[hope_full]

Great article on CNN. "Don't Blame the Oil Speculators"

link too long

Don't blame the oil 'speculators'
A campaign in Congress to punish traders for record oil prices reveals a fundamental misunderstanding of how futures markets work.
By Jon Birger, senior writer
Last Updated: June 27, 2008: 9:11 AM EDT


NEW YORK (Fortune) -- "Make no mistake about it," U.S. Rep. Bart Stupak, D-Mich., said Monday while chairing a meeting of the House Energy and Commerce subcommittee on Oversight and Investigations. "Excessive speculation in commodity markets is having a devastating effect at the gas pump that is rippling through our entire economy."

Here's a suggestion: The next time a Congressional committee wants to hold a hearing on how "speculators" are driving up oil prices, each committee member should first be required to demonstrate - preferably in their opening remarks - a basic understanding of the mechanics of futures trading.

Even better, they should be required to explain in detail how it is that investors who never take delivery of a single barrel of crude - and thus never remove a drop of oil from the open market - are causing record high oil prices.

[JohnDenver]

Even better, they should be required to explain in detail how it is that investors who never take delivery of a single barrel of crude - and thus never remove a drop of oil from the open market - are causing record high oil prices.

Here's that explanation:

Most crude oil is traded based on long-term contracts, and the prices in those contracts are set by adding a premium to, or subtracting a discount from, the prices of certain benchmark crudes, namely: WTI (NYMEX), Brent (ICE) and Dubai-Oman. The benchmark prices are in turn set by futures traders, in a process called "price discovery". This is the mechanism by which futures prices directly affect physical prices throughout the world. For some genuine information on the structure of oil pricing see here and Section 2 (P. 3) of OPEC Pricing Power The Need for a New Perspective (pdf). Matt Simmons also describes this mechanism here.

The author of the CNN article is an obvious shill for Wall Street and speculators, and no doubt invested up the gills in oil futures/ETFs etc.

[MrBill]

Yes, John, but before the contract month matures paper traders have to sell their longs to avoid taking delivery. They can then buy the next month out - or any future's month along the curve - but at the end of the period their net position is zero.

What 'index investors' are doing is absorbing 'offers' from those that either need to sell to hedge physical production and/or those willing to sell in expectation of prices falling. They are using up liquidity as opposed to adding to it like regular speculators that routinely buy and sell.

Congress' actions are still misguided and will ultimately fail. The physical price of crude is set globally in open markets. Those prices can be indexed to benchmark futures prices, but the 'basis' (the spread over or under the future's price) is set by supply and demand.

No one is likely to sell physical crude for $70 when the futures price is $140, but if hedgers and speculators thought $140 was too high then they would be increasing their short positions. And if physical users of crude thought $140 was too cheap they would buy futures and take deliver at maturity. Oil is fungible, so the only difference is transport costs. Also reflected in the basis.

The price remains stubbornly high because demand is growing faster than supply. The IEA calculates that three-fifths of the increase in crude prices in the past year - roughly double - has been absorbed by subsidies to shield end users from the high cost of petrol. Therefore, those high prices are not filtering down to the consumer to signal that they should reduce demand. Subsidies always encourage over-consumption. And that is something that Congress has very little control over.

[MrBill]

youtube

Some simple explanations why oil speculation is not the reason for current price rises.

Sorry, cipi604, but I merged the two threads. Thanks. MrBill.

[TheDude]

New chart from Bloomberg:



Bets on Oil Futures Drop to 15-Month Low, Face U.S. Limits: Chart of Day

The chart of the day shows oil prices (white line) and open interest (red line) since the start of 2007. Futures contracts peaked at a record 1.58 million on July 16 even as crude has almost doubled since. There were 1.29 million on June 25 and 1.30 million the following day, according to Nymex.

Commercial users, which include energy companies selling future production as well as oil-index investors, have switched their net position from short 102,835 in the beginning of March, when crude first closed above $100 per barrel, to long 4,635 last week.

Almost all of Pemex's windfall has gone into maintaining the Mexican subsidies. The price rise has kept up with their production's depletion to maintain a balance of government revenue but that will reach a tipping point somewhere along the line.

[MrBill]

PEMEX has been Mexico's cash cow for so long that I doubt they will know what to do once it is milked dry? A cautionary tale for all those that would like to see private oil cos. nationalized.