It’s Decision Time – Oil Speculators or The American Consumer?

[JimofPennsylvan]

Congress has a super critical task before it and that is to stop the increase in the price of a barrel of oil in the commodity markets from speculators. Speculators being those individuals that buy oil future contracts in the commodity markets never to receive the oil that is the subject matter of the contract but rather only for the investment opportunity provided by buying and then selling that contract at a profit. Speculators include those investors that buy oil contracts when the price of those contracts begin to rise whether its from a political or production problem connected with an oil producing country, a drop in the dollar, etc. and in their buying along with other such investor buyers accentuate or magnify the market price increase of oil contracts to a higher degree than the negative circumstances warrant. Speculators also include those investor buyers of oil future contracts who individually or collectively with other such buyers because of the their buying power of oil future contracts and utilization of such power, that is their buying alone – no other supply/demand/currency issue, can cause an increase in market prices in oil future contract prices and sometimes a quite significant increase.

To get to the heart of the issue here, the public hears from the top managers of the New York Mercantile Exchange and ICE Futures Europe Exchange, the U.S. oil commodity exchanges, that if Congress passes regulation increasing the collateral or margin requirements to fifty percent from the current practice of a single digit percentage, sellers and buyers of oil future contracts will just take their business to foreign oil commodity markets outside the reach of U.S. regulation and the price of a barrel of oil will still be the same and U.S. financial markets will just have lost business. By the use of the terms collateral or margin it is meant that if an investor buys an oil futures contract worth $100,000.00 in value how much money does that investor have to pay to make the purchase of that contract, currently the standard is often a single digit percentage many in Congress want to make it fifty percent which in the instant case would be $50,000.00, which as a practical matter would have at least some dampening effect on the buying power of these speculator investors and thus have a dampening effect on their ability to drive-up oil contract prices in the market. The American public and their elected leaders have to keep in mind that what these NYMEX and ICE Futures managers and the investors they advocate for are saying with their proclamations don’t increase the collateral or margin requirements otherwise massive amounts of oil futures trading will just move to foreign commodity markets is that large scale speculative oil trading is going to continue no matter what the U.S. government does and the U.S. government can’t do anything about it and is not going to be able to protect American consumers and for that matter world-wide consumers from this harm.

To borrow a famous reply from an heroic U.S. general in the Battle of the Bulge during World War II when asked to surrender, the American people and Congress should tell these Financial Market pariahs “Nuts”. The Congress’s position should be come hell or high water this speculation harm is going to stop. One course of action Congress could take is to enact legislation increasing the margin to fifty percent and to reduce the harm from this speculative oil trading just moving to foreign markets Congress could do the following. Make it a crime for any U.S. citizen or U.S. business to buy oil future contracts in any foreign commodity market throughout the world in violation of this fifty percent margin requirement. Moreover, for any non-U.S. citizen or non-U.S. business that buys oil futures contracts in foreign commodity markets in violation of this fifty percent margin requirement the Congress should ban such a person or business from be able to participate in U.S. securities (stocks and bonds) and commodity markets for a period of ten years after that unlawful buy and if at the time of the unlawful buy such a person or business owns U.S. securities or commodities such property will be confiscated and liquidated expeditiously regardless of any loss incurred from a speedy sale. This type of government action would surly help improve this speculation problem. Oil is to important to the U.S. and the World economies to let things continue as is; from what the world’s seen in the last six months in a real sense oil is the lifeblood of these economies, and this speculative trading is a serious blood disease which must be largely eliminated or it will cripple or kill these economies.

 

[gonegolfin]

Congress has a super critical task before it and that is to stop the increase in the price of a barrel of oil in the commodity markets from speculators. Speculators being those individuals that buy oil future contracts in the commodity markets never to receive the oil that is the subject matter of the contract but rather only for the investment opportunity provided by buying and then selling that contract at a profit.

So, you are in favor of eliminating hedging altogether? Just who do you think the speculators are? Show me futures data that illustrates that the long speculators are responsible for driving up the price of oil. It might surprise you what you find.

Brian

 

[AllieBaba]

He's just mindlessly regurgitating what he's been fed.

 

[Charles_Main]

He's just mindlessly regurgitating what he's been fed.

Yep!

 

[Paulie]

He's just mindlessly regurgitating what he's been fed.

Oh, so you don't think the run-up in the price of oil is largely attributed to speculators?

 

[Toro]

So, you are in favor of eliminating hedging altogether? Just who do you think the speculators are? Show me futures data that illustrates that the long speculators are responsible for driving up the price of oil. It might surprise you what you find.

Brian

Congress says 70% of buyers are "speculators."

Speculative traders' interest in crude oil has grown to the point that they now account for roughly 70% of all trading in West Texas Intermediate crude on the New York Mercantile Exchange, compared with 37% in 2000, according to an investigation by a congressional subcommittee that forms part of an escalating political assault on Wall Street's role in the run-up in oil prices.

The subcommittee's findings, based on data obtained from federal commodity-futures regulators, are the latest sign that Washington is gearing up to try to limit the role of hedge funds, investment banks and other speculative traders in the oil markets. ...

The main targets of critics of speculative oil trading are pension funds and investment banks that never take physical custody of oil, but instead invest in oil futures contracts as a way to hedge against inflation and diversify their portfolios. In recent weeks, the federal agency charged with regulating commodity trades -- the Commodity Futures Trading Commission -- has begun to gather more data on unregulated trading of oil. Last week, it announced it would require the London-based ICE Futures Europe exchange to adopt limits used in the U.S. for trading positions in the West Texas Intermediate crude-oil contract.

Free Preview - WSJ.com

Though I'd be a little skeptical of what Congress say.

But I will go back to Michael Masters.

In the popular press the explanation given most often for rising oil prices is the increased demand for oil from China. According to the DOE, annual Chinese demand for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion barrels, an increase of 920 million barrels. Over the same five-year period, Index Speculatorsʼ demand for petroleum futures has increased by 848 million barrels. The increase in demand from Index Speculators is almost equal to the increase in demand from China!

http://hsgac.senate.gov/public/_files/052008Masters.pdf

I also read somewhere recently that the primary driver of incremental gold demand this decade has been ETFs.

Citi estimates that total investment capitalization for commodities is $400 billion. That's less than the market cap of Exxon. Thus, it doesn't take much in capital flows to move the needle.

Plus, the movement in oil feels awfully bubbly to me. From BCA

The following chart is taken from the latest issue of the superb Bank Credit Analyst. The broken line on this chart depicts what BCA terms the "Mania Index." This index is a composite of past major investment bubbles; e.g., silver, gold, the Nikkei 225, cocoa, the dollar, the NASDAQ, Taiwan stocks and nickel prices.

 

[Paulie]

Congress says 70% of buyers are "speculators."



Free Preview - WSJ.com

Though I'd be a little skeptical of what Congress say.

But I will go back to Michael Masters.



http://hsgac.senate.gov/public/_files/052008Masters.pdf

I also read somewhere recently that the primary driver of incremental gold demand this decade has been ETFs.

Citi estimates that total investment capitalization for commodities is $400 billion. That's less than the market cap of Exxon. Thus, it doesn't take much in capital flows to move the needle.

Plus, the movement in oil feels awfully bubbly to me. From BCA

The following chart is taken from the latest issue of the superb Bank Credit Analyst. The broken line on this chart depicts what BCA terms the "Mania Index." This index is a composite of past major investment bubbles; e.g., silver, gold, the Nikkei 225, cocoa, the dollar, the NASDAQ, Taiwan stocks and nickel prices.

So let's say for the sake of argument, that the speculators are causing 40% of the run-up. We take them out, and then what else is going to stop the price from continually rising? Interest rates can not be raised anytime soon, at least in my unprofessional opinion. So it looks like a long time before there's going to be any real worthwhile gains in USD value, with definitely some more drop left.

The price of oil doesn't seem like it has much of an opportunity to drop even without the speculators. I'm sure we probably disagree on the time frame of when the Dollar might gain significant value again, though.

I believe the speculation is largely fueled by political and economic uncertainty, it's definitely why I bought USO. Assuming it is, then it still seems unlikely the price will stay lower. But I haven't seen your opinion on why the speculation exists.

 

[Toro]

So let's say for the sake of argument, that the speculators are causing 40% of the run-up. We take them out, and then what else is going to stop the price from continually rising? Interest rates can not be raised anytime soon, at least in my unprofessional opinion. So it looks like a long time before there's going to be any real worthwhile gains in USD value, with definitely some more drop left.

Bubbles can just fall on their own weight. They don't need central bank tightening though it helps.

I see a lot of problems. Global economies are slowing, including emerging markets.

The China stock market is down ~60%. India is down ~40%. If the economy isn't slowing in those countries, why have their stock markets been crushed?

Plus, the dollar is bottoming.

Personally, I hope oil gets to $200. I'm going to lay out a ton of deep, long dated, out of the money puts on crude. Easy money IMHO.

Remember that in 1979-1980, Volcker was tightening hard and oil continued to climb for about a year. Investors in bubbles often ignore fundamentals believing things are different this time. Then, at some time, the asset collapses.

That will happen with oil and all commodities eventually. I just don't know when.

 

[gonegolfin]

Though I'd be a little skeptical of what Congress say.

But I will go back to Michael Masters.

http://hsgac.senate.gov/public/_files/052008Masters.pdf

You have good reason to be skeptical of what Congress has to say. They prefer to blame others instead of themselves for the reckless spending and neglectful stewardship of the currency under their watch.

Make no mistake, I believe that the futures market has played its part in the price of oil. But it is not the index funds that are to blame. The speculative shorts are to blame. But this is not the story being told by Congress. This story would not support the solution they have in mind to bring oil prices back down (blaming the index funds and forcing them to liquidate long positions, among a variety of other measures).

The index funds were welcomed into the market, with many of them commencing operation in the past couple of years. For example, one of the popular oil index funds (DBO) began trading on 1/5/07. They were very clear with their intentions ... they would take out and hold long positions in the underlying commodities they represent. The speculative shorts (mostly commercial institutional shorts, not the commercial hedgers that are also classified in the commercials category) were salivating because they knew the index funds (as well as the pension funds) would never demand delivery (eliminates the short squeeze). Additionally, it was well known that the index funds would need to roll over their positions to the next contract month periodically. This set up the opportunity for arbitrage. When the index funds were starting up, supply and demand fundamentals were not so tight. It looked like easy money for the shorts. And it was ... for a while. But then the supply/demand situation began changing.

By August of 2007, the index funds were in their long positions and the short speculators were loaded to the hilt. Oil was trading just over $70.00 at the time. Obviously the price has since doubled. And the speculative shorts are screaming. And their shorts are burning.

Once the supply/demand situation tightened and continued to get worse, the speculative shorts were boxed in. They have been looking for a way out and do not like that the index funds are utilizing a buy and hold strategy as it impedes that objective. They want the long positions liquidated such that they can make their exit. The index funds are not the real speculators. They are playing by the rules and are executing a buy and hold strategy, much to the dismay of the real speculators (the shorts).

The index and pension funds are classified as commercials in the COT reports. You can easily verify that since last August (when oil was at $72.42), the number of contracts held by the commercial longs has actually declined (rather dramatically). So, it is not the index funds driving the price up. However, the number of contracts held by the commercial shorts has declined dramatically. They have been covering their shorts and thus driving the price upwards. While their short positions are down dramatically from last August, they are still higher than when the index fund boom commenced. So, there is more short covering to go.

The following is some interesting data that illustrates my point ...

You can examine the historical COT reports here ...
Historical Commitments of Traders Reports

Date - NYMEX Futures Price (light sweet crude) - Commercial Long/Short Positions
---
06/24/08 - $137.00 - 807,846/803,211 (latest COT report)
06/03/08 - $124.31 - 830,940/850,616
05/06/08 - $121.84 - 857,629/881,738
04/01/08 - $100.98 - 865,064/905,226
03/03/08 - $99.52 - 879,674/982,509
02/05/08 - $88.41 - 883,191/908,166
01/08/08 - $96.33 - 871,166/971,672
12/04/07 - $88.32 - 897,346/942,629
11/06/07 - $96.70 - 911,816/996,004
10/02/07 - $80.05 - 867,494/927,028
09/04/07 - $75.08 - 938,837/973,366
08/07/07 - $72.42 - 900,395/1,017,930

- Index funds and speculative shorts were entering the market in the latter part of '06 and the first half of '07
- You can see the short covering beginning in August of '07. It has been consistent ... meanwhile the commercial longs have been reducing their positions, not increasing them. They have taken some profits.

07/03/07 - $71.41 - 907,129/1,000,431
06/05/07 - $65.61 - 897,214/947,336
05/01/07 - $64.40 - 830,557/890,444
04/03/07 - $64.64 - 865,686/922,271
03/06/07 - $60.69 - 813,652/833,204
02/06/07 - $58.88 - 822,894/784,268
01/03/07 - $58.32 - 754,040/744,275
11/07/06 - $58.93 - 698,770/685,537
07/03/06 - $73.93 - 563,193/596,678
01/03/06 - $63.14 - 532,650/503,932

Also of interest, the futures price has been trailing the spot price during this runnup in the price of oil.
Speculative nonsense, once again - Paul Krugman - Op-Ed Columnist - New York Times Blog

In a related article, Krugman responds to Masters' claims.
Calvo on commodities - Paul Krugman - Op-Ed Columnist - New York Times Blog

Brian

 

[Charles_Main]

The speculators are only the mechanism that raises the price, they are not the sole cause.

The Cause is our energy policies. The cause is the prospect of Democrat Domination of our government. the cause is Opec deliberately holding back supply, The cause is our refineries running at capacity World wide. The speculators are only able to drive the price up, because people have real fears about supply, and inept energy policy which is sure to come with Democrat rule. The Dems continue to ignore 70% of Americans who are screaming for drilling. As usual Liberals think they know best and most protect us from ourselves. Elitist asses that they are. As usual they are selling a lie to the American people, claiming drilling will not help, or we can not drill our way out of this. Of course we cant, but we sure as hell can help a little by doing so.

If you want to blame somebody blame those who have repeatedly stood in the way of Drilling for oil, building more refineries, and more Nuke Plants. These are real things we could have done long ago to avoid this crisis.

Thank Bill Clinton for vetoing drilling in 95. Blame Enviromentalist for blocking any attempt to gain more supply, or build Nuke plants, Then and only then can you blame speculators.

Charles

 

[Toro]

Brian

What do you make of Masters' argument?

Today, Index Speculators are pouring billions of dollars into the commodities futures markets, speculating that commodity prices will increase. Chart One shows Assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008, and the prices of the 25 commodities that compose these indices have risen by an average of 183% in those five years!

This is his math for his calculations determining the total volume of index activity.

If someone knows how much money is invested in the total index then it is easy to calculate how much must be in each commodity in dollars and in futures contracts.

Total Dollars Invested In Index X Weight Of Individual Commodity = Dollars In Individual Commodity

Total Dollars Invested In Index X Weight Of Individual Commodity / Dollar Value Of A Commodity Contract = # Of Contracts In An Individual Commodity

And therefore if someone knows how many contracts are in an individual commodity along with the dollar value of a contract and the weight of that commodity in the index then you can calculate the total dollars invested in the index as follows:

# Of Contracts In An Individual Commodity X Dollar Value Of A Commodity Contract / Weight Of Individual Commodity = Total Dollars Invested In Index

The CFTC starting in January 2006 has been publishing the Commodity Index Trader Supplement to the Commitments Of Traders report. This supplemental report shows the reported positions of Index Speculators in 12 different agricultural commodities. Of the 12, two commodities:, KC Wheat and Feeder Cattle, are part of the S&P GSCI (and not the DJ-AIG) and one commodity: Soybean Oil, is part of the DJ-AIG (and not the S&P-GSCI). Note that 95% of dollars indexed to commodities are replicating either the S&P-GSCI or DJ-AIG.

Both the S&P-GSCI and DJ-AIG publish on a daily basis the individual weights of their constituent commodities. Also futures market data providers like Bloomberg publish daily closing prices for the commodities. Since the futures contract terms do not change that enables someone to calculate the daily dollar values of the individual commodity contracts.

So with these three data points it is simple to calculate the total dollars invested in the S&P-GSCI and the DJ-AIG on a weekly basis. And once the total dollars invested in these two indices is known then that results in the ability to calculate the number of contracts held by Index Speculators in the other 13 non-agricultural commodities.

He gives an example in the pdf

Also, I know that the investment banks are classified as commercials when they hedge out their commodity swaps but what about funds that invest in futures directly? I didn't think, for example, that CalPERS is considered to be a commercial.

As for Krugman's argument, I disagree with this statement

The short answer is that I think his testimony is just stupid. Here’s what he says:

Index Speculators’ trading strategies amount to virtual hoarding via the commodities futures markets. Institutional Investors are buying up essential items that exist in limited quantities for the sole purpose of reaping speculative profits.

That quote pretty much epitomizes what’s wrong with a lot of what people say about speculation. Buying a futures contract for oil does not reduce the quantity of oil available for consumption; there’s no such thing as “virtual hoarding”.

And Masters really is confused about the difference between paper contracts and physical stuff. He compares the growth in the futures market with increased consumption from China, and says

The increase in demand from Index Speculators is almost equal to the increase in demand from China!

Again, the fact that someone bought a futures contract (which means that someone else sold one) doesn’t reduce the amount of oil available to consume.

In a discussion having nothing to do with this, I read a 25 year commodities floor trader say that, indeed, the demand in the futures markets can very much effect the price. The mere fact that CalPERS is going to throw $10 billion into the market will make traders behave differently than they otherwise would. Heisenberg's Principal in the pits. And if those who would naturally short the position instead see their competitors getting their heads cut off trying to do so, they are less likely to try themselves.

I also question the idea that whether or not a futures market is in contango or backwardation is a rebuttal to whether or not institutions are increasing their allocation to commodities and effecting the price. Such a supposition presupposes that the actions of index investors have no effect on commercial interests. In reality, it does. It plainly occurred in the recent housing market collapse as the "commercials" i.e. Toll Bros, DR Horton, Standard Pacific etc reacted to the so-called irrationality of the housing market by speculating in house prices themselves rather than taking down supply. A similar situation occurred during the Asian Contagion of 1998 when large commercial real estate companies collapsed after speculating in real estate. "Reflexivity" is what George Soros calls it, I believe. Commercial interests, believing that the market is rational, speculate themselves, driving up the price in both the spot AND the futures markets.

But maybe I'm wrong, I don't know.

Many of the commodities certainly feel bubble, a la tech stocks c1999.

 

[editec]

I think there's just too much liquidity in the commodities market, to be frank.

Eventually the market will correct and when it does, people speculating on margin are going to lose their shirts.

 

[dilloduck]

So basically are we paying $4 dollars a gallon for gas because speculators have gambled that Americans will continue to HAVE to pay that much and are willing to do so ?

 

[Paulie]

So basically are we paying $4 dollars a gallon for gas because speculators have gambled that Americans will continue to HAVE to pay that much and are willing to do so ?

I say yes, and no. It's not JUST speculation, and the speculators aren't gambling in my opinion. The geo-political fundamentals indicate every reason to be bullish long term about oil.

If drilling was allowed, some new refineries were built, government cut spending and borrowing so that some surpluss was built up to pay down the debt, and the Dollar started making a serious come back, I'd say there would be good reason to back off on oil.

I don't think any ONE of those points could make enough of an impact on its own, because the others would eventually cancel that one out. But if they should all start coming to fruition together, there would be a great environment for an ease in the price of oil.

 

[editec]

So basically are we paying $4 dollars a gallon for gas because speculators have gambled that Americans will continue to HAVE to pay that much and are willing to do so ?

Sort of.

Withthe collapse of the real estate bubble, and with the fibrilation of the stock market, and the bond market, there is one hell of a lot of money that need investing someplace.

What's left but the commodities markets?

Now the amount of money being invested in far in above what that market needs for the nature hedgeing that producers and consumers needed to give the market stability.

Swo there's a lot of long term plays out there betting that the cost will escalate which is making the long plays more expensive.

What I don't think I understand AT ALL, is the relationship between the spot prices and the futures markets.

The pure speculators are not going to be taking delievery of the oil they're betting on, so why is the spot price so damned high.

I do not pretend to understand these relationships, I mean I really don't know. (and I really HATE it when I can't understand stuff like this, too, damn it!)

 

[dilloduck]

Sort of.

Withthe collapse of the real estate bubble, and with the fibrilation of the stock market, and the bond market, there is one hell of a lot of money that need investing someplace.

What's left but the commodities markets?

Now the amount of money being invested in far in above what that market needs for the nature hedgeing that producers and consumers needed to give the market stability.

Swo there's a lot of long term plays out there betting that the cost will escalate which is making the long plays more expensive.

What I don't think I understand AT ALL, is the relationship between the spot prices and the futures markets.

The pure speculators are not going to be taking delievery of the oil they're betting on, so why is the spot price so damned high.

I do not pretend to understand these relationships, I mean I really don't know. (and I really HATE it when I can't understand stuff like this, too, damn it!)

Ditto----I'm all for cleaner alternative energy sources but this huge debate over why a commodity has suddenly got so expensive baffles me. IMHO it is one reason why people are so angry about it. ( in addition to the fact that something that it now considered a NEED costs so damn much ).

If Congress wants to investigate something they need to know a little bit about what they are investigating and somehow I don't think that's gonna happen any time soon.

 

[JimH52]

The speculators driving up the price of crude are people who cannot even take delivery of the crude. I watched some of the CSPAN committee meetings and it was pointed out that probably about 1% of those who drive the price up could actually take delivery. But I am convinced the committee will do nothing. Just be prepared to pay $4.50 oil soon if you aren't already.

 

[sealybobo]

I understand that the bush appointee that oversees the energy industry won't enforce the laws because he is an oil man himself. and you can't get the justice dept to do anything because it too has ben politicized. I don't think ppl realize what's going on. so outragous that if you try to explain it, you sound like a conspiracy nut.

 

[JimH52]

The people testifying said Congress could do something about the speculators...but as you said, they won't. Lots of people are getting very rich right now. The speculators will continue to push the price as far as they can. Right now I don't see an end in sight.

 

[gonegolfin]

Brian

What do you make of Masters' argument?

Quote:
"Today, Index Speculators are pouring billions of dollars into the commodities futures markets, speculating that commodity prices will increase. Chart One shows Assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008, and the prices of the 25 commodities that compose these indices have risen by an average of 183% in those five years!"

Of course, here Masters is referring to a variety of commodities and not just oil. But I agree that a lot of money has been poured into the commodities futures market on a bet that commodity prices will increase. I have done it myself as I believe you have as well.

And up to until nearly a year ago, the commercial shorts (other than the expected hedgers) had been piling in against the commercial longs (which for some strange reason includes the index funds) ... until the supply/demand situation began tightening nearly 11 months ago. This is when the real price move took place (doubling to $140). And in that time period, the "speculators" (index funds) actually reduced their positions. So, I have a real problem with labeling the "speculators" (index funds) as evil here. Everything was dandy when the commercial shorts (who are the real "speculators" here) were making money off of the "speculators" (index funds). But once the physical market began to move away from them, they started covering (buying back their shorts) ... providing fuel for the rise in price. During this period of time, the "speculators" (index funds) actually had a negative (downward) impact on the price of oil as they were reducing their long positions.

I do not so much disagree with what Masters has to say. It is where Congress wants to take it (without providing the real truth) that I despise.

Also, I know that the investment banks are classified as commercials when they hedge out their commodity swaps but what about funds that invest in futures directly? I didn't think, for example, that CalPERS is considered to be a commercial.

Yes, the investment banks as well as the producers are considered as commercial investors (commercials). The users (Ex. airline industry in the case of oil, refiners) are also considered commercials.

But the long-only index funds are also typically registered as commercials. The reasoning being that the long-only index funds get their exposure from the investment banks via the sale of swaps. In my opinion, both the investment banks (selling the oil swaps) and the long-only index funds should be considered as speculators according to the CFTC. Thus, I think they should be included in the non-commercial category. But they are not ... I think that either both need to be reported as commercials or both as non-commercials. You cannot split them.

As for Krugman's argument, I disagree with this statement

I am with you. I am a believer that the futures market affects traders' behavior and thus the physical market. You see it in Gold and Silver all the time.

Whether or not we are really in an oil bubble (or a commodities bubble), I really do not know. There are so many variables here and many of them point towards higher prices. But it has also been a parabolic run. I don't think the right thing to do is to come in after the fact and saddle the long-index funds with artificial market correcting measures (intervention). If it really a bubble, it will correct. If it is not, intervention will make the problem worse down the road (while providing the illusion short term that it was the correct action to take).

Brian