures contracts cause oil price spikes. These are paper barrels, they are not physical barrels of oil. No oil supply is removed from the market in an oil futures trade. Instead, in commodities trading, when oil positions are being hedged, each contract has a buyer and a seller, so for every contract that says that prices are going up, the other side of the trade is essentially betting they are going down, offsetting the trade.

    The question is, do the price setters in the markets look to futures prices to set the cost of oil per barrel? Of course they do-it’s likely why Saudi Arabia has threatened to keep their oil in the ground for the future generations.

    But supply and demand matter more in setting oil futures prices, which in turn are used to set oil prices. More to the point, it is the shoddy information on forward supply and demand that is hurting the market. More on this in a future blog.

    And recently, the country’s top energy analyst, Daniel Yergin, head of Cambridge Energy Research Associates, said in testimony before the Joint Economic Committee that when it comes to oil price spikes, history “demonstrates that changes of this scale and significance result not from a single cause, but rather from a confluence of factors.”

    Yergin acknowledged that speculators have played a role in fueling oil price spikes, however, he said they largely add to the mania behind price scares and noted the credit crisis and a weaker dollar are largely to blame.

    http://emac.blogs.foxbusiness.com/2008/07/01/who-is-oil-speculator-expert-michael-masters/

    Comment by Searching for the Truth | July 5, 2008

  34. At present, the incoming tsunami of hot money from investment banks, swap dealers, index investors and ETF investors is all classified as commercial, non-speculative

    This “tsunami” has the commercial long positions just a few thousand contracts above the short positions.

    But since you seem to think all the data is bogus anyway, no matter I guess.

    Comment by Anonymous | July 6, 2008


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