Oil's Trending Up, But Speculators Aren't to Blame

I read with skepticism an editorial in a prominent paper Monday entitled Stop the Speculators, about how we should blame "Big Wall Street Banks" (a direct quote, as juvenile as it sounds) for the price of rising oil. This is essentially a reprint of every populist gripe about the high price of oil (and hence, gasoline) that Americans experienced last year.

Here are some quotes from the editor that essentially sound like a politician looking to curry favor with ill-informed constituents prior to an election to rile them up and put an evil face on traders, energy companies and well, anyone but 1) the US population, 2) a complete lack of a comprehensive energy policy and 3) a Fed that's printing money like it's goin' outta style. Rather than giving a page to consumers on say, how to hedge fuel prices as an individual consumer, they printed this drivel. I could nitpick this thing apart line by line, but I'm just going to try to stick to a few key paragraphs:

One of the most basic concepts of economics is the law of supply and demand, which helps determine the price of goods, services, and commodities. Unless, of course, that commodity is crude oil.

Just ask the motorists getting gouged at the pump by soaring gas prices what happened to basic economics.

OK, so first of all, this editorial starts off like my 8th grade term paper...um, so, word X is defined in Webster's as... but I digress. Oil is arguably the most efficiently traded commodity on the planet. To claim that the law of supply and demand breaks down for oil more than any other traded instrument (like swine flu stocks jumping 100% in a day was based on rationale supply OR demand of anything other than hype?) is misguided. Oil trades on perceptions of everything from future supply and demand, interruptions to supply, growing demand in emerging markets that previously did not consume oil to the degree they will in the future and so many other factors that the actual price movement of oil simply cannot be predicted with any degree of certainty. Current supply and demand is an afterthought. I mean, look at the macro view of the market now. Is it logical that with unemployment hitting 10% soon, the market has rallied 40% since March? Does this make sense in the author's model of "supply and demand" for beginners?

Consumers getting gouged at the pumps? Is that what you call it when the country hasn't built a new refinery in how many years?

NewsFlash!

Oil and Gasoline don't have a perfect 1.0 correlation. Take a look at this chart comparing the price of oil with gasoline via their respective ETFs. Gasoline has its own capacity constraints, crack spreads, and oh yeah - those evil speculators as well. They are each their own beast and let's see, now perhaps we can blame two evil sets of speculators. And really, is gouging such a bad thing? As controversial as it may sound, if it did occur, it actually might help temporarily restrain demand, hence lowering prices for those who really need it. I mean, how did those gas lines work out for everyone in the 70s with price caps on gas and the subsequent rationing that occurred? It's as simple as letting the free market dictate the prices - if one gas station tried to gouge, there's one up the road looking to take away those customers with lower prices.

click to enlarge

Then, there are the Wall Street speculators.

Big Wall Street banks, like Goldman Sachs (GS) and Morgan Stanley (MS), as well as pension funds and hedge funds, are helping to drive up prices. These firms are buying up oil futures contracts as a hedge against inflation.

Aren't these some of the same investment firms that drove the economy over the cliff, and then needed a taxpayer bailout?

Now they are back in action.

Those evil speculators. They're "helping to drive up prices"; but are they? I started posting in 2008 about the oil contango which ended up resolving itself with higher prices, but this was seen from a mile away from a part time blogger. Was this me "driving up the prices"? The last time I checked, there were no pension funds or hedge funds participating in a taxpayer bailout, just the big Wall Street Firms with the real lobbying dollars and ex-CEOs in cabinet positions.

But really, what does a bailout have to do with their ability to trade oil? Shouldn't they be TRYING to turn a profit so they can actually PAY BACK the bailout money to begin with? I'm not sure what the author's getting at. If their energy analysts predict a rally in oil, shouldn't they trade on that advice? Oh, let's see, if you took bailout money, you shouldn't try and execute a profitable trading policy to fulfill your fiduciary responsibility to shareholders (including the government). I don't see the connection and it's just more juvenile fodder for the gullible reader. Oh, and why do we have inflation on the horizon? Hmmm, no mention of our government's monopoly money game or perhaps the prospect that our currency won't buy what it used to in the future.

The article then goes on to cite some government-sponsored reports blaming speculators for part of the oil runup last year, which I'm sure won some praise from angry consumers. This article, and others like it fail to recognize the reality of complex, volatile markets such as this:

• Speculators have always been able to speculate on the price of oil - they've been doing it for over a hundred years and they'll continue to do so into the future. Investors can speculate now on 3X Leveraged ETFs with no collateral.

• Why is it that 2008, and again in 2009 - these are the only times that the evil speculators chose to wreak havoc on oil prices? Why weren't they doing this in 2006 or earlier this year as oil prices sank? Oh, and how were those speculators doing when oil dropped from $140 to $30 a barrel? They got slaughtered. There IS risk to speculating and the speculators aren't getting a free ride since prices can decline precipitously, as was evidenced recently. In short, if it were this easy and the "evil speculators" could manipulate prices upward at will, wouldn't oil be on a continuous upward slope to infinity? Well, perhaps they all conspire together in the "evil speculators' fraternity" as they conjure up a cartel-like manipulation of the oil markets.

Congress, with their dog and pony hearings and the naive gas boycott movement each summer - it's all pretty silly when you consider the facts.

Comments

[User 357705:]

Its NOT our fault! No, really!

Jun 16 08:57 AM

[greg weitzner:]

I feel your frustration when I listen to fellow college students make similar ridiculous arguments. This may be an issue that the majority will never understand.

Jun 16 10:40 AM

[Mr. Big:]

The only true disruption to a market such as oil (or any other market) is government intervention.

Jun 16 11:01 AM

[blu:]

Nice to read a sensible argument that I have been concurring with, and posting such, for months.
The populist arguments mentioned, will not go away. For some reason the media has to find a "blame", "evil conspiracy", or "scapegoat" for every news item that comes across their desks.

I have long advocated that people should hedge against increasing energy costs by participating in the markets. Most will not listen to arguments similar to the above article, because they have been "taught" to look for a scapegoat and not truthful, rational explanations that really make sense.
It's how America has evolved... JMHO

Jun 16 11:59 AM

[Federico:]

YES there is no manipulation.

You see there is nothing wrong big oil trader to put all that excess supply put on ships (enviromental single hulled accidents waiting to happen) and watch the price go up.

I as a trader, am also allowed to bid up the price on margins that require me to put up 5 percent of the total value of the "asset class". I as a big trader can form numerous off-balance sheet hedge funds thereby hiding my real share of the daily energy trade.

I also as a big trader have no relationship with analysts and economists working for my principal. So when the analyst and economist comes out with an "educated" analysis which helps push up the price and makes me billions richer, it is pure coincidence.

So damn all those companies, the truckers, airlines, utilities, food producers and their whining. Why did they not hid our investments bankers and hedge their costs (and allow our investment bankers to grab their fair share).

Jun 16 12:49 PM

[Dave Dorgan:]

I'm not following your "it's all pretty silly when you consider the facts" statement. From my read, I did not see you provide any. These are the facts as I know them:
- April 14 - GSach's Form 8-K - Under Trading and Principal Investments they report "Net revenues in Fixed Income, Currency and Commodities (FICC) were $6.56 billion, more than double the amount in the first quarter of 2008". Also, "Net revenues in currencies were solid, but lower compared with a particularly strong first quarter of 2008". It goes on to say that FI lost money. One can infer that Commodities did a majority of the heavy lifting. Not much of a stretch to understand how TARP money can be repayed.
- May 14th - OPEC increases their estimates for the size the decline in demand for the year.
- TICS numbers are bad.
- Industrial production numbers are down worse that expected in the US (-1.1%) and Europe (CHF -13.1%).
- TICS #s are down.
- This chart does a good job of summing up demand for oil: omrpublic.iea.org/dema...
How I see it. Opportunistic speculation? Yes. Logical behavior? Not from a fundamental perspective. Media sensationalizing to generate add revenue? Yes. Should we be more focused on the formation of a bubble in more than just oil, but other commodities too? Oh, very much yes. And, now were back to opportunistic speculation.

Jun 16 01:38 PM

[Mad Hedge F...:]

Cash in the chips. Get me out of oil! I love a core long position in this commodity (see madhedgefundtrader.com...), and expect it to hit $200 before I join the AARP. But we have really gone too far, too fast, and are seriously in overshoot territory. Industry traders have been taking advantage of the greatest contango of all time, buying the front month contract, taking delivery, keeping it in storage, and reselling it forward to reap returns of up to 50%. And that is without leverage! Clever analysts are resorting to Google Earth to spy on storage facilities via satellite. Non industry players have been buying it as a dollar replacement. Crude burns better than dollar bills. As a result, crude in storage has ballooned to record levels. All fine and good when the price is going up. But crude can’t stay this high once the sugar high that is sustaining the economy burns off. Better to bail now at $70 and buy it back at $50 once reality sets in. And for Heaven sakes, don’t try to get to clever by shorting the stuff!

Jun 16 02:17 PM

[awake09:]

Can't I just get gas back down to $2.00 a gallon? I don't care how y'all do it.

Jun 16 02:52 PM

[User 357705:]

Doesn't matter how? So, you're all for killing 100's of thousands brown people who may or may not worship a God other than the one you do! Good on ya! They hate us for our freedoms! Yeah right.


On Jun 16 02:52 PM awake09 wrote:

> Can't I just get gas back down to $2.00 a gallon? I don't care how
> y'all do it.

Jun 16 03:09 PM

[ValueInvestor:]

Is this author serious?

"Consumers getting gouged at the pumps? Is that what you call it when the country hasn't built a new refinery in how many years?"

Refineries are running below 90% usage and even during the energy crisis of 2008 they were running at about 95%. We haven't built any new refineries because there isn't a need for new ones. Expansion of existing refineries has more than made up for this.

I could easily poke holes in your arguments just as you did to the story your article is about.

The truth is, nobody really knows whats going on unless you have access to clearing and brokerage house statements of the traders/speculators/pr... trading in oil. Only the exchanges and regulatory bodies have access to that, everything we say is speculation.

Jun 16 03:59 PM

[HardwoodFlo...:]

Huh. So the $8 billion in Commodity ETFs that has come BACK to the market in the last little bit has had no barring? (you should see the graph of money going into Commodity ETFs and overlay that over oil- it's the exact mirror both up and down).

So, wow, I guess it must be the hurricane season or the "summer" driving season, or political instability or what ever chaos theory suits/rules the day.

I do have one question: what is up with the SOR? Is is a reserve or a drain. I cannot believe they are still putting oil in that thing. They wouldn't be buying oil, using the reserve, to create political stability for Russia and Saudi would they?

In one respect you might be right it's not "speculators". It's the same trade as last summer: bid the dollar down, bid commodities up (this in turn will raise input costs to companies and squeeze the consumer) then short stocks because the raising input costs will not be offset by increase consumer demand. It's a terrific world the hedge funds, totally unregulated, have created for themselves- being a pariah on the consumer. I'm so glad they are unregulated! I'm also glad they aren't speculators but, instead, greedy disgusting little pin heads who create and add no value at all. At least they will be able to afford their rentals in South Hampton, Nantucket and Newport this summer.

Jun 16 05:48 PM

[HardwoodFlo...:]

Raise the margin requirement on commodities- from 10% to 30% and watch the cockroaches head for the exits. as it stands right now the downside loss potential is only 10%- the fund just declares bankruptcy with a 10% loss if the "bet" goes the wronge way. I'm sorry I mean investment not "bet".

Jun 16 05:51 PM

[HardwoodFlo...:]

Also, there were two guys from Stanford who did an anlysis of the oil market last fall. They proved that with just $10B you could control the price of world wide oil.

Jun 16 05:53 PM

[stockferret:]

"Oil is arguably the most efficiently traded commodity on the planet. "

I think I will have to argue this. The fate of world oil prices is almost completely dependant on the storage capacity of some podunk village in Oklahoma.

I'm not sure the word 'efficient' is the one that I would use.

Jun 16 06:04 PM

[Mad Hedge F...:]

I think they are. First of all, let’s get some facts straight. No one is buying oil here at $72 because they play to burn it, use it to drive more miles, make asphalt or plastics, or rub it all over their bodies. They are buying Texas tea because they hate the dollar and there is no other surrogate reserve currency. Some of the biggest buyers of crude now are the oil producers, desperate for any appreciating asset they can park their revenues in size. This is why you can now walk across the Caribbean and not get your feet wet, jumping from one storage tanker to the next. The world is choking of surplus crude. Does anyone see anything wrong with this picture? Even perma bull Boone Pickens has a target of only $75. I hope he remembers to sell this time (sorry for the cheap shot Boone). The problem is that when you have so many hedge funds, financial players, and non consumers bunching up in a trade, the turns can be particularly vicious. All it would take is a little more evidence of a double dip economy, or even just an innocently strong dollar. Watch those green shoots with a magnifying glass.

Jun 16 06:41 PM

[E.D. Hart:]

Speculation is trading, and trading is the American way. Where would we be without trading and speculation? Why arent people upset about the increasing stock market speculation that has driven prices up in the last 3 months? Oh, because thats in their 401k. Why not hedge oil price increase by buying the oil producers?

Jun 17 12:08 AM

[ENCE:]

while speculation can be good,....... just look at this financial crisis, too much is not good for society

Jun 17 12:58 AM

[john s. gordon:]

'it isn't the speculators'

this is the same self-serving b.s. that we heard in july-august 2008 as goldman sachs drove the barrel to 147.
> jack

Jun 17 09:19 AM

[Ferdinand E...:]

Your statement about the efficient trading of oil is absolutely correct.

I've written a lot about speculators the last couple of days, and so I'll summarize my finding.

Speculators, evil and saintly, as a group know more about oil than any other group because of their efficiency in interpreting the fundamentals. They know when oil is plentiful, and so even if they push up the oil supply during a war or rumor of war, they leave the market soon, and so what we get is a spike rather than a sustained rise in oil price. I've studied to very large spikes in detail, with the oil price pushed up 100% once and more than 300 % another time, but that was soon over. The speculators knew that there was plenty of oil in the ground and so they started shouting 'dump it all' when the price rise slowed down.

In 2008 the oil demand was outrunning supply, and OPEC was on the ball. So the price started up in a sustainable mode, and kept moving up - until the macro-financial market meltdown. The speculators read the signs right where oil was concerned, but they did't understand what was happening on the macro-financial side.
Now they have absorbed the macro-financial situation, and so.....

Jun 17 09:22 AM

[Bob van der...:]

Crude oil can be explored and produced as a basic raw product to be refined into fuels for $40 a barrel. Any price paid over that amount is profit to the refining and marketing side of the business. Just review the profit statements of the vertically integrated major oil companies, broken down by quarters in the 2007 and 2008, to prove my point.

Speculators drive up prices by hedging their bets based on rumors of interrruptions and world conflicts and are the cause of the wild fluctuations in the price of oil.

Plain numbers show they we have only used up about 700 billion barrels of oil of the 7 trillion barrels of conventional and 4 trillion barrels of unconventional crude oil store underground in the world.

We just have to have the wherewithal and the guts to go after it.

"Bad Lands" Bob the Gas Guy
Terry, Montana

Jun 17 11:19 AM

[The Greates...:]

We can all thank Phil Graham for this mess. He re-wrote the futures energy bill that led to the Enron collapse. Great for large oil firms and the energy speculators who have inside knowledge into the industry. (almost sounds illegal doesn’t it?)
So how about something original lets regulate the futures energy commodities market? Or better yet, free us from the use of oil altogether? The oil industry as a whole made around $476 Billion in net profit over the last 6 years, the pulse of the worlds economy is under the thumb of 13 OPEC nations and 5 major oil companies. Is this the legacy we want to leave our children and grand children?

Jun 17 11:43 AM

[toobad41:]

I've said it before and I will say it again (probably many times) and it is this: You have to know and work inside the business of finding and producing oil and natural gas. Without this knowledge you cannot hope to be an investor. To own or have a working interest in an oil or gas well is to be an investor. And the reason you invest your money is to hope you can get your investment back and make a profit. On the other hand, to put money into oil or gas commodities, oil company stocks, ETF's, energy mutual funds for the long or short term can only be speculating or trading.

Jun 17 01:01 PM

[User 357705:]

Sounds like a strong case can be made for insider trading if we're to believe your thesis. I have no reason not to at this time.


On Jun 17 01:01 PM toobad41 wrote:

> I've said it before and I will say it again (probably many times)
> and it is this: You have to know and work inside the business of
> finding and producing oil and natural gas. Without this knowledge
> you cannot hope to be an investor. To own or have a working interest
> in an oil or gas well is to be an investor. And the reason you
> invest your money is to hope you can get your investment back and
> make a profit. On the other hand, to put money into oil or gas
> commodities, oil company stocks, ETF's, energy mutual funds for the
> long or short term can only be speculating or trading.

Jun 17 01:25 PM

[Alfredo Mar...:]

Oh right, that energy-futures bill was signed into law by none other than President Bill Clinton:
en.wikipedia.org/wiki/...

Funny how you forgot to mention that. Why aren't you mad at Bill Clinton? He was the one that signed it into law. I would hold him more accountable than one Senator.

BTW, It was also co-sponsored by several other Democrat Senators.
thomas.loc.gov/cgi-bin...:@@@P

Most of these deregulation bills liberals blame for destroying the financial system were signed by Democrat Bill Clinton.


On Jun 17 11:43 AM The Greatest Rip Off of our Time wrote:

> We can all thank Phil Graham for this mess. He re-wrote the futures
> energy bill that led to the Enron collapse. Great for large oil firms
> and the energy speculators who have inside knowledge into the industry.
> (almost sounds illegal doesn’t it?)
> So how about something original lets regulate the futures energy
> commodities market? Or better yet, free us from the use of oil altogether?
> The oil industry as a whole made around $476 Billion in net profit
> over the last 6 years, the pulse of the worlds economy is under the
> thumb of 13 OPEC nations and 5 major oil companies. Is this the legacy
> we want to leave our children and grand children?

Jun 17 01:29 PM

[User 357705:]

You're still singing from the old hymnal. There is no difference between red - blue, GOP - DEM left or right. There is but one party in US the BIZ party. GOP - DEM are just warring factions within the BIZ party. You're being played if you think anything else is true.


On Jun 17 01:29 PM Alfredo Martinez wrote:

> Oh right, that energy-futures bill was signed into law by none other
> than President Bill Clinton:
> en.wikipedia.org/wiki/...
>
>
> Funny how you forgot to mention that. Why aren't you mad at Bill
> Clinton? He was the one that signed it into law. I would hold him
> more accountable than one Senator.
>
> BTW, It was also co-sponsored by several other Democrat Senators.
>
> thomas.loc.gov/cgi-bin...:@@@P
>
> Most of these deregulation bills liberals blame for destroying the
> financial system were signed by Democrat Bill Clinton.

Jun 17 02:36 PM

[TurtleTrader72:]

Oil goes up when the US dollar goes down. Try overlaying the longer term weekly charts and see. Oil hit a high (over $140) about the same time the US dollar hit a low (72.40 on the Dollar index). Furthermore oil traded under $40 just as the dollar was peaking out at about 88 on the US dollar index. Everyone keeps talking about increasing demand and/or decreasing supply but in reality it is all about the buy power of the US dollar. Don't take my word for it. Simply take a look at the longer term charts. Coincidence? Probably not!

Jun 17 03:09 PM

[long roh:]

With significant demand weakness at present and no real supply issues to contend with (other than the cartel), the recent move is almost certainly tied to speculation. The question is whether that speculation is a good thing.

It is conventional wisdom that fossil fuels are a finite resource and that developed countries consume it rapidly. As more and more developing countries become developed countries, rational people expect fossil fuel consumption to dramatically increase while supply remains finite. This leads to a rational expectation that energy prices will be higher in the future, and speculators are trying to profit from that rational expectation. The effect of that speculation is to raise prices now beyond what current production and consumption would suggest. (E.g. contango traders storing oil in tankers have to buy it now to sell it later -- that increases present demand.) Higher oil prices lead to more investment in finding more oil and alternative sources of energy -- a good thing. Higher oil prices also reduce consumption of oil-based fuels -- a good thing (putting aside environmental issues, reduced consumption now might at the very least delay an energy crisis in the future by x number of years, months or days). The downside is obviously that consumers are paying higher prices today, but that just begs the question of what is a fair price: a price based on current production/consumption, or a price transferring to the present some of the pain from the inevitable squeeze that will occur in the future (and which may help us avoid that squeeze).

In sum, yes, speculators are responsible, but they are just doing their job and provide a net benefit to the market.

Jun 17 03:28 PM

[rdd:]

I don't have a problem with the speculation. It is just part of price discovery.

I do have a problem with speculation at 30x + leverage where we, the taxpayer, have to step in and bail out the gamblers who bet wrong. I am sure that part of the $14 trillion in US government guarantees and cash input helped to rescue speculators who helped cause $147 oil last summer.

Obama et al need to put in regulations that reduce the available leverage as entities and bets get bigger. By the time the bets and entities are "too big too fail," they should look like Canadian banks. This would include the derivatives markets with significant collateral required to be posted for large individual and cumulative bets.

Jun 17 04:34 PM

[Tony Daltorio:]

Oil is up because of "evil" speculators. Wake up, America - there is a looming energy crisis staring you in the face!

And yes, there are speculators. I see them all the time in stocks, especially in tech darlings like Apple. But that's ok??

Jun 17 06:34 PM

[mac123449:]

oil is to important why don't we build nuclear power plants and let them run they practically run them selves and have electric cars screw oil.

Jun 18 12:29 AM

[CMB$$$:]

Im not the most edumacated guy in the world just your average evryday consumer...........The bottom line is greedy oil companys!Who else can decide to raise prices when times are slow while cutting back on production. Thats like having Burgerking make less whoppers and raising the prices when less people buy them because they are out of work. They lost money compared to when prices hit $147 per bl. Now they are trying to make up for it in the price of gas. Less demand,Slow production and cry we are having a rough time keeping enough gas on the market. Yea got some swamp land I can sell ya in in Arizona. You Wallstreet boys can argue all you want over whos at fault.......but even your basic everyday Joe knows the real reason but cant do a damn thing about it......

Jun 18 01:31 AM

[User 357705:]

Nobody needs and Apple whatever. Everybody needs oil. Therein lies the difference. Speculate all you want on crap nobody needs. Be responsible to something greater than yourself. Oh, wait a second that's against the Fuck You Capitalist creed. Sorry, I went off the tracks there.


On Jun 17 06:34 PM Tony Daltorio wrote:

> Oil is up because of "evil" speculators. Wake up, America - there
> is a looming energy crisis staring you in the face!
>
> And yes, there are speculators. I see them all the time in stocks,
> especially in tech darlings like Apple. But that's ok??

Jun 18 02:32 AM

[acsanet:]

The dollar has been falling due to perception of the weak US economy, and the Treaury repurchases, and slow movement to excise toxic assets from banks by the Treaury.

Oil is priced in US Dollars, so as the dollar falls, the price of oil rises to compensate, more or less automatically.

Jun 18 03:00 AM

[lefty37:]

Oil, gas, and ALL other commodities should be (by law) have only one path. From producer to wholesaler to retailer, then to consumer.
Then and only then will the price be honest.

Jun 18 06:49 AM

[Bob van der...:]

Fred Hartley, the CEO of Unocal, gave the warning about the effects speculators trading paper instead of wet barrels would have on fuel prices at a meeting held at the Petroleum Club in the Los Angeles Hilton Hotel in October of 1984.

He should be recognized on his prediction that we created the monster that we are dealing with today for ourselves. The big money would switch to investing on ICE even if we put further restrictions on the trading oil on the NYMEX.

I would like so see the internal memos and emails from Goldman Sachs during the period from March through July 2008 dealing with their crude oil trades. They put the squeeze on Semgroup Holdings. You can read the complete Forbes article at:

forbes.com/forbes/2009...

Where is the outrage and anger from the trading community after enduring similar mischief at Enron?

Jun 18 08:32 AM

[jerrydd:]

All trades should have a .25% tax and be required to have at least 25% stake to lose. This would stop most speculation scams/bubbles.

Myself I drive my EV's that cost very little and get 250 to 600mpg fuel cost equivalent for my EV sportswagon and 3wh MC. And if electric goes too high I'll just make my own. Since my electric bill is only $22-45/month for heat, cool, cooking, ect because I'm eff it's not a big deal yet but if it goes higher RE is easy.

Within 10 yrs most other will figure this out too. EV's and home RE is the low cost energy future. And big oil, utilities will be left out in the cold.

Jun 19 10:57 AM