Earth to McCain: Crude Oil Speculation Department
There’s more to this than you can investigate
By blackhedd Posted in CFTC | Crude Oil | Economy | futures markets | McCain | speculation — Comments (18) / Email this page » / Leave a comment »
Senator McCain is quoted as having said in a television interview that speculators have contributed to the recent high prices for crude oil.
McCain acknowledges that he can’t judge how big the effect of speculation is. Very few people actually know the answer to the question, and they’re not talking. McCain also believes there should be a thorough investigation.
Ok, fine, let’s convene a blue-ribbon panel and buy them some expensive lunches and air travel so they can produce a report three years from now that no one will read and contains no action items anyway.
Until then, let me fill you in a bit.
Keep reading…
Crude oil is a commodity that combines very large size (trillions of dollars per year) with excellent liquidity on futures markets, and is in demand.
Global demand for crude oil is at least stable (it’s falling in the developed countries, but rising like a rocket in Asia and the Middle East). That puts a floor under the crude price in the near term.
As a result, crude oil has taken on many of the characteristics of an asset class (the kind of thing that investors buy) in addition to an industrial commodity. And as an asset, oil is very attractive because it acts as a hedge against inflation.
Why are investors buying an industrial commodity instead of the fixed-income securities they usually buy? Simple. Because there’s still a huge amount of sovereign money in the world (what Ben Bernanke calls the “savings glut”) and it tends to migrate into US Treasury debt. That raises the price and lowers the yield.
Over the last five years, the low yields available to global investors were one of the factors that attracted them to invest heavily in the US mortgage market. Well, we know how that ended up. Today’s reality is that investors have largely shunned all but the safest debt, and are demanding relatively high yields for most corporate debt.
That means that there is a supply shortage in the market for investment securities. That’s one of the reasons that investors (aka “speculators”) are piling into crude oil. Broad uncertainty over the direction of the global economy is another reason. And momentum is yet another. (Whenever something is going up in price, it will tend to keep going up because everyone tends to follow the herd.)
Ok, all of that sounds at least coherent. How can you go and confirm it? Well, you could look at the net purchases of crude-oil futures contracts and compare them to what we estimate that industry actually needs to make gasoline, heating oil, jet fuel, petrochemical feedstocks, and windfall profits. (Just kidding about the last one.)
As an aside, I’ve read in several very prestigious financial newspapers that financial buying of oil futures can’t affect the price because futures are zero-sum: every open contract must eventually be offset by a close. (You’ll often hear this expressed as: “you can’t buy more oil than can actually be delivered!”) But that ignores the fact that people can and do roll their expiring contracts forward into subsequent months.
If forward purchases significantly exceed industrial demand, that’s pretty good evidence of the existence of “paper barrels,” or speculative pressure on the oil price.
Well, the Commodities and Futures Trading Commission has all those figures, don’t they?
Ummm, not quite. Yes, the CFTC publishes a weekly open-position report on trading in all regulated commodities.
But it turns out that you can buy and sell crude oil futures, even for accounts domiciled in the US, without needing to report your trades to the CFTC. You just go through the London Intercontinental Exchange.
There is significant anecdotal evidence that some of the household-name firms on Wall Street have crude-oil trading desks that are doing just this. That’s a huge amount of activity that may be adding $50 dollars or more to the price of every barrel of crude oil.
So one big problem is that we have no real visibility into the extent of this trading. This is a data problem that could be solved with an overhaul of CFTC regulations. (And watch very carefully which CEO pops his head up to howl about it: that’s how you’ll know which firms are raking in the megabucks from oil speculation.)
Now what if you decided to actually curtail crude-oil speculation?
Well, that’s a much bigger issue. Global capital is flowing into crude oil because there are limits on where else it can go. The fundamental problem that results in expensive crude oil is located in the credit and money markets, not the crude oil markets. Crude oil is working as a safety valve.
Solve the credit/money problem, and the price of crude will collapse right back to perhaps 70 or 80 dollars a barrel, where supply and demand say it should be.
But take away the safety valve by restricting speculation, and all hell will break loose. My SWAG is that you’d see a sharp steepening of the yield curve, with the potential for a repeat of the money-market trauma that took place last March and April after the Bear Stearns collapse.
-Francis Cianfrocca (“blackhedd”)
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Great article. Stop blaming speculators and actually do something.
Here's a pretty good article on the topic "Who is an oil speculator": http://www.greenfaucet.com/economy/who-is-an-oil-speculator
Some solutions besides drilling to the current problem
Love your stuff, it's always something I just don't totally understand and want to know more about. Thumbs up.
"Whom you vote for says a lot about your character."
It certainly does, and to whom you give half-a-vote does as well. I'll be sure and thank you for your shining principles as I send in my bigger and bigger tax bill under Obama. That'll teach me to cavalierly and immorally vote for McCain.
Has anyone ever heard of a primary? Good grief. You do realize that not voting doesn't mean we don't have to have a president, right? We still have to LIVE through whatever administration comes along.
We're 60 years along and we haven't come close to cleaning up the disaster that was FDR. How people think we can just suddenly roll things back is beyond me. Yeah, Reagan lowered taxes-- McCain supports lowering them now.
Lord help us.
PS (To a mindset, not particular person) Being 'in the desert' doesn't suddenly make us the chosen people. It just puts us in the desert. The Bible has already been written, self-inflicted suffering is closer to suicide than virtue.
"If all men were just, there would be no need of valor."
- Agesilaus
http://globaleconomicanalysis.blogspot.com/2008/05/quantifying-commoditi...
Go to where it says "Krugman misses the boat".
It details very accurately that this oil fiasco is complete speculation.
The numbers will ASTOUND you.
"Strength and Honor."
"What we do in life, echoes in eternity."
retro-nostalgia attack, and am off to feed my pet rock.
I think I'll listen to a few Jimmy Carter speeches. Both current and retro.
Drill Here. Drill Now.
If increased oil production is on the horizon, futures prices will fall.
So, not only will we have more supply "in 10 years", but we will see the price go down now.
Remember that if speculation accounts for some significant portion of the current crude price, then increasing supply 10 or 15 years from now won't do much to change it. But forget about that.
I've decided that from now till the election, whenever anyone says "The answer to America's energy problem is to produce more energy domestically," I'm going to make the following point, as loud as I can:
No. Drilling for oil and gas in the United States is a non-starter, because it assumes that the objective is to make more energy available to Americans at a lower price.
This is most emphatically not the objective of the Democratic Party, which on no credible projection will lose any of its power this year.
The Democrats are determined to make less energy available to Americans, at higher prices, because they are convinced on moral grounds that this is the right thing to do.
Forget about fighting them on this. You'll be beating your head against a wall. And yes, you'll get sick and tired of hearing me repeat it.
....we just need to win the public opinion battle and convince the voters.
“.....women and minorities hardest hit”
Then your self-fulfilling prophecy will of course come true.
The democrats have probably never been as vulnerable as they are now - energy, immigration, how wrong they were about Iraq (war is lost Reid), etc
The problem is that we are trying our best to repeat 06, which WAS self-inflicted. It is a 100% true fact of history that no force surrendering on the field has ever won the battle. I won't give up, because I would rather fight to the last and lose than to give up and have to live with it.
when he said on CNN that speculators add $50-70 to the price of a barrel. He didn't say they cause it, necessarily. Your explanation is the best I've yet seen.
The major networks really ought to have you on to educate the public about these things. That is, if they had an editorial incentive to do so...
Myself and America - Just got hired onto an oil rig in the gulf - Yeehaw!
Drill here, drill now, pay less and keep me employed!
Should be flogged.
"Those who expect to reap the blessings of freedom must, like men, undergo the fatigue of supporting it."
-Thomas Paine: The American Crisis, No. 4, 1777
A year ago an owner of production who was worried about price volatility might have presold his 2008 contractually for, say, $80 per barrel. He'd do this to take the (lowside) price risk out of his ownership position. So, while he's physically selling barrels at today's price (nominally $130), he has to write a check for $50 for every barrel he sells to make the contract good.
Conversely, George Soros may have taken a long position in oil a year ago, and now is $50/bbl to the good.
Which one has the windfall profit, and why is one morally reprehensible, while the other is Just How Capitalism Works?
Without deviation from the norm, progress is not possible. - Frank Zappa
"Those who expect to reap the blessings of freedom must, like men, undergo the fatigue of supporting it."
-Thomas Paine: The American Crisis, No. 4, 1777
He's probably the guy that runs the hedge fund that your state Teachers and Firefighters Pension Fund has invested in. Or your local university endowment. Or your 401(k) plan manager.
If I had to guess, I'd say Soros isn't long anymore (assuming he ever was). That's because he's been trying to talk the market down lately.
They say God loves fools, which I increasingly believe given the two major candidates running for President this year.
Someone needs to reach out to McCain and stop him from running his mouth when he latches onto the latest snake-oil, emotional ploy. First we had McCain proclaiming he buys the immunization urban legends, then it was his believe in the Church of Gaia's man-caused global warming myth. Now he's latching onto this nonsense about speculators being the cause (while McCain's role in rejecting oil and refining development for over 30 years isn't recognized as a cause?). What kind of nonsense is this goober going to believe when he's got foreign interests and countless political influences trying to manipulate his presidency?
Nothing about this person of marginal intelligence and anger management problems causes me to find a rationale for voting for him. I drew the line at the big tent party Bush represented and told our party members after Bush, we needed to move further to the right, not the left. Looking at McCain vs. President Clinton's record, he's left of Clinton.
Whom you vote for says a lot about your character. I don't think McCain will find enough misfits outside of the moderate left that have a need to support his unqualified run.