Wednesday, May 04, 2011

What Can Onions Teach Us About Oil Prices?

Onions have no futures market, yet their price volatility makes the swings in oil look tame.

Fortune Magazine (June 30, 2008) -- "Before the government starts scrutinizing the role that speculators may have played in driving up fuel and food prices, investigators may want to take a look at price swings in a commodity not in today's news: onions. 

The bulbous root is the only commodity for which futures trading is banned. Back in 1958, onion growers convinced themselves that futures traders were responsible for falling onion prices, so they lobbied an up-and-coming Michigan Congressman named Gerald Ford to push through a law banning all futures trading in onions. The law still stands.  

And yet even with no traders to blame, the volatility in onion prices makes the swings in oil and corn look tame, reinforcing academics' belief that futures trading diminishes extreme price swings. Since 2006, oil prices have risen 100%, and corn is up 300%. But onion prices soared 400% between October 2006 and April 2007, when weather reduced crops, only to crash 96% by March 2008 on overproduction and then rebound 300% by this past April (see top chart above, click to enlarge)."

MP: The bottom chart above shows the monthly percentage changes in oil prices and onions prices. Between 2000 and 2011, onion prices have been 7 times more volatile than oil prices, based on the difference in the standard deviations of monthly price changes.   

See John Stossel's related column today "Gasoline and Onions."

34 Comments:

At 5/04/2011 3:57 PM, Blogger Benjamin said...

Of course, this onions v. oil could only mean that some interests are steadily gaming the oil prices higher, taking advantage of inelastic demand, while onions face a wild and free market, where prices and demand can collapse.

Steadily rising prices could be the result of artificial non-free-market forces.

Volatility may result from free markets.

Not a clear picture.

 
At 5/04/2011 4:16 PM, Blogger Anni_V said...

Oil is tied to the USD. As long as we manipulate the dollar, oil's price is also manipulated. Don't need much of anything else for it's volatility now days with the "free press" at the Fed.

 
At 5/04/2011 4:22 PM, Blogger Jet Beagle said...

benjamin: "some interests are steadily gaming the oil prices higher, taking advantage of inelastic demand."

First, it is not clear whether you mean "perfectly inelastic demand" or "relatively inelastic demand".

We know from history that the demand for oil products is not perfectly inelastic. Real inflation-adjusted increases in gasoline prices have led to decreases in gasoline usage. Likewise, real inflation-adjusted decreases in gasoline prices have led to increases in gasoline usage.

Second, what do you mean by "artificial non-free-market forces"? Are you referring to oil producers and gasoline producers raising prices in order to maximize profits as "artifical non-free-market forces"?

 
At 5/04/2011 4:49 PM, Blogger Benjamin said...

Jet Beagle-

Excellent questions!

For brevity's sake, I kept my comments tight. Here's more--

1. Inelastic demand. Oil demand is inelastic for the short-term, and becomes more elastic over time. I contend that oil demand in the long-run is highly elastic, although I am defining the "long-run" as 10 years or more. This is why I am not a "Peak Oil" weenie.

Still, the NYMEX or other oil exchanges could be steadily gamed up for serious stretches of time, resulting in relative price stability compared to a free market in a commodity such as onions.

2. Artificial forces. We have seen the emergence of huge ETFs and sovereign wealth funds in the last 10 years. Obviously, OPEC is a major player.
It is legal to plant "oil shortage" or "Peak Oil" scare stories in the media, and take a position on the NYMEX. It is legal to cloak identity. It is legal to leverage to the moon on the NYMEX.

What would prevent,say, a Putin-Russia from trading contracts higher and higher on the NYMEX? They would break even on their contracts, and make a boodle on their real oil.

I suspect some form of fever-hype-speculation-manipulation drove the NYMEX before, to $147.

At some point, real demand craters, even in the short-term, while supplies keep growing. You get a bust.

Now, the cycle has started again.

I do not blame "oil giants" or any of the smaller players.

The oil markets today are a NYMEX-Brent thing, and the players are oil-thug states, ETFs, and maybe Goldman Sachs.

BTW, thanks to wonderful innovations and conservation initiatives developed in the last oil price spike, this one may be limited, and topping out already.

I sense commodities fever is waning.

On deck: Equities and real estate.

 
At 5/04/2011 4:58 PM, Blogger Jet Beagle said...

Benjamin,

Just to be sure we are using the same terms:

price inelastic - the percentage change in quantity demanded is less than the percentage change in price

perfectly price inelastic - the quantity demanded remains unchanged regardless of the change in price

The demand for oil and the demand for gasoline have both been price inelastic for all of my lifetime (60 years). But the demand for neither have ever been perfectly perfectly price inelastic.

If you wish, I can provide links to research which proves what I have just asserted.

 
At 5/04/2011 5:03 PM, Blogger Jet Beagle said...

"this onions v. oil could only mean that some interests are steadily gaming the oil prices higher, taking advantage of inelastic demand, while onions face a wild and free market"

In a free market, producers would - and should - "take advantage of inelastic demand". It is exactly the higher profits existing supplierss receive which motivates them and other potential suppliers to produce more. It is exactly the resulting higher prices paid by consumers which motivates them to seek alternatives to their existing levels of consumption.

 
At 5/04/2011 5:12 PM, Blogger Benjamin said...

Jet Beagle-

If I understand you correctly, on this matter we agree about nearly everything.

 
At 5/04/2011 5:35 PM, Blogger rjs said...

onion volatility is probably caused by the hoarding in india

 
At 5/04/2011 6:34 PM, Blogger Hydra said...

Volatility may result from free markets.


Would not free markets include the freedom to trade futures?

 
At 5/04/2011 6:38 PM, Blogger Hydra said...

What is hoarding except investing in the commoddity and betting against the futures?

 
At 5/04/2011 6:40 PM, Blogger Ron H. said...

Bunny

"Still, the NYMEX or other oil exchanges could be steadily gamed up for serious stretches of time, resulting in relative price stability compared to a free market in a commodity such as onions."

Exactly how would this work for long periods of time? Is someone hoarding large amounts of oil? Buying more and more contracts can certain raise the price in the short term, but at some point you have a helluva lot of contracts - or oil - to dispose of. What happens to the price then?

Speculators guessing on the direction oil prices will take, can't work in one direction only. Some win big, some lose big. Few want physical oil, so they must sell at some point. What happens to prices when people sell?

An exchange in which anyone can buy and sell oil sounds pretty free-market to me. What's not free about it? THe deceptive practices you mention don't make the market less free, only riskier.

"What would prevent,say, a Putin-Russia from trading contracts higher and higher on the NYMEX? They would break even on their contracts, and make a boodle on their real oil."

Well, I dunno, maybe few buyers at the higher prices? Trading higher implies there are buyers involved.

 
At 5/04/2011 7:21 PM, Blogger Benjamin said...

Ron H-

My dear friend Ron.

Please--a Russia could (through cloaked identities) buy and sell the same contract. They then agree to buy and sell at prices that creep higher, thus setting the market.

According to the CFTC, more than 80 percent of trades originate from a handful of entities. One trader controlled 11 percent of trades, during a period under study.

Also, remember, the vast bulk of NYMEX contract expire, and no physical delivery is made. Only cash.

 
At 5/04/2011 7:30 PM, Blogger Richard Rider, Chair, San Diego Tax Fighters said...

Ask the Texas Hunt brothers how manipulating up the price of silver with futures contracts worked for the in the70's. They had huge POTENTIAL profits, but selling some contracts started a quick collapse (the price dropped 50% in four days), leaving them with massive losses that all but broke them financially. Between that and other setbacks, within a decade they had lost 80% of their $5 billion fortune.

 
At 5/04/2011 9:55 PM, Blogger Ron H. said...

Bunny

"Please--a Russia could (through cloaked identities) buy and sell the same contract. They then agree to buy and sell at prices that creep higher, thus setting the market."

Yes, I understand that. Anything is possible, but on a short term basis. Ultimately someone must deal with physical oil, or there is no market. This isn't a market in imaginary gases, like the now defunct CCX.

"Also, remember, the vast bulk of NYMEX contract expire, and no physical delivery is made. Only cash."

I'm aware of that. Some at a profit, and some at a loss. THe contract price and spot price can't be miles apart all the time.

 
At 5/05/2011 1:04 AM, Blogger Jet Beagle said...

Benjamin: "If I understand you correctly, on this matter we agree about nearly everything"

No, we do not.

 
At 5/05/2011 8:21 AM, Blogger morganovich said...

futures markets lessen volatility in price. it's very simple benji.

short term supply shocks will cause huge moves in price in a spot commodity. the onion harvest is small, and demand needs to come down so price goes up wildly.

had there been futures, that would not happen as the price would have been agreed upon months earlier.

"Steadily rising prices could be the result of artificial non-free-market forces. "

this is a meaningless statement.

how?

how do you drive up oil prices "artificially" with futures?

at some point you either have to sell them, driving price down, or take delivery. so how do you "hold the price high"? you seem to lack even rudimentary understanding of capital markets.

so what are these mythical "artificial non free market forces"? are you talking about opec? even oligopolistic behavior is free market and profit maximization is hardly artificial.

 
At 5/05/2011 8:27 AM, Blogger morganovich said...

mark-

i think there may be a flaw with your comparison.

agricultural commodities are much more prone to acute shortages than minerals, particularly oil.

as a result, i'm not sure it's valid to compare onions to oil for volatility and assume that the difference comes from futures markets.

you may just be discovering that:

a. agricultural commodities are more volatile than oil.

b. small dollar value commodities (in terms of traded value) are more volatile than larger ones.

i think this would be more valid if you found a non futures traded commodity (or basket thereof) whose price was not driven by weather to use as a comparator.

 
At 5/05/2011 8:35 AM, Blogger morganovich said...

"Please--a Russia could (through cloaked identities) buy and sell the same contract. They then agree to buy and sell at prices that creep higher, thus setting the market. "

no.

this would not work at all. your understanding of markets is flawed.

so russia trades with itself. big deal. that's one print.

now who is the bid?

if russia isn't, then the price will fall back down to where the other traders are.

if they are, then you can sell to them, and they are now making a directional bet.

further, they cannot run the price up as you describe either.

exchange rules state that you MUST trade at the best available price.

thus, if i am a seller at $112, russia cannot run the price up to 113 trading with itself until they buy my oil first.

so again, they are no directionally exposed. they own my oil. if they want to be risk free, they need to sell it again.

so long as someone else is on the offer, you cannot run a commodity higher by trading with yourself.

try this yourself with 2 etrade accounts if you like. you'll lose your ass.

you clearly have no idea at all how an exchange trades.

 
At 5/05/2011 9:23 AM, Blogger Mike said...

Can somebody help me with a question?

I just did a sort of 'crash-and-burn' look at some numbers, so I may have made a mistake, but one number is clearly out of whack.

If you look (from Jan 2011 to this week) at the dollar, the euro, oil and gold - the prices are pretty consistent in their relation - give or take, about 12-13% rise in those commodities prices in $ - but gasoline is up over 30% in the same time.

If there is no notable change in taxes, refining, distribution or consumption, why wouldn't gasoline more closely reflect the price of oil?

 
At 5/05/2011 2:08 PM, Blogger Jet Beagle said...

Mike,

Gasoline prices are determined by both supply and demand. Demand for gasoline in the U.S. is seasonal, and thus prices should also show seasonality. From 2001 through 2010, the average Jan to May increase in gasoline prices has been 21.5%. This includes at least two years when demand was dampened by recessions.

(Data Source: Table 9.4. Motor Gasoline Retail Prices, U.S. City Average, from the Energy Information Administration )

I hope this helps.

 
At 5/05/2011 2:29 PM, Blogger Jet Beagle said...

I forgot about one more cause for gasoline price seasonality: gasoline blends for warm weather are different from the blends for cool weather. For pollution control, summer gasoline contains more oxygenates, which increase the cost of gasoline. Furthermore, the shift from winter to summer blends is usually accompanied by refinery maintenance shutdowns. Those shutdowns temporarily decrease the supply of gasoline in the spring.

 
At 5/05/2011 2:57 PM, Blogger Benjamin said...

See? I was right.

I exposed the Russians yesterday, and today the oil market tumbles badly.

Just keep asking me, and i will keep telling you the truth.

 
At 5/05/2011 2:59 PM, Blogger Benjamin said...

I wonder if Vange and Morgan Frank lost their rear ends on the oil price collapse?

 
At 5/05/2011 4:10 PM, Blogger morganovich said...

banji-

you are an epic dolt.

did you even bother to try and understand why your russian plot is impossible?

your endless ability to ignore hard facts astounds me.

 
At 5/05/2011 4:35 PM, Blogger morganovich said...

ps.

can't speak for vange, but i made a killing today.

 
At 5/06/2011 6:58 AM, Blogger Bill said...

There is an easy way to find the answer. Repeal the law on trading futures in onions, open an onion futures, exchange, and see what happens. And yes, I know this will never happen in real life.

 
At 5/06/2011 6:59 AM, Blogger bobby said...

"did you even bother to try and understand why your russian plot is impossible?"

Actually, with onions, you get into that "fungible v. not really fungible" complication of a small and highly variable full-season crop.

If those nineteen reefer containers over there (a hypothetical "there") are full of strawberries sent to market by my uncle Joe, and said strawberries are the very very best ever grown on this earth, I could indeed run up the price of those strawberries through repeated sales back and forth between me and the berries' owner.

 
At 5/06/2011 8:19 AM, Blogger morganovich said...

bobby-

"I could indeed run up the price of those strawberries through repeated sales back and forth between me and the berries' owner."

1. not and make any money you couldn't. at some point, someone other than you has to pay for them for you to benefit.

2. even if you succeed in running them up, so what? you won't move the rest of the strawberry market. the buyers will not become more interested nor the sellers more hesitant to sell. you'll just me creating a little sideshow and the minute you end it, there will be no bid.

3. it's not a comparable example. oil is exchange traded. exchange have rules. you cannot trade, even with yourself, above the lowest offered price without first hitting that ask and buying that oil. try trading IBM with yourself at $200. see what happens.

you'll put in a $200 bid and a $200 offer, your bid will get filled at $170 and your offer will sit there and not trade. to move the price to $200 you'd probably need to buy 50+ million shares all at once. the minute you were done buying, the price would likely fall. people have a good idea what IBM is worth and you'd attract serious selling at $200. then you'd lose your shirt. oil works the same way.

that's why benji's purported "russian self dealing" plat is just more of his febrile imaginings. the process he describes is not possible. it's just nonsense propagated by ignorant populists.

 
At 5/06/2011 11:06 AM, Blogger Junkyard_hawg1985 said...

Perhaps the sharp swings in onion prices is due to the LACK of a futures market. If you have onions and the price is low, but a six month contract shows higher prices, you buy physical onions, build a facility to store them, then sell at the contract price. The lack of a fixed future contract price discourages the investment for physical storage of onions.

 
At 5/06/2011 11:54 AM, Blogger Mike said...

Jet,

Thanks for the input. I tried to factor in seasonal pricing, but I based it on what I thought was 10% from last year, over the same time period.

Last night, one of my friends, an institutional trader, told me my oil numbers were a bit low.

I'll look at the info you attached later today.

 
At 5/08/2011 3:25 PM, Blogger Collin said...

Your point would have been far more clear if you had not switched the colors for oil and onions between the two charts.

 
At 5/13/2011 2:54 PM, Blogger Jazzbumpa said...

Apples and oranges are now passe. The new paradigm for fatuous comparison is become onions and crude oil. Thanks!

Other than coming out of the ground, these two items have virtually nothing in common. Deciding that the meaningful difference is the lack of a futures market is grotesque cherry picking.

Setting the definition of elasticity aside, though I love onions in things as diverse as omelets and lentil soup, I could easily live out my days quite happily without ever consuming another onion. Leeks might provide a substitute. OTOH, I can't get through the rest of this day without consuming petroleum, and there is no substitute.

And, to the best of my knowledge, there is no OOPC.

Just this week, an oil exec estimated the supply-demand price of oil at around %70. the rest is a rent-seeking speculative premium. Nothing to see here, though.

The right question isn't "should futures markets exist?" Of course they should. The right question is, "what is the effect of excess money at some high multiple beyond what is required to provide liquidity?" Might that be a bit bubblicious?

Also - What is the effect of not having to supply or receive when a contract expires? How does volatility now compare to when that was not the case?

Get in the real world, folks.

Cheers!
JzB

 
At 5/13/2011 2:55 PM, Blogger Jazzbumpa said...

Typo. That should be $70, not %70.

Lo siento,
JzB

 
At 5/06/2012 9:50 AM, Blogger bgamall said...

Mark, how come everyone is using the second chart instead of the first chart? Everyone spreads the second chart about volatility but not the chart that shows clearly the upward movement of oil prices because, IMO, there is MASSIVE speculation.

 

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