OPEC Wants Less Speculation on Oil Futures

Ride OPEC's outrage to 70% gains

"I am shocked – SHOCKED – to discover that there is gambling going on here."

– Captain Renault (Claude Raines, Casablanca, 1942)

That just might be my all-time favorite movie line. Bogart aficionados know it was exclaimed by Claude Rains' jolly Nazi collaborator, as he simultaneously collected his ill-got gambling gains and closed down Rick Blaine's casino.

The reason I love it is that it so well captures this sort of hypocrisy. The line is so perfect it's downright archetypal. Take most any week's news and you will read some dolt somewhere echo its sentiments.

The Fly in OPEC's Ointment

For example, on Wednesday, the secretary-general of the Organization of Petroleum Exporting Countries, one Abdalla El-Badri, called upon the regulators of the world's futures markets to do something about all the rampant speculation on his client's precious crude oil.

Prior to attending this week's big confab in Davos, Switzerland, El-Badri opined via e-mail that

OPEC has repeatedly called for the need to reduce the role of excessive speculative activity in the market. Today, it is impossible to know who is actually buying and selling oil futures.

In case you somehow missed it, allow me to sketch out a brief history of the events that have El-Badri so hot and bothered.

Some Is Good…

Oil had been making overall advances in price for most all the seven years that the folks in the Oil Patch held the White House (and perhaps more importantly, the Old Executive Office Building, from where Vice President Cheney appears to have been determining most of our energy policy). But even that steady creep didn't hold a candle to the excesses of volatility we experienced in 2008.

The first half of the year saw crude oil surge some 46%, an incredible increase in view of the fact that there were no material events genuinely impacting supply or demand in that time. Sure there were the usual storms, strikes and minor military skirmishes that encumber most any trading season. But in the end, none of this actually impacted supply in any serious fashion.

Meanwhile, on the demand side, we now know that the U.S. economy was already well ensconced in recession. And yet, prices at the wellhead and gas pump continued to skyrocket.

But Too Much Stinks

If you want to find the mysterious driving force for this first-half-2008 spike, you need look no further than the trading floor of the New York Mercantile Exchange. By March of last year, speculators had racked up some 115,145 net-long crude future positions (as per those fine folks at the CFTC, who supposedly regulate this market).

Now, one would imagine those other fine folks at OPEC would enjoy seeing prices climb that high. $147 per barrel will buy you one heck of a new marble-and-gold palace, or perhaps even forestall a revolution amongst your eternally beleaguered poor another year or two.

And yet, this sudden largesse was making the folks at OPEC increasingly nervous. You see, they had been down this road a time or two before, and had learned a critical lesson along the way.

Waking Up Dead

Have you ever boiled a lobster? (Stick with me here: it's germane. Really!) If you dump the wrigglers into boiling water, they thrash about and panic, supposedly spoiling their delicate flavor. (Not that anyone can really tell under all that butter.)

No, the trick is to place the live lobster into a pot of cold water, and then slowly raise the temperature. Little fella doesn't even notice until he wakes up dead, as it were.

The same is true of crude oil consumers. Crank up prices an average of four bits a year for the better part of a decade, and no one says boo. Spike prices 50% in one season, however, and suddenly folks are looking to change their habits.

Change for the Better?

Last year, that's exactly what happened. Miles driven were cut back to levels unseen since the 1940s. Thermostats were dialed back, electric lights turned off, and massive SUVs sat languishing on auto sales lots.

By mid-July, the folks at the NYMEX were forced to switch trading direction, with floor contracts showing a net short position for the first time in decades. By November, the CFTC showed 52,984 contracts speculating on further price drops.

And drop it did. By December, we were seeing crude futures in the high $30s – an astounding fall of nearly 75%. As anyone in any capital-intensive biz will tell you, this is no way to run a railroad.

Or a Turn for the Worst?

This whole affair drives the oil types nuts for a myriad of reasons. First of all, it makes it darned hard to plan. Exploration and development take years and billions to work out. A field that seems reasonably worth exploiting at $60 a barrel may be a windfall at $120/barrel, a tax shelter at $50 and a bankrupting boondoggle at $30.

But you know what I think really bothers the sheiks, et al.? It's a fair guess that the trading floor was an exclusive insiders' preserve for decades. Now guys like El-Badri complain that wild-eyed speculators are raiding their private cellars: "Today, it is impossible to know who is actually buying and selling oil futures."

When El-Badri and his cronies ask for "more transparency," what they really want is more exclusivity and control. And seeing as how Washington is somewhat inclined toward "centralized command and control" these days (that was a joke, albeit a grim one), I do believe that they will most probably conspire with the sheiks and oil companies to shut the speculators out of the market.

I'll Take My Winnings Now, Rick

Seeing as how we can't stop this juggernaut, I suggest we ride it instead. A smoothly operating oil patch will most probably benefit all the usual suspects, so let's start by picking up shares of the biggest, meanest fellow about. That would be ExxonMobil (NYSE: XOM). Or, if you would care to leverage a bit, you might do as we suggested to WaveStrength Options Weekly readers and purchase mid-dated, at-the-money calls against the same, looking for some 60% to 70% over the next month or two.

Call me cynical, or just a pragmatist like our dear Captain Renault. I'll take my winnings now, thank you.

Disclosure: no positions

Comments

[ROLEX18K:]

Of course OPEC wants regulation in Oil futures trading, then it will control the pit with the "boys" ( biggest Oil companies ).
If OPEC would not speculate and manipulate the price of Oil, I would support increased regulation in how many contracts individual trader or a commercial can trade, but it will never happen as in the end capitalist system is stronger ( richer ) than the OPEC's will and markets in futures will remain what they are, a place where fortunes are made and broken.
There will be some noise about increased regulation, but in the end lobbyist in financial trading will shut the congressmen's mouths and fill their pockets and life on the pits and trading floors will continue as it always does.

Jan 30 05:58 AM

[Ferdinand E...:]

This is an interesting article. I happen to be doing some work on the oil futures market at this moment and so I cannot agree with everything in it, but so what. The presence of the word "hypocrisy" makes it worth reading. It would have been even better if the word 'ignorance' was used.

I've taught futures markets in four or five countries, and since the people who took these courses did so because they wanted to make money, everything was smooth and easy. What I can't understand is why many people who haven't been exposed to my brilliant teaching can't understand anything.

The reason for the statement about futures by the OPEC gentleman was that he had been asked why the oil price was going into orbit, and instead of suggesting that whoever asked that question should look at production and consumption statistics, he went into his song and dance about 'speculation'. I didn't know however that he mentioned the futures market, but if I had I would have asked - as Tina Turner probably would have asked - what does the futures market have to do with this? It so happens that the more liquidity on that market the more comfortable inventory holders are, which in turn translates into larger inventories and less destructive price spikes.

By the way, my favorite line in that film is "I was with the American army when they blundered into Berlin". They didn't, but since that war probably couldn't have been won without them it didn't make any difference.

Jan 30 11:19 AM

[Urbane Gori...:]

"I am shocked – SHOCKED – to discover that there is gambling going on here."... Love the quote, movie and the lobster story.... Great writing style... And IMHO you're right.... jegan

Jan 30 02:06 PM

[scotty1560:]

Economic growth is dead for years...we are just going to have to accept
that fact...overbuilt..over consumed..over leveraged..no checks & balances..

Anything tied to growth including oil is going to stay in a trading range
with the exception of geo conflct...

My guess is some regulation will find it's way to equities and lending..
we now know the downside of deregulation...

Foreclosures have to run their course...banks will need to collapse or
consolidate...US needs more balanced trade...these issues won't be
solved in 6 months or even 2 years....Myself, like many are starting to live
in fear of my savings liquidity, earning powers, debt service.

Jan 30 03:07 PM

[bill d:]

Like my stepdad would say to OPEC - wish in one hand and crap into the other - and see which one gets full the soonest.
I recall a time when Shell, et al was developing the oil fields and 2 - 3 $/bbl being paid to the "rulers" and they were happy to take it. My - how times change.

Jan 30 03:21 PM

[john s. gordon:]

remember what the arab said :

my father rode a camel.
i drive a car.
my son flies a jet plane.
my grandson will ride a camel.

sic transit gloria mundi.
(there might be an equivalent of this in arabic, but i don;t know what it is).
> jack

Jan 30 05:56 PM

[je:]

What Adam sees is an inverse head and shoulders thaIthink will end up being a continuation pattern to the down side as oil makes a double bottom

Jan 30 07:40 PM

[Mr. Ed, Jr.:]

When oil was $140 a barrel and gas was over $4 a gallon, and the populists were screaming that it was being run up by "speculators", the unanimous response from the oil industry was that it was simply "supply and demand".

As Andy Griffith would say , "If that don't beat all..."

Jan 31 01:40 AM

[athena:]

Live with leverage, die by leverage.

Feb 01 09:42 AM