Monday, April 23, 2012

Speculators Are Driving Down Oil Futures Prices

In anticipation of rising future supply and/or declining future demand, oil speculators are now driving oil prices down for December 2016 crude oil futures contracts.  In just the last three weeks, futures prices for delivery in 2016 have fallen by more than 5%, from $94.75 per barrel in early April to below $90 in recent trading.  

Are these the same destabilizing, market-manipulating oil speculators who are supposedly to blame for oil prices rising in the short term?  Or are these the "good" speculators whose trading leads to falling prices, as opposed to the "bad" speculators whose trading raises prices? 


At 4/23/2012 3:51 PM, Blogger PeakTrader said...

The good speculators bet on lower prices and the bad speculators bet on higher prices.

So, Obama wants to put the bad speculators in prison.

At 4/23/2012 3:55 PM, Blogger Methinks said...

Well, I dunno, Mark. What happened to all those ETFs rolling futures contracts and keeping oil off the market because we're sure people have financialized oil? Aren't they supposed to be encouraging slower production and hoarding, keeping the price up?

At 4/23/2012 3:56 PM, Blogger Methinks said...

Peak, you obviously didn't get the memo we were all sent in 2008:

You can't buy commodities and you can't sell stocks.

Welcome to our world.

At 4/23/2012 4:02 PM, Blogger PeakTrader said...

Methinks, I think, Obama has done an excellent job keeping commodity prices low.

He spent trillions of dollars for a depression.

At 4/23/2012 4:09 PM, Blogger Methinks said...

Peak, my husband can't stop laughing. Thanks.

At 4/23/2012 4:17 PM, Blogger PeakTrader said...

Methinks, you know Obama is special. It's a rare talent to spend trillions of dollars and actually achieve nothing.

At 4/23/2012 4:25 PM, Blogger Methinks said...


How can you call perverting incentives, destroying health care, mangling financial markets, jacking up moral hazard and terrorizing producers "achieving nothing"?

At 4/23/2012 4:28 PM, Blogger PeakTrader said...

Methinks, those weren't really achievements.

They were the results of what Obama was trying to achieve.

At 4/23/2012 4:33 PM, Blogger Methinks said...

This comment has been removed by the author.

At 4/23/2012 4:33 PM, Blogger Methinks said...

Well, you know how it is, man's terrorism is another man's achievement. gotta break a few eggs, hang a couple of speculators, print a few dollars on your way to Paradise.

At 4/23/2012 5:34 PM, Blogger ws4whgfb said...

The good speculators are those in the industry who buy or sell oil or oil products who need to hedge their bets or raise money in the short term to fund their business. These people bet on what they think prices will be in the future.

The bad speculators are those people in the financial industry who bet according to what they think their peers will think the future prices will be. They are not in the oil industry doing business, they are professional gamblers distorting markets.

At 4/23/2012 5:47 PM, Blogger ws4whgfb said...

A good price is a fair price.

If I publish a fake news story that causes oil prices to be too high, buyers would be getting cheated. If I publish a fake news story that causes prices to be too low then, sellers would be getting cheated.

If professional gamblers (speculators) artificially change the price of oil, that artificial price is "bad" whether it is too high or too low.

The professional gamblers can create a bubble, irrational exuberence - people buy because prices are going up (people buy because other people are buying) rather than because there is value in the product - like the tulip mainia. This herd mentality determining prices rather than the value of the product (in this case the value of oil to users) is "bad".

If people didn't buy tulips as a form of gamboling, but only gardeners (professoinal and amature ) and nurserys bought and sold tulip bulbs there wouldn't have been a mania.

At 4/23/2012 5:54 PM, Blogger Methinks said...

And here we have a commenter who reminds us that scapegoating speculators is a tried and true tradition spanning hundreds of years and the ignorant but certain are unwilling to part with it regardless of evidence.

Like, for instance, prices have gone down despite the presence of spooky speculators artificially changing the price of oil...and stuff...

At 4/23/2012 7:56 PM, Blogger Unknown said...

Methinks: You could have pretty much said the same thing in a much shorter way: Here we have an Obama-lover...

At 4/23/2012 8:07 PM, Blogger Jon Murphy said...

Hm...the timing of these contracts are interesting for a reason that I will never tell any of you :-P

At 4/23/2012 8:12 PM, Blogger Methinks said...

Abir, you're right. was too verbose.


Don't kid yourself. I will eventually get it out of you. Vee have vays.

At 4/23/2012 8:42 PM, Blogger Jon Murphy said...

Don't kid yourself. I will eventually get it out of you. Vee have vays.

I'll save you the trouble: I'll tell you for 5 grand.

At 4/23/2012 8:59 PM, Blogger Methinks said...

How do I now it's worth 5 grand? you'll have to give me more information.

WAIT!! Don't tell me! Obama caught and killed a posse of speculators in a raid like the one on bin Laden!

At 4/23/2012 9:27 PM, Blogger Jon Murphy said...

How do I now it's worth 5 grand? you'll have to give me more information.

I'm giving you a "Friends of Liberty" discount. We sell this info to companies at $6G a pop.

At 4/24/2012 4:42 AM, Blogger Ron H. said...

"WAIT!! Don't tell me! Obama caught and killed a posse of speculators in a raid like the one on bin Laden!"

A "posse" of speculators? I learn something every day. :) I need to write that one down.

At 4/24/2012 7:17 AM, Blogger Methinks said...

$6K? That doesn't sound like it's more than the same opinion I was paid to write when I was an analyst. Experience tells me it's overpriced (knowing nothing else about it, of course).

At 4/24/2012 8:15 AM, Blogger Hydra said...

If you draw a least squares lain across the full spectrum of that chart, it would appear to trend up, not down.

Not that Obama has anything to do with it.

The amusing part of this is that one could replace Obama with ANY Democratic president and the vituperous remarks here would barely change, thus showing that the issues have nothing to do with Obama.

I'm not defending the guy, just remarking that I doubt ANYONE could actually be responsible for everything he gets credit/blame for.

If some of you applied the same standard of causality/correlation and the same standard of evidence to Obama and national events as you seem to require for, say, CO2 production and global warming, the conversation, such as it is, would sound a lot different.

For myself, I pretty much discount any argument that depends on demonizing or "geeking" the opponent.

I expect insults to follow.

At 4/24/2012 8:20 AM, Blogger Karl said...


Sorry I could not see your comments at Cafe Hayek.

I did not realize that one could insist on a physical settle on NYMEX WTI. I had been operating on the misunderstanding that the exchange would take a cash settle as obligation met.

Also do I understand you correctly in saying that the introduction of ETFs cannot increase the steepness of the forward curve?

If you are effectively trying to hold oil crude oil as a store of value rather than process it, does this not increase the demand for holding oil?
In which case the relevant comparison would be between ETF size and physical storage capacity.

At 4/24/2012 8:26 AM, Blogger Hydra said...

"If people didn't buy tulips as a form of gamboling, but only gardeners (professoinal and amature ) and nurserys bought and sold tulip bulbs there wouldn't have been a mania."


OK, so I have a special warehouse for storing apples, in an ethylene atmosphere that keeps them from spoiling for months. This alters the market for apples.

I rent space in the warehouse and I buy and sell apples,in order to recover my investment, otherwise I have no use for the apples, myself, and I could care less what my tenants do with the apples they store. Some are bakers who buy apples and rent storage for them when the price is low, Some are orchardists who rent space for their apples until the price is higher. Some are speculators in apples who care only about the price changes, and not the apples.

Since all of this changes the price of apples, how do I know if the new price is "bad"?

At 4/24/2012 8:29 AM, Blogger Hydra said...

If traders gamboled at the markets, then the markets would be a lot more entertaining.

At 4/24/2012 11:08 AM, Blogger Methinks said...


Those comments wouldn't post. It's a facebook issue, I'm told. Frustrating.

Here's a link to the contract specs for the light sweet contract so you can examine it for yourself:
What you're interested in is "settlement" on the left hand side (unless you're dying to know all the trading rules).

Futures and forwards are both binding contracts. Both specify every detail of quantity, quality of the commodity, price and delivery. The difference is that futures are standardized contracts that lend themselves well to trading on exchanges where they benefit from the clearing process (eliminating counterparty risk). Forwards are OTC negotiated contracts and the lack of standardization makes them unsuitable for trading in a secondary market and counterparty risk is retained. Some ETFs allow themselves the option of buying forwards in their OAs, but don't prefer them because of the liquidity issue. You’ll find that the ETFs have a strong preference for the light sweet contract for that reason.

While forwards contracts can write in whatever options they want, futures contracts usually don’t include optionality. The ETF managers arrive in the oil pit (80% of the futures USO holds , for example, are traded on the floor) and roll the contracts before settlement. Since the future is so liquid and the fund only holds about 12,000 contracts, they are never afraid of being forced to hold to settlement. So, I think you may be conflating monetizing a contract before settlement with an option to settle for cash.

You were bang on correct that the managers persistently overpay for contracts. They don’t care if they overpay for contracts and they don’t bother working the trade to get the best prices. It's one of the reasons the funds underperform and I don't think they're particularly well run, but that's a different discussion. Managers stomp into the pit to roll the contracts and are arbed by the pit every month in basically the way I described in the email I sent to Don Boudreaux and which he posted on the CH wall on FB since it wouldn't post into the blog( I wasn't sure what you were talking about when I read your first comment there, btw. I wasn’t sure you were talking about the ETFs as I was thrown off by your talk of forwards).

However, once the contracts are rolled, the managers evaporate and the arbitrage opportunities are gone. There is no lasting effect. Contango is actually quite nuanced and we could spend all day talking about it, and it’s very interesting (to me alone maybe) but the main take-away is that it doesn’t represent a sustained arbitrage opportunity for shorts.

My personal guess is that more than buying oil to hedge against inflation, people realize that as consumers of oil they are by definition short oil. So, they try to hedge their personal commodity exposure by buying oil ETFs. I don't know for sure, but then I don't think it's correct to say one knows

At 4/24/2012 11:09 AM, Blogger Methinks said...

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At 4/24/2012 11:11 AM, Blogger Methinks said...

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At 4/24/2012 11:12 AM, Blogger Methinks said...

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At 4/24/2012 11:14 AM, Blogger VangelV said...

Makes sense. With Europe imploding and the real economy in the US unable to recover it looks as if demand will fall. The bet is that there will not be a supply side disruption in the Middle East and that demand will weaken in the developing world.

At 4/25/2012 4:05 PM, Blogger Methinks said...

Fabulous. These are my attempts to reply to Karl yesterday.

At 4/25/2012 4:07 PM, Blogger Methinks said...


for sure, but then I don't think it's correct to say one knows for sure that all those people are hedging against inflation either. And that effect would be spread among all storable commodities anyway, I would expect.

Certainly, long ETFs theoretically increase the price of the commodity by increasing demand. But are they doing that in practice to any significant degree?

I can't see how the effect is large enough to worry about. There are roughly 10 long ETFs (and at least three inverse ETFs, at least one of which is an ultra-short which will work as a counter to the effects of long ETFs). The largest pure play is USO. Its assets are $1.27 billion which corresponds to just over 12,000 contracts, each of which are for 1,000 bbls of oil, translating to a claim on 12 million barrels of oil. Consider that roughly 85 million bbls are produced daily . USL holds only 131 light sweet contracts with a claim on 131,000 bbls of oil. UCO Ultra DJ-UBS Crude oil holds 1,774 light sweet contracts with a notional value of just under $184 million. I haven’t done all the math as a mere blog comment doesn’t warrant the time, but if the largest is $1.2B and most are under $500MM, I generously estimate the long ETFs combined are have less $5 billion in assets and their portfolios would hold claim on about 50 million bbls In total. In a market that produces over 31 billion bbls annually. And that’s before we factor in the countering effects of the inverse oil ETFs that don’t hedge their short exposure by buying the underlying and also just roll contracts. There are hedge funds that trade these contracts as well, but they are in and out.

I just can’t see how one can make a case that these funds are having any significant effects on the market even if my back of the envelope analysis is off by an order of Magnitude as large as Mike Masters’s.

I do, of course, agree that if these funds grow (and they’d have to grow astronomically) they will have a huge effect on the demand for storage and will push up the forward curve in the short run (as happens occasionally now when demand for storage spikes as the market adjusts expectations), but then we’re talking about a hoarding scenario and there doesn’t seem to be any evidence of that. And, unless everyone stops looking for more oil, hoarding is a high risk game anyway. I think the papers Mark Perry linked to today have more in-depth research on this issue. I’ve only skimmed it so far.

Frankly, I’m not a fan of those ETFs. They underperform and they’re badly managed (but I repeat myself). I’d rather short them and buy their underlying portfolio. But, here again theory and practice diverge. Often the negative rebate for borrowing shares will exceed all your theoretical edge.


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