Saturday, April 21, 2012

Oil Speculator Smackdown: Kennedy vs. Hamilton

In a recent New York Times op-ed, Joseph Kennedy (D-MA) explained why he believes that speculators are responsible for high oil prices, and why pure speculation should be "eliminated":

"Today, speculators dominate the trading of oil futures. According to Congressional testimony by the commodities specialist Michael W. Masters in 2009, the oil futures markets routinely trade more than one billion barrels of oil per day. Given that the entire world produces only around 85 million actual “wet” barrels a day, this means that more than 90 percent of trading involves speculators' exchanging "paper" barrels with one another.

Eliminating pure speculation on oil futures is a question of fairness. The choice is between a world of hedge-fund traders who make enormous amounts of money at the expense of people who need to drive their cars and heat their homes, and a world where the fundamentals of life — food, housing, health care, education and energy — remain affordable for all."

James Hamilton responds:

"Last Friday, 227,000 contracts were traded corresponding to 227 million barrels of oil, which is indeed a large multiple of daily production. But it is worth noting that at the end of Friday, total open interest-- the number of contracts people actually held as of the end of the day-- was only 128,000 contracts, much smaller than the total number of trades during the day, and not much changed from the total open interest as of the end of Thursday. Many of the traders who bought a contract on Friday turned around and sold that same contract later in the day. If the purchase in the morning is argued to have driven the price up, one would think that the sale in the afternoon would bring the price back down. It is unclear by what mechanism Representative Kennedy maintains that the combined effect of a purchase and subsequent sale produces any net effect on the price.

It's also worth noting that on that same day, there were 146,000 May natural gas contracts traded, which if held to maturity would call for delivery of natural gas at Henry Hub in Louisiana. A single contract represents about 10 million cubic feet, so Kennedy's calculations would invite us to compare the 1,146 billion cubic feet of "paper" natural gas traded on Friday with the total of 78 billion cubic feet of natural gas that the U.S. physically produced on an average each day in 2011. Once again, the vast majority of Friday's natural gas futures trades were matched by an offsetting trade during the same day so as to have little effect on end-of-day open interest.

By what mysterious process can all this within-day buying and selling of "paper" energy be the factor that is responsible for both a price of oil in excess of $100/barrel and a price of natural gas at record lows below $2 per thousand cubic feet? I suspect the reason that Kennedy does not explain the details to us is because he does not have a clue himself."

MP: Great question, Professor Hamilton!

41 Comments:

At 4/21/2012 2:53 PM, Blogger Walt G. said...

This comment has been removed by the author.

 
At 4/21/2012 3:05 PM, Blogger Benjamin said...

Not sure about this post.

When the Hunt Bros. gamed the silver market, did it mean the platinum market had to be gamed too?

What if oil-producing thug-states---such as Russia---intend to game the NYMEX or Brent, but not natural gas?

What if there are simply too many players to game natural gas prices upwards? Too much production easily comes online---in contrast to a commodity (oil) that be gamed up on short-term inelastic demand or supply?

Also consider this: Putin has no scruples or ethics, and has billions at his disposal, and in the commodities markets, cloaking one's identity is easy.

It is in Putin's interest, and Russia's interest, to have higher oil prices. Indeed, it would be Putin's patriotic duty to game oil prices higher.

It is safe to assume Putin is trying to game oil prices higher, covertly, and has billions to try at the game.

Why not just take both sides of trades, at higher and higher prices?

One truism: They can't game the market higher forever (although they can make a few extra hundred billion or trillion along the way).

Look for an oil price collapse somewhere in the next three years. Demand is flat, and at $100 a barrel there is not an oilfield in the world that doesn't make money. Soon there will tankers full of oil at Malta, nowhere to offload. That happened in 2008.

It took a few months more for the price to crack, but when it did it went from $147 to $47.

This time I am looking from $100 to $70.

 
At 4/21/2012 3:45 PM, Blogger Methinks said...

I love James Hamilton.

This looks to me like largely the activity of market makers - facilitators of transactions, providers of liquidity, narrowers of bid/ask spreads, reducers of volatility and ensurers of fair value.

Though the average person does not know what a market maker is, they perform a vital function. They do not bet on the direction of price and seek to make money by buying from customers just below fair value and selling to customers just above fair value - hence the constant in and out of contracts.

The profit margins on market making are tiny, but these guys will be pushed out in an effort to shoo speculators who seem (in the minds of the average congressidiot and Benji) to be far more interested in working against the interest of others at a cost to themselves than in advancing their own individual interests.

 
At 4/21/2012 3:55 PM, Blogger Methinks said...

What if there are simply too many players to game natural gas prices upwards?

Let's see, Benji.... If you seem to almost understand that it is harder to push price around in a large, liquid market with lots of participants, how does removingparticipants from a market reduce the ability of the remaining participants to have a bigger influence on price?

It is safe to assume Putin is trying to game oil prices higher, covertly, and has billions to try at the game.

So glad to hear you know so much about Putin. Unfortunately for him and the idiocy you regularly advance on this blog, he's a price taker.

Bully for his billions, but the much smaller spot market trades $3.1 trillion of oil annually. Putin's a drop in that bucket, baby.

If you think you can game the market, Bunny, just let me know. I'll be on the other side of every one of your *%#@ trades. I love dumb money.

 
At 4/21/2012 4:06 PM, Blogger Methinks said...

When the Hunt Bros. gamed the silver market, did it mean the platinum market had to be gamed too?

If manipulating markets is so profitable, why would you leave one out?

I've already explained to you what happened with the Hunt brothers. Your resistance to learning is amusing.

One thing, though. Gold also experienced an almost identical price move during the time that the Evil Hunt brothers (now replaced with the even more evil Kochs) were buying up silver. The Hunts bought no gold at all. So, why the price move?

Hint: double digit inflation in the seventies.

 
At 4/21/2012 5:09 PM, Blogger Reliapundit said...

http://astuteblogger.blogspot.com/2012/04/oil-speculation-explained-via-colombian.html

CUTE VIDEO EXPLAINS HOW OIL FUTURES/SPECULATION WORKS - AND EXPLAINS IT IN A WAY YOU'D THINK A KENNEDY WOULD UNDERSTAND... HEH.

 
At 4/21/2012 6:30 PM, Blogger Abir Mandal said...

Benji
without speculators, you may not have volatility, but that will not stop prices from rising. Instead of rising and falling throughout the day and week and trending over a longer period, oil prices would just spike upwards or downwards without warning. Speculators do a great job of furnishing liquidity in the market and providing price signals. "Speculation" is just another scapegoat in the Obama "It's not my fault" dictionary.

 
At 4/21/2012 7:09 PM, Blogger Methinks said...

Abir,

Actually, when you remove speculators, there's more volatility. In fact, you know that because the price spikes and collapses you describe in your post are volatility.

Speculators in the commodities markets and shorts in equities have long been Enemies of the People in this country. Which is ironic because they make the markets work so much better for the very people who hate them.

 
At 4/21/2012 7:44 PM, Blogger Abir Mandal said...

Methinks: Volatility is short term fluctuations. The price spikes I was talking about are long term ones. Instead of gradually increasing over time as they do now, they would increase sharply at once, throwing the economy into a tailspin.

 
At 4/21/2012 7:54 PM, Blogger Abir Mandal said...

I agree, speculators prevent that. You just repeated what I said, albeit more clearly.

 
At 4/21/2012 9:51 PM, Blogger aorod said...

For Roman Senators.. er.. the Kennedys, buying and selling things should be perfectly understandable.

 
At 4/21/2012 9:56 PM, Blogger Benjamin said...

Methinks-

http://www.michaelgreenberger.com/

This fellow has a great deal of experience, and believes the oil futures markets are manipulated. He has a great deal of credibility, having served in senior positions in government.

You may disagree with him and that's fine. But you won't learn anything in an echo chamber.

Text on an interview here:

http://www.cafemom.com/group/115890/forums/read/16280271/High_Oil_Prices_Must_be_Subject_of_Criminal_Investigation

Remember, we have a strange confluence going on now, of OPEC (which obviously restricts supply to boost prices), Russia, powerful financial interests, and Peak OIl scaremongers.

World supplies are lush, Cushing is full and building more tanks, oil tanker rates are plunging.

See oil tanker rates falling.

"Rates to charter the largest oil tankers fell for a ninth session, extending a second weekly drop, as demand for cargoes dwindled.
Daily hire costs for very large crude carriers on the benchmark Saudi Arabia-to-Japan voyage declined 0.3 percent to 48.88 industry-standard Worldscale points, according to the Baltic Exchange in London today. Charter rates have slid 25 percent during the longest losing streak since August. Each of the ships can hold 2 million barrels of oil."
--30--

Yes, oil is being manipulated; and yes they can't keep it up for years. Supply and demand are price inelastic, but only for so long.

Look for another oil bust in 2013-4, a crackdown to the $70s range.

 
At 4/21/2012 11:41 PM, Blogger Benjamin said...

"McClatchy Newspapers documented in a series of reports last year how the futures markets - where contracts for future delivery of commodities ranging from oil to coffee to cotton are traded - have been overrun by financial speculators. Historically, end users of these products, who are hedging against price shifts, made up 70 percent of trading activity in these commodities. Speculators traditionally played an important but secondary role in what economists call "price discovery," the market finding the rational price for a product based on supply-and-demand fundamentals.

In recent years, the ratio flipped, with oil speculators who have no intent of taking delivery of oil now making up 70 percent or more of trading activity. Critics such as Michael Greenberger, the former head of the trading division of the Commodity Futures Trading Commission - which regulates the futures markets - contend that this flood of financial-sector speculation has pushed up the price of oil and is divorced from underlying market fundamentals of supply and demand.

"People, including the administration and others, are coming to realize that money moves these markets, and money sloshing around in the crude oil market, or any other market, is going to move the price," said Michael Masters, a hedge fund manager whose repeated testimony before Congress highlighted the "financialization" of oil markets.

Researchers at the Federal Reserve Bank of St. Louis determined in a March 13 report that speculation was the second-largest contributor to rising oil prices, accounting for about 15 percent of the rise. Former Fed Chairman Alan Greenspan has said speculation is driving up oil prices, and Saudi Oil Minister Ali al-Naimi last month complained that current oil prices are "unjustifiable" given that there are not global supply shortages, a view he repeated last week.

--30--

I would say if the Fed St. Louis is saying speculators are raising oil prices, then there is something worth looking into.

 
At 4/22/2012 12:33 AM, Blogger Sailor36 said...

It's useful to remember that every trade has two sides: for every trade to the upside, there is a seller who thinks that prices might fall.
If driving the price of oil higher were merely a matter of buying contracts, then everyone would do it and become rich.

It's not that simple, is it?

 
At 4/22/2012 8:14 AM, Blogger Methinks said...

He has a great deal of credibility, having served in senior positions in government.

Ha Ha HA HA HA!!!!

AND he's from the CFTC!

HA HA HA HA HA!!!!!

AND he sounds no smarter than you. If there are "speculators", they must be manipulating and if they are manipulating in commodities, they must always manipulate the price up. In equities, always the manipulation is down. Speculators are so weird like that. Better give the CFTC more power, eh? When are you going to learn the regulators' game, Bunny?

Masters is a repeat moron. He'd like to claim that all energy funds (some of which invest in energy companies, not oil contracts) are buying forward contracts and driving the price up. Except that even if you take his highly inflated estimate of $240 billion (which is the aggregate AUM he claims these companies are tossing into the oil market - inanely it's all buying and never selling), it's a laughably small number compared to the approximately $3.1 trillion annual oil SPOT market. And the spot market is orders of magnitude smaller than the futures market.

Drop in the bucket, Bunny. Which is why Masters is constantly mocked.

Considering the size of the oil market, allegations of manipulation are even more hilarious. Every time I read a charge from the CFTC, it's somebody who is clearly hedging. No matter. The CFTC is the one who decides whether to fine them or not and the fine is always set just below the point where it's worth the legal fees fighting it. Thus, the company pays the mafia to stop the torture, the public thinks that only the guilty pay fines (in reality every single regulated firm pays fines in addition to reg fees every year) and the CFTC mafia gets to win brownie points with its political overlords and the grateful, ignorant public.


Alan Greenspan, our former central planner has said a lot of things since he left his post as head central planner. Apparently, he regrets that he ever believed the markets could right themselves...after he completely mangled incentives. The Saudis would like to deflect anger about oil prices away from themselves (not that anger at the Kingdom is justified either). It costs the Kingdom nothing to say it.

But, I'm confused, Bunny. Weren't you just a few days ago yammering about how, as a producer, the Kindgom benefited from ever higher oil prices and you were certain they were manipulating upward upward too. Like Putin? Hmmmm? Which is it?

If speculators are the problem, why are commodities markets with no futures or forwards and thus no speculation more volatile? Why have their prices also risen sharply?

What role has the Fed's monetary policy had in the changes in the prices of commodities?

I think speculators can and do move prices both up and down. I also know from the days when I covered oil and gas producers that their hedging divisions also sometimes speculated. We should all be grateful to these people because they provide a great service at no risk to us. They, unlike our political overlords, only risk their own money.

If you're so certain we're headed for an oil bust, go sell some futures, Benj. Put your money where you mouth is. Walk the walk, buttercup.

 
At 4/22/2012 9:50 AM, Blogger Hans said...

MeThinks, scores a KO over the challenger, Ben Jamin, in the second round to remain Heavyweight Champion of Carpe Diem...

 
At 4/22/2012 10:00 AM, Blogger Hans said...

Speculators (socialists minds or those of the indolent) = Public Enemy...

Kennedy, is himself a speculator since he can not identify them...

The Russian Commies use the same argument against rich farmers resulting in famine..

MeThinks, remembers the lesson Professor Perry taught us about onions..

 
At 4/22/2012 11:47 AM, Blogger juandos said...

Thank you realiapundit for the link to that video clip...

Not only informative but entertaining...

"Researchers at the Federal Reserve Bank of St. Louis determined in a March 13 report that speculation was the second-largest contributor to rising oil prices, accounting for about 15 percent of the rise"...

No wonder the country is in an economic mess...

We have these bureaucratic, rent seeking. parasites in the local Fed branch that are always good for a few Joe Biden like sound bites...

Leave it to the Kenyan Kommie Klown to screw it up even more though...

From Reuters: Under Obama’s request to Congress, the Commodity Futures Trading Commission (CFTC) would determine how much speculators need to pay to trade U.S. crude oil futures, in theory increasing the amount when prices move too far, too fast.

But economists and traders cautioned that pushing smaller investors out of markets would only hand greater influence to the largest hedge funds and Wall Street banks. Ultimately, there may not be enough traders left to do business with oil producers and consumers looking to hedge their needs.

“Reduced liquidity often means greater volatility,” said broker Jay Levine at Enerjay LLC in Main
...

 
At 4/22/2012 12:23 PM, Blogger Benjamin said...

The gibes here from the peanut galley are not worth dismissing.

Serious readers, continue on to this:

Researchers at the Federal Reserve Bank of St. Louis determined in a March 13 report that speculation was the second-largest contributor to rising oil prices, accounting for about 15 percent of the rise. Former Fed Chairman Alan Greenspan has said speculation is driving up oil prices, and Saudi Oil Minister Ali al-Naimi last month complained that current oil prices are "unjustifiable" given that there are not global supply shortages, a view he repeated last week.

A sensible approach would be higher margin requirement and transparency. We know who buys and trades stocks. Let's make the futures market transparent, full disclosure.

 
At 4/22/2012 12:30 PM, Blogger Walt G. said...

Hans,

Kennedy does not have to identify the speculators. He has to identify his voters and optimize his strategy to be re-elected.

A politican cannot usually have a public smackdown with a college professor because one is usually making a normative statement while the other is making a positive statement: Different games, different strategies, different payoffs.

 
At 4/22/2012 12:44 PM, Blogger Buddy R Pacifico said...

"... speculation was the second-largest contributor to rising oil prices,..."

Speculation must be the second largest contributor to rising natural gas prices also, if logic gives guidance.

Benji, please give evidence of rising natural gas prices, BECAUSE immense fortunes could be made by speculators at this time.

 
At 4/22/2012 1:12 PM, Blogger Walt G. said...

Buddy R Pacifico,

You would need an assumption that numerous pricing factors carry the same weighting for different products for your logical conclusion.

 
At 4/22/2012 1:27 PM, Blogger Buddy R Pacifico said...

Walt, Benjamin cited a report that speculation was the second largest contributor of rising oil prices, or fifteen percent.

So, why are natural gas prices not rising if speculators can mark-up the price 15%? Speculation in natural gas at this time would seem to be an elegant way to make an instant 15% on huge low interest borrowed sums.

 
At 4/22/2012 1:46 PM, Blogger juandos said...

"Serious readers, continue on to this"...

That's in pseudo benny world where those reader reside...

Here they're called a whole lot of things except 'serious readers'...

Obviously pseudo benny you need to brush up on your basic concepts on economics...

pseudo benny your boyfriend is at it again...

Oil Speculator Crackdown Cometh: Central Planner In Chief Announces Self-Promotion To Margin Hiker In Chief

 
At 4/22/2012 1:46 PM, Blogger juandos said...

This comment has been removed by the author.

 
At 4/22/2012 1:48 PM, Blogger Methinks said...

How about the spike in coal prices in 2008? No futures market there and yet coal prices rose faster than oil?

Since speculators in energy only serve to push up the price of the commodity, who was manipulating coal?

Same thing happened with barley. Again....no futures market for speculators to sink their teeth into.

 
At 4/22/2012 1:48 PM, Blogger Jon Murphy said...

Researchers at the Federal Reserve Bank of St. Louis determined in a March 13 report that speculation was the second-largest contributor to rising oil prices, accounting for about 15 percent of the rise. Former Fed Chairman Alan Greenspan has said speculation is driving up oil prices, and Saudi Oil Minister Ali al-Naimi last month complained that current oil prices are "unjustifiable" given that there are not global supply shortages, a view he repeated last week.

I've read this report, too, and it does do nothing to address the questions raised by Hamilton.

Speculators operate in all kinds of commodity markets. If oil speculators are causing the prices to rise, then they must have the same effect on other markets, unless oil has some special property that makes it more susceptible to price manipulation. But we do not see that effect in other markets nor is oil special.

 
At 4/22/2012 2:26 PM, Blogger juandos said...

jon murphy notes: "If oil speculators are causing the prices to rise, then they must have the same effect on other markets..."...

Ahhh, but is the price of oil actually rising?

From Forbes' Charles Kadlec: The cost of this deception goes well beyond the vilification of the oil industry and free markets. The real price of the on-going debauchery of the dollar is measured by the loss of our prosperity and the debasement of our liberty...

 
At 4/22/2012 2:34 PM, Blogger Walt G. said...

I spent a few minutes on Michigan U.S. Senator Levin's (D) website. Here's a quotation of a legal brief on their court case below (Source: Civil Action No. 1:11-CV-2146-RLW). It seems as though the "experts" are at odds.

"Plaintiffs’ brief mentions dozens of “‘studies by institutional, academic, and industry professionals’ relating to the need for and efficacy of position limits . . . that demonstrate[ ] ‘virtually unanimous academic agreement that commodity price changes have been driven by fundamental market conditions, not by speculation.’” See Motion for Summary Judgment at 14 (citations omitted). The relevant question here is not what certain experts or academics may believe about excessive speculation and the efficacy of position limits, but what Congress understood and intended when enacting Dodd-Frank. Congress was well aware of the types of studies to which Plaintiffs refer, not all of which point to the same conclusions about commodity speculation and some of which warrant skepticism due to reliance on industry funding. The Subcommittee considered those studies and consulted a wide range of experts in connection with its own bipartisan investigative efforts in the years leading up to Dodd-Frank. Its investigative reports were unequivocal in finding that the lack of position limits for certain transactions and in certain markets contributed to “the sustained increases in the price and price volatility of these essential commodities[.]” See 2006 Oil and Gas Report at 1; see also 2009 Wheat Report at 181 (“waiv[ing] position limits for commodity index traders facilitated excessive speculation”)"

 
At 4/22/2012 3:06 PM, Blogger Methinks said...

Bunny,

I understand the comfort you find in the appeal to authority since you have no capacity to appeal to logic, reason or facts.

 
At 4/22/2012 3:12 PM, Blogger Methinks said...

Good Lord, Juandos, I hope they do it (the zerohedge link).

In fact, I'm secretly - or not so secretly - rooting for them to shut down the whole market.

These idiots should get what they're asking for and they should get it good and hard. These days I'm delighted whenever more trading moves out of the United States.

Some people can only learn by experience.

 
At 4/22/2012 3:56 PM, Blogger Methinks said...

in theory increasing the amount when prices move too far, too fast.

Ha ha ha! My guess is that "too far too fast" is code for "move up". That's great because the oil options skew is in the put. That means that the probability of a sharp drop in price is much higher than the probability of a spike upward. So, prices are far more likely to move "too much" downward.

Anyone think margin cuts will happen if price tanks? Anyone?

 
At 4/22/2012 4:17 PM, Blogger Buddy R Pacifico said...

"That means that the probability of a sharp drop in price is much higher than the probability of a spike upward."

Yep, more likely sudden panic on the downside than the upside.

 
At 4/22/2012 4:25 PM, Blogger Benjamin said...

Buddy-

Natural gas markets are different from oil markets.

There are too many suppliers in natural gas. It is almost a classic commodity market.

Oil has a few suppliers, OPEC and Russia.

Demand and supply for oil is short-term price inelastic. Ergo, if the NYMEX price is manipulated up, the price can stick.

Natural gas has so many suppliers that if gas prices rise, you get more supply immediately.

Oil is going to crack, just don't know when. Fundamental do come to bear, but it takes time.

In the meantime, hundreds of billions of your dollars are siphoned into oil producing thug states.

 
At 4/22/2012 4:39 PM, Blogger Methinks said...

I see, Bunny, the NG market has a natural "speculator repellent" and OPEC is now suddenly one supplier.

Also, the United States is not the second or third largest producer in the world

The same U.S. independents that produce natural gas in the United States also produce oil. NG is just overcooked oil, Bunn. And then there's Exxon, Shell, Elf, etc. etc. etc. etc.

There are plenty of oil producers - enough to make all of them price takers.

Someone has definitely siphoned something from you, Bunny, but it ain't money.

 
At 4/22/2012 5:26 PM, Blogger Jon Murphy said...

Oil has a few suppliers, OPEC and Russia.

What about the US? Canada? Netherlands? UK? Mexico? China? Scandinavia? OPEC accounts for about 44% of the world's oil production. Russia does not account for the other 56%.

Realistically, oil would be less sustainable to price manipulation since it's an easily tradable commodity. Natural Gas, on the other hand, is very hard to trade and domestic markets usually rule supreme (although I suspect that will change over the next few years).

 
At 4/22/2012 6:06 PM, Blogger Buddy R Pacifico said...

Benjiman states:

"Natural gas markets are different from oil markets.

There are too many suppliers in natural gas. It is almost a classic commodity market.

Oil has a few suppliers, OPEC and Russia."


Therefore -> Too much demand for the supply of oil and not enough demand for the supply of natural gas. This explains the price movements of each commodity. Other explanations are really the speculation in these markets.

 
At 4/22/2012 7:47 PM, Blogger arbitrage789 said...

"By what mysterious process can all this within-day buying and selling of paper energy be the factor that is responsible for ... a price of oil in excess of $100/barrel... Kennedy does not explain the details to us is because he does not have a clue himself."
_______________

Actually, I'm willing to give Kennedy more credit than that. I think that he might actually know more about the economic reality of the situation than he lets on. He's just exploiting the ignorance of tens of millions of Americans.

As a POLITICAL strategy, I think it makes a lot of sense. (If you're a Democrat).

 
At 4/22/2012 10:06 PM, Blogger juandos said...

"Some people can only learn by experience"...

Well methinks I'm thinking you're being tad bit zealous in your optimism if you think a Democrat senator can learn by experience IMHO...

How many of these Democrat senators actually realize the reduced value (purchasing power) of the dollar amounts that are being tossed around?

 
At 4/22/2012 10:31 PM, Blogger Methinks said...

This comment has been removed by the author.

 
At 4/22/2012 10:32 PM, Blogger Methinks said...

I have to agree, Juandos. I was really talking about the population. The people writing the dishonorable Senator are many and ignorant.

But, even there I might be a touch overly optimistic.

 

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