Wednesday, June 25, 2008

Oil Prices Double, Futures Contracts Flat and Falling: Where's The Excessive Speculation?

WASHINGTON -- Lawmakers eager to curb speculation in oil markets got support Monday from witnesses who told a House subcommittee that oil prices could fall sharply if Congress put strict limits on trading in energy futures by investment banks, pension funds and other financial investors.

Lawmakers in both the House and Senate are aggressively exploring ways to rein in what they believe is excessive speculation driving skyrocketing oil prices.

"Speculators" in the oil futures market have become a prime target on Capitol Hill, as lawmakers look to respond to voter anxiety about soaring motor fuel prices. A hearing Monday before the House Energy and Commerce subcommittee on Oversight and Investigations highlighted fundamental disputes over the role of financial investors in the recent spike in oil prices.

MP: The chart above provides evidence suggesting that speculators and futures trading may have played almost no role in the recent oil spikes. Since January 2007, oil prices have more than doubled from about $58 to $138 per barrel, a 138% increase. During that same time period, the open interest for futures contracts has remainded relatively stable at an average of about 333,000 contracts (see chart). Further, notice during the recent 55% surge in oil prices since last November ($88.60 to $137), open interest has been falling, not rising!

Where's the "excessive: speculation? The data suggest otherwise.


At 6/25/2008 2:05 PM, Blogger Sophist said...

"During that same time period, the volume of oil futures contracts (open interest) has remainded relatively stable at an average of about 333,000 contracts (see chart)."

Prof. Perry, volume and open interest are two different things.

Then, please present data going back to 2005 so people can understand the difference between then and now. You can see then the geoth in traded volume.

At 6/25/2008 2:08 PM, Blogger Mark J. Perry said...

Post has been updated with the term "open interest," instead of volume.

At 6/25/2008 2:09 PM, Anonymous Ryan said...

If only economics were taught in K-12 schools as a regular subject, much like the standard science or math classes, then maybe people would not believe this crap from the government. The fact that politians are able get away with this kind of lunacy, in the face of so much contrary evidence and theoretical basis, can only be a reflection of that one sad fact. Teach the children economics!

At 6/25/2008 2:44 PM, Blogger Sophist said...

Yep, sustained to slightly falling open interst at these levels can do the damage.

I was trading oil futures back in the late 80s and vol, OI were at much lower levels then. What is important ot realize is the sustainability of the OI at these levels. Usually in the past you would get wide swings of these numbers depending on market conditions.

IMO the chart you presented is another strong indicatio of sustained manipulation by a certain class of speculators. Also, do not forget the other exchanges and that some of teh action has shifted there.

AS they say, beauty is in the eyes of the beholder..

At 6/25/2008 4:26 PM, Blogger bobble said...

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At 6/25/2008 5:58 PM, Blogger Bill Linstrom said...

Prof Perry, I am new to your blog and love it. Thank you.

Can you please explain why no growth in the number of contracts means that "speculators" have had almost no impact on oil prices? Is it not possible that speculators are taking profits along the way, employing many sequential contracts driving up the price by increments in a way similar to stocks that are speculatively inflated beyond their fundamentals?

At 6/25/2008 6:33 PM, Anonymous Sam said...

Professor, I am a novice at this and I enjoy your blog, but from what I can understand there's a difference between the traditional speculation[of farmers and airlines] and index speculation [by pension funds and investment banks ]. Index speculators create a paper demand and usually don't take physical possession of any commodity like traditional speculators. Pension funds buy long driving up prices. Food and oil are essential to the world economy and should not be driven upward by paper demand,only by true physical demand. The commodity markets are small compared to stocks, so billions invested on the unregulated intercontinental exchange (ICE) maybe distorting this market. We need congress to close the Enron loophole they created and let's see what happens. Would like your comment on unregulated exchanges.

At 6/25/2008 8:02 PM, Blogger Zaidon said...

Hello Professor, alright we understand that the open interest is decline but price still shoot upwards. So do you have any theory to explain why is this happen? Someone at says that oil price should more room to go maybe USD170 per barrel before its make a major decline. What do you think?

At 6/25/2008 8:27 PM, Blogger Ken Braun said...

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At 6/25/2008 8:28 PM, Blogger Ken Braun said...

What we need is a futures market on government solutions: People betting their own money on how much the price of gasoline will decline if the alleged "speculators" are punished.

I'm betting the results of this market won't portray congress' proposed solution nearly as neutral as the media.

I also predict that the success of this market in predicting government failure will -- very quickly -- lead to a congressional hearing regarding whether we should punish the speculators who are "skewing" the market for predicting congressional folly.

At 6/26/2008 11:46 AM, Blogger Enginerd said...

The volume of traded contracts has increased dramatically:

I haven't been able to find good history (in the past 5 seconds of research), but I believe daily volume in 2000 was ~ 10k, whereas now it's more like 1 million. This suggests a massive increase in participation in markets, which suggests additional speculation.

At 6/26/2008 1:30 PM, Blogger Bill Linstrom said...

if the volume of trading has gone up dramatically, it is suggestive of speculation. an earlier comment mentioned that "normal" traders will reign in the speculators and keep prices from spiraling upward. But when speculators trade with speculators prices will spiral. Thus, a spike in volume of trading and spiraling prices might indicate speculator on speculator trading; a bubble.

At 6/30/2008 8:48 PM, Anonymous Brightwater said...

If you added another curve to your chart - in addition to open interest - to show volume of trading, we could assess how likely sequential trades are to be driving up prices.

At 7/01/2008 12:47 PM, Anonymous Joseph said...

(newb question) I have been reading about this stuff recently and was wondering:

If the speculators are buying contracts without physical delivery, wouldnt that (over long term) create a huge surplus of unused oil? eventually causing a crash in prices? Much like the housing crisis.

At 7/01/2008 11:00 PM, Anonymous Anonymous said...

You have to be kidding with that analysis, right?

First of all, you have looked at open interest in exchange traded futures.

That might be a tiny portion of the aggregate market. The OTC (over-the-counter market) in oil and other commodities might well be very large.

In the early 2000s, Southwest airlines bought long-term futures contracts to lock into the then-current price. Do you think they went to the exchange and bought future contracts (which, btw, are often short-term). Southwest probably went to big broker-dealers and did OTC contracts. The broker dealers probably hedged their exposure by buying the underlying commodity.

So to analyze this problem more thoroughly, and systematically, you have to:

1. establish the size of the aggregate oild derivates market,

2. hopefully while you did that, you found the different groups of derivatives, e.g., exchange-traded futures, OTC futures, OTC forward contracts, exchange traded options, OTC options, and everything else,

3. for each of the above groups, you need to determine how much of the aggregate notional is hedged using the commodity. for example, positions in the options might be hedged using positions in futures contract, i.e., no additional demand for the commodity has been created.

i'd challenge you to get the OTC data first.

At 7/15/2008 9:48 PM, Blogger softwareNerd said...

Could you explain the source of your data a little more please. I came across your post while search for information on oil open-interest, and your graph has very different figures from this one (admitted from a politician).


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