Why Crude Oil Traders Should Care About Wheat 25 comments
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Last week the Senate released a report that concluded that non-commercial participants, particularly index speculators have been disrupting the wheat futures market (for those not inclined to read the 174-page report, there’s a good summary in this BusinessWeek article). The term, “index speculators,” refers to that new breed of market participant that treats commodities as buy-and-hold investments rather than as short-term trading vehicles. Index speculators are often people and institutions one would not associate with speculation — endowments and pensions, for example. They generally have bought into the notion that a basket of commodities (or commodity futures) is a legitimate investment asset class; this is a view I dispute – I know of no other “investments” where the inherent value can only be realized in the consumption and destruction of the asset.
The wheat report highlights one of the dangers of “overspeculated” futures markets, a condition where non-commercial interests so outnumber commercial participants that the relationship between cash and futures prices (the “basis”) breaks down. An erratic basis in a commodity futures contract is more than a mere curiosity: it can mean that the futures markets no longer offer reliable risk mangement tools for producers and users. It’s worth remembering that these markets were never intended to serve investors, but were chartered from the begining to serve the commercial commodity industry. Dramatic shifts in the basis can also cause severe financial problems for commercial hedgers who must meet margin calls.
A spike in the cotton basis in March of last year was devastating for that industry. I’ve often thought that the cotton problem was the “canary in the coal mine,” warning us of dangers ahead. Wheat going down the same path is troubling indeed. From the standpoint of greatest economic risk, one must wonder whether crude oil is also heading in this direction. If crude oil is “overspeculated,” there’s a particular vulnerability given the geopolitical risks that can crop up with oil. My sense is that much of the oil in storage is part of a cash/futures arbitrage play which means, as I believe happened with cotton, a sudden influx of futures buying would have no natural constraints, sending futures prices soaring. With the central role energy prices play in the economy and the heavy participation in the crude oil markets by our wounded financial companies, a price disruption of this nature could have far reaching consequences.
Last year there was a great debate about the role of index and other speculators in disrupting commodity prices. Unfortunately, too much of this debate centered on the oil industry, not only one of the deepest markets, but also one of the most opaque. It’s simply hard to get the data needed to see the risks in crude. Looking at smaller markets like cotton, it is easier to grasp that treating commodity futures as investment assets can cause grave problems. Although the debate is still tainted by politics, it’s good to see that these dangers are getting the recognition they deserve.
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This article has 25 comments:
You are wrong to say "the inherent value can only be realized in the consumption and destruction of the asset".The value in the asset can be realized by trading it, like ...one or two other assets I can think of. Do you think that farmers realize the value in their assets by consuming them? That would be some meal.
Meanwhile the scene is set for ever greater demand for exposure to agricultural commodities. It is fairly likely that we will see some combination of:
- increasing global population
- increasing demand for meat and hence grain
- water shortages and other climate impacts
- increasing fuel and other input costs
- poor performance of equities, bonds and industrial commodities
These would all increase the demand for agricultural investments.
You say that "these markets were never intended to serve investors" and your attitude seems to be: keep out! If I may say so, I think you have your head in the sand. The solution lies not in trying to keep investors out, but in finding ways to accomodate the investment demand that will inevitably come.
Why would the farmers not be in favor of rising prices for their products in the futures markets? This would seem to work in their favor in almost any case?
Massive monetary and fiscal stimulus have justifiably called into question the long term value of the dollar. People who converted assets into cash during the panic last year are feeling less safe about their cash. Like someone caught out on thin ice, investors are spreading out as much as they can. Commodities have to be examined as a store of value. Like the age old sardine can, a bushel of wheat may find more use as a trading item than a consumptions item.
There have been a couple pieces on this site suggesting the 'next bubble' could be commodities. The market dislocations described above support such a notion.
On Jul 01 07:58 AM Henry Buttal wrote:
> Setting oil aside, lets focus on the farmers for a minute.
>
> Why would the farmers not be in favor of rising prices for their
> products in the futures markets? This would seem to work in their
> favor in almost any case?
As for commodities being an asset class: At our farm here in Nigeria we used to (in my parents generation) store about a third to half of our harvest to eat and sell during the year. If we needed money or if prices went up we would increase our selling. There is no CPA who wouldn't book it as an asset? Whether or not it belongs to an 'asset class' I defer to the author. smartinvestorafrica.com
This is a GOOD THING. While with the economic downturn right now there is overcapacity in many areas, in general the world has operated with supply (I mean peak supply, ie where it would take years to develop more) perilously close to actual demand in many key commodities. The commodity basket investors are essentially paying to expand supply and making the risk of sudden supply disruption a lot lower, and they are doing this at the best possible time ie when commodities would otherwise be in a much more severe downturn.
The whole idea of the futures market is for producers to hedge their crop/s or commodities with speculators, that is the plan!
This is a quote from Wikipedia "The social utility of futures markets is considered to be mainly in the transfer of risk, and increase liquidity between traders with different risk and time preferences, from a hedger to a speculator, for example".
You mean to tell me you play commodities and you do not even understand the basic principal?
Or you would like to play futures but those pesky speculators scare you?
As for cotton, well i vote we all buy cotton and hoard it on tankers around the world, then dump it on the market later. Im ringing my broker now!
I don't normally take the time to reply, but you obviously put some good thought into your comments, so I wanted to provide you with some additional info. Your last comments are dead on, but are based on the assumption that a producer has not already hedged his cotton. What I believe happened (and the statistics support) is that all this pension and investment money in cotton had already made forward selling so attractive that virtually every bale of cotton was already hedged. The commitment of traders report showed that the commercial short positions in cotton exceeded the annual production of the U.S. by Feb of 08. This meant that a rise in futures (with cash staying constant) was only a negative -- a cash flow squeeze; no hedger could take advantage of the higher price. I spoke with people in the industry who literally had to mortgage their homes to stay in business. The magnitude of the squeeze was enormous, and required more credit than even the most prudent participant could reasonably have established in advance.
I'm all for speculators of the traditional sort - and have been one myself, having actively traded about 20 different markets (financials, softs, grains, meats, metals). They indeed provide liquidity and aid in price discovery. The problem is the new type of index speculator who provides not liquidity, but rather a big, fat bid (liquidity is 2-sided, this is not). For the economy to operate efficiently, price discovery should be determined by producers and users of the commodity, with speculators assisting, not determining the price ahead of those fundamentals.
Your points about the benefits of stockpiling are also quite astute and an issue I've wrestled with. However, as long as the cotango is held up by index speculators, those stockpiles won't be released into the market, but simply rolled. At some point, you run out of storage, and the whole thing may unravel, but that has its economic costs as well. At the end of the day, it is economically more efficient for most commodities that are produced to be used rather than stored. Stockpiling should be more of a marginal activity, not a major use of the production.
Thanks for your thoughtful and thought-provoking comments. --Jeff K.
On Jul 01 01:05 PM rayden wrote:
> Just read up on the cotton spike; interesting, and that story had
> stayed below my radar until now. My analysis of what happened and
> why is a little different though. This was a liquidity (lack of)
> driven spike. If I am a hedger of cotton, and I have an actual crop
> in the field or bales in a warehouse, such a spike is almost the
> best thing that can happen to me: I will sell, sell, sell forward
> (waaay into future years if necessary) and then simply wait for expiration
> and deliver physical. There is no conceivable reason why I should
> ever want to close an existing long position due to such a spike.
> However... there is such a thing as too much of a good thing. In
> order to do that, if I already have large long positions, I would
> need someone to lend me enough money for the margin I would need.
> Such lending is actually very low risk, and given what the market
> was doing, even taking a loan at usurious interest rates for margin
> would have had an excellent rate of return (as margin is leveraged,
> the interest would be diluted, and the loan would be repaid as soon
> as the spike is over). So, there are basically just 2 things needed
> to make such a spike work for you as a producer/hedger: a) someone
> willing to lend to you on SOME terms, perhaps with your entire physical+futures
> position as collateral (btw: I would have happily lent a lot of cash
> to the cotton merchants at 20% annual, so no prob there ;) and b)
> for you to keep your cool and not blink. I think in cotton, hedgers
> failed at both of those. There is a lesson here: if you're a commercial
> hedger and you're net short futures, make SURE you have agreed upon
> margin financing for essentially unlimited moves in the commodity,
> so you are never forced to liquidate a position.
I understand the principle, but I think you miss both the nature and implied pre-supposition of my point.
The farmer, often an agribusiness, has the best insight into his crop, his risk, and his potential gain, AND HIS TIMING. He is in a better position than any speculator to balance his risk along a growing/producing season. It is unlikely that improper pricing will continue throughout the agribusiness production cycle. The agribusinesses that most often get into trouble are the ones that are speculating, or not managing their production and risk (I have seen this kill at least one of these businesses).
The individual farmer ( a rare beast these days) is at greater risk, but still has better information than the speculator
On Jul 01 02:00 PM Jeffrey Korzenik wrote:
> rayden-
> I don't normally take the time to reply, but you obviously put some
> good thought into your comments, so I wanted to provide you with
> some additional info. Your last comments are dead on, but are based
> on the assumption that a producer has not already hedged his cotton.
> What I believe happened (and the statistics support) is that all
> this pension and investment money in cotton had already made forward
> selling so attractive that virtually every bale of cotton was already
> hedged. The commitment of traders report showed that the commercial
> short positions in cotton exceeded the annual production of the U.S.
> by Feb of 08. This meant that a rise in futures (with cash staying
> constant) was only a negative -- a cash flow squeeze; no hedger could
> take advantage of the higher price. I spoke with people in the industry
> who literally had to mortgage their homes to stay in business. The
> magnitude of the squeeze was enormous, and required more credit than
> even the most prudent participant could reasonably have established
> in advance.
> I'm all for speculators of the traditional sort - and have been one
> myself, having actively traded about 20 different markets (financials,
> softs, grains, meats, metals). They indeed provide liquidity and
> aid in price discovery. The problem is the new type of index speculator
> who provides not liquidity, but rather a big, fat bid (liquidity
> is 2-sided, this is not). For the economy to operate efficiently,
> price discovery should be determined by producers and users of the
> commodity, with speculators assisting, not determining the price
> ahead of those fundamentals.
> Your points about the benefits of stockpiling are also quite astute
> and an issue I've wrestled with. However, as long as the cotango
> is held up by index speculators, those stockpiles won't be released
> into the market, but simply rolled. At some point, you run out of
> storage, and the whole thing may unravel, but that has its economic
> costs as well. At the end of the day, it is economically more efficient
> for most commodities that are produced to be used rather than stored.
> Stockpiling should be more of a marginal activity, not a major use
> of the production.
> Thanks for your thoughtful and thought-provoking comments. --Jeff
> K.
Jeff - thank you for the thoughtful reply. As a speculator I have certainly struggled with the question of what value speculators provide: I find that my trades fare much better when I am very clear on that point and aim to provide value rather than simply catch a move ;)
On cotton: you say "more credit than even the most prudent participant could reasonably have established" - well, clearly prudent just got redefined in the new high-volatility environment. If I was hedging I would surely use long puts or the synthetic equivalent instead of just shorting the commodity, and I would make damn sure I had enough credit to hold that position against literally an arbitrary price move. Sure, that strategy has a significant cost; but without it, one is exposed to exactly the type of blowup that happened in cotton, and so a hedge instead of providing safety provides a massive (albeit rare) risk.
You say "However, as long as the contango is held up by index speculators, those stockpiles won't be released into the market, but simply rolled." - not exactly true. Let's walk through this, assuming an infinitely storable commodity: buy today (and take delivery) at $70, sell futures at $80, store and wait, when futures expire deliver, let's assume the contango and price have both remained constant, so the price at delivery is once again at $70: net effect, producer gets $70, consumer pays $80, and you get the difference less storage costs. Stockpilers make money from the contango, but the index investors (a different group) set up the contango. This reduces present consumption, expands future production, and is paid for about half/half by index investors and those users who hedge future consumption. Conversely, in non-stockpileable commodities this simply expands future production and consumption and is paid for entirely by index investors.
I think the index investors are essentially expressing a desire for safety in the face of uncertainty (which has as of late gotten much more uncertain); their market position can be understood as a sort of call option that really kicks in if there is some kind of major supply problem. This is understandable and prudent, and also entirely consistent with commodities being driven primarily by fear (of shortages) rather than greed. Uncertainty reduction is an economic good in and of itself; even if we never run short on oil (for example), any cost of stockpiling it is easily offset by the benefit of having an assured supply in the short to medium term. Index investors are paying for this, and making everyone else pay for part of it as well. You say stockpiling should be a marginal activity, but what size margin is needed depends entirely upon what size event you want to be able to handle, right? To me, the margin today is far, far too thin: it represents a level of complacency that borders on insanity (global oil and food stocks equivalent to a couple of MONTHS?! of consumption?). If people want to reduce uncertainty by stockpiling, they will do so, and that is precisely what we're seeing by the rush into commodity indexes which is very much a crowd phenomenon and not just driven by a few large speculators. I think it's a great idea, I am just concerned we don't have nearly enough of it yet. True, it can create unintentional painful disruptions for some market participants (cotton again), but it also provides good opportunities to trade along with it.
--Rayden
On Jul 01 02:00 PM Jeffrey Korzenik wrote:
> rayden-
> I don't normally take the time to reply, but you obviously put some
> good thought into your comments, so I wanted to provide you with
> some additional info. Your last comments are dead on, but are based
> on the assumption that a producer has not already hedged his cotton.
> What I believe happened (and the statistics support) is that all
> this pension and investment money in cotton had already made forward
> selling so attractive that virtually every bale of cotton was already
> hedged. The commitment of traders report showed that the commercial
> short positions in cotton exceeded the annual production of the U.S.
> by Feb of 08. This meant that a rise in futures (with cash staying
> constant) was only a negative -- a cash flow squeeze; no hedger could
> take advantage of the higher price. I spoke with people in the industry
> who literally had to mortgage their homes to stay in business. The
> magnitude of the squeeze was enormous, and required more credit than
> even the most prudent participant could reasonably have established
> in advance.
> I'm all for speculators of the traditional sort - and have been one
> myself, having actively traded about 20 different markets (financials,
> softs, grains, meats, metals). They indeed provide liquidity and
> aid in price discovery. The problem is the new type of index speculator
> who provides not liquidity, but rather a big, fat bid (liquidity
> is 2-sided, this is not). For the economy to operate efficiently,
> price discovery should be determined by producers and users of the
> commodity, with speculators assisting, not determining the price
> ahead of those fundamentals.
> Your points about the benefits of stockpiling are also quite astute
> and an issue I've wrestled with. However, as long as the cotango
> is held up by index speculators, those stockpiles won't be released
> into the market, but simply rolled. At some point, you run out of
> storage, and the whole thing may unravel, but that has its economic
> costs as well. At the end of the day, it is economically more efficient
> for most commodities that are produced to be used rather than stored.
> Stockpiling should be more of a marginal activity, not a major use
> of the production.
> Thanks for your thoughtful and thought-provoking comments. --Jeff
> K.
Essentially, the position of commodity index speculators can be understood as a bet on major supply problems. It definitely influences the market: someone has to take the other side of such a bet, which is to provide more supply (if they can). So, inevitably, supply expands as a result, on an intermediate to long time scale. Depending on whether we are talking about something storable or not, present consumption may be forcibly reduced by diversion into storage or not; future consumption will definitely be expanded in either case. IF the index speculators are wrong, they simply make sure there is more of the commodity at a lower price for everyone to consume, and they basically pay for excess supply they created. IF they are right about the supply problem, they make it less a severe problem, and get paid (a lot) for the excess supply they have secured. The detailed mechanics of how all this happens I will leave to you to figure out - it involves multiple intermediate parties that each play a different role - but that is precisely what is going on at a fundamental level.
Whether the index speculators are correct or not is irrelevant; if they are wrong, they will certainly pay for it, in the long run.
Lastly: $200B does not strike me as very much money for essential commodities at all; if the commodities market is small enough that this has a major effect, then perhaps commodities just need to be revalued to be worth far more relative to other things. Essentials should have an essential-ness premium, over the cost to produce. Perhaps you can deliver to me a gallon of gasoline competitively for $1.50 today, but if I am willing to pay far more than that, say $3.00 for a guaranteed supply, then someone can buy from you, store some of it and sell some of it to me with a guarantee of continued availability from the storage. Which is more or less what the market is in the process of doing.
On Jul 01 04:05 PM Nathaniel C wrote:
> I think it is important to distinguish between traditional speculators
> and index speculators like endowments, pension funds, etc. Traditional
> speculators are both long and short the market. Index speculators
> are long only and hold their positions for a long time. Traditional
> speculators provide liquidity to the market and are beneficial to
> the market. Index speculators pile tons of money to only buy and
> roll over their contracts every month. These index investors have
> overwhelmed the futures markets by the large amount of money they
> commit. The futures markets are really small compared to the stock
> market or bond market. It was estimated that you could corner the
> oil market with only $10 billion. By JUL 08, index speculators had
> committed over $200 billion to commodity related invesmtents. You
> can see how this would distort the futures markets.
the article makes the following point, which is valid:
the futures markets were created to provide a vehicle for producers and commercial users to hedge production or consumption of the product. when one of the parties to a two party trade originates it as a hedge, the intended role of the speculator was to take the other side of the trade. speculation occurs only as a result of a hedge and it serves a legitimate role in such cases.
the problem today is that trading increasingly occurs absent an intended hedge; hence speculators start to control prices in these markets...not commercial producers and consumers. anyone who thinks this does not have the potential to lead to dysfunctional markets has his head in the sand.
what's wrong with speculators controlling prices you say? here is the answer: speculators profit most when prices are volatile...the more volatile the better. bubbles are their friend...so are busts. a vicious cycle of escalating prices and ultimate collapse helps them and hurts industry as well as consumers. they're self serving jackals who wrap themselves in a cloak of virtue by claiming they provide "liquidity." what horseshit.
the poster child for speculative abuse occurred in the oil market last year. anyone who would like to argue that the unfounded run up and crash of this market helped the world's economies, feel free to make your case.
On Jul 01 12:50 PM Maxe Paul wrote:
> "It’s worth remembering that these markets were never intended to
> serve investors, but were chartered from the begining to serve the
> commercial commodity industry"
>
> The whole idea of the futures market is for producers to hedge their
> crop/s or commodities with speculators, that is the plan!
>
> This is a quote from Wikipedia "The social utility of futures markets
> is considered to be mainly in the transfer of risk, and increase
> liquidity between traders with different risk and time preferences,
> from a hedger to a speculator, for example".
>
> You mean to tell me you play commodities and you do not even understand
> the basic principal?
>
> Or you would like to play futures but those pesky speculators scare
> you?
>
> As for cotton, well i vote we all buy cotton and hoard it on tankers
> around the world, then dump it on the market later. Im ringing my
> broker now!
> the article makes the following point, which is valid:
>
> the futures markets were created to provide a vehicle for producers
> and commercial users to hedge production or consumption of the product.
> when one of the parties to a two party trade originates it as a hedge,
> the intended role of the speculator was to take the other side of
> the trade. speculation occurs only as a result of a hedge and it
> serves a legitimate role in such cases.
the job of the speculator is to balance supply and demand more correctly than anyone else. by taking the other side of hedgers' trades, yes, sometimes, but also by offsetting supply or demand in time counter to external fluctuations regardless of source. you can think of the latter as taking the opposite side of potential hedgers who are not smart enough to hedge themselves appropriately.
> the problem today is that trading increasingly occurs absent an intended
> hedge; hence speculators start to control prices in these markets...not
> commercial producers and consumers. anyone who thinks this does
> not have the potential to lead to dysfunctional markets has his head
> in the sand.
see above. taking the other side of hedge trades is NOT the only valid speculative function.
> what's wrong with speculators controlling prices you say? here is
> the answer: speculators profit most when prices are volatile...the
> more volatile the better. bubbles are their friend...so are busts.
> a vicious cycle of escalating prices and ultimate collapse helps
> them and hurts industry as well as consumers. they're self serving
> jackals who wrap themselves in a cloak of virtue by claiming they
> provide "liquidity." what horseshit.
speculators profit when prices are volatile by trading AGAINST volatility. trading the other way is sure to lose money. nobody is big enough to control prices except on the smallest scale, that's nonsense.
> the poster child for speculative abuse occurred in the oil market
> last year. anyone who would like to argue that the unfounded run
> up and crash of this market helped the world's economies, feel free
> to make your case.
ok, sure. i've been trading oil pretty actively for the past 5 years or so. based on some pretty detailed analysis, i decided the marginal cost of supply was right around $60, so that was the level i wanted to trade around (oversimplifying things here, so i won't even go into the demand picture, but you get the idea). i bought oil in 2004 at 40-50, sold it in 2006 at 70-80, bought again at 50-60, sold at 90-110, and shorted it bigtime in 2008 at 120-140 pretty close to the actual peak which was nice. i covered the short and went long at 40-50 early this year. if you think of that i did as price manipulation, it was certainly always in the direction of stabilizing prices towards my assumed equilibrium level. not surprisingly, that makes money; the opposite trades lose money. QED.
"unfounded run up" is also a matter of opinion ;) i believe that oil (and natgas) needed a period of high prices to get a bunch of new projects funded and started and so expand supply, otherwise there was a very real possibility of a shortage. the year or so of high prices basicaly expanded supply by something like 2mbbl/day, and by the time all those projects are completed probably another 3-5mmbl/day. this plus a drop in demand pretty much removed any possibility of a shortage, so prices came down. the people who indirectly financed drilling offshore in Brazil are basically the people who bought oil above 120 and then sold below 50 (ie: probably SemGroup ;) how is this bad again?
Do not be fooled again. The concept of the Commodity Index Fund was created by none other than Governmnet Sachs, and promoted under its former chief manipulator and grand master of the Bush/Cheney Financial Fleecing Squad, ole Henry himself.
So, given its origins and history, why would you question the problems in commodity prices and the sequeezing out of the real hedgers was nothing other than a successful attempt on the Greed Meisters themselves to exploit yet, another area of the economy at the expense of the American Family. I said thi sall last year and supported Mike Master's and Prof Greenberger, as many of you scoffed him.
Our Financial giants lost thier butts last year in CDS, (AIG, MS, JPM, Citi and numerous hedge/pension funds) where half were from commodities/oil -- and NOT just from mortgages. Housing/ mortgages were the Bush/Cheney "reason" we had problems, cause they were 'in play' with the GS crowd, and Big Oil. Can't blame those that really created the mess.
And for those of you are still naive to the truth, just who do you think was the first to SHORT OIL at the end of June last summer, getting out somewhat whole while their colleagues took it on the chin in mid-July...after they had ginned up the price for 6 months, reaped huge fees on the inlux of innocent pension funds they lured into the 'long only positions'...Yep you guess it GS....those who listen to this clan of greed meisters deserve the carnage their investment advice brings.
Who do you think is behind the current oil/gasoline bubble...? Will you be fooled again?
MUST READ - Matt Taibbi's Bubble article in the current edition of Rollingstone mag.
GT
On Jul 01 08:59 PM rayden wrote:
> the year or so of high prices basicaly expanded supply by something like 2mbbl/day, and by the time
> all those projects are completed probably another 3-5mmbl/day.
P.S. There is a subtle point here: the existence of a substantial bet on shortages soon removed the likelyhood of shortages and hence the basis for the bet (and then the bet had to be unwound at a loss, bringing us to the current excess supply). Markets are self-correcting that way. Nevertheless, the bet was not unreasonable, the people making the bet simply thought both supply and demand were slightly less elastic (or perhaps slower to adjust) than they proved to be in fact. Had there not been such a bet at all in 2005-07, shortages in 2007-08 would have been a real possibility.
arguments that speculation aid "price discovery" work just fine in textbooks. it's a convenient theory that keeps the ignoramuses who should be regulating risk at bay. the ignoramuses in the treasury and federal reserve also thought derivative financial products and excess leverage couldn't possibly blow up the financial system. dumb as stumps...all of them. don't expect them to take a pro-active regulatory stand on anything.
moderate speculation is harmless, but that's not what we're talking here. when everyone in the herd...and that includes you, my friend....decides to jump on the same side of a trade and prices go vertical until they crash it can be exceedingly damaging...just ask the airline industry. and while you're at it, ask them how effective their hedges were in such a volatile environment. wait....you don't have to ask, i'll tell you....hedging is worthless in such volatile conditions. i suspect that airlines collectively lost more money hedging than they saved in fuel costs in the last 24 months, simply based on the irrational belief that oil prices were going to $200/bbl shortly. even t-bone....i mean t-boone...said, as prices started to crash, "ah no ohl praces won go balow $100 dollas a barral." and he's an oil genius, they say. and even if it were effective, how, exactly, should the travel and automobile industries, both devastated by the speculative surge in oil prices, hedge against such a catastrophic event? i'd say it's a bit out of their job description, wouldn't you?
finally, your assertion that "the job of the speculator is to balance supply and demand more correctly than anyone else" is as arrogant as it is simplistic. it sounds like it came from a poorly written graduate thesis or a heavily discounted economics textbook. how do you think supply and demand were balanced before the advent of the futures markets in the not so distant past? they sure as hell didn't need speculators to get it done. it was done by buyers and sellers of the raw product who turned over hard cash for every barrel of oil bought and sold. none of this dime on the dollar down casino crap like we have today. markets worked just fine then.
if you want to speculate on orange juice futures or hog bellies i don't give a damn because people don't have to drink OJ or eat pork....lots of substitutes for each. but oil is a critical resource that is needed by industry and consumers alike, around the world. speculators should not be permitted to distort that market which they've done once and will do again because crude oil has become a currency proxy thanks to the feckless actions of the u.s. treasury and federal reserve. it's time to shut that trade down before it causes lasting damage. the way to do it is to raise margin requirements to 50%. how many contracts could you afford to trade then?
On Jul 01 08:59 PM rayden wrote:
> On Jul 01 08:11 PM icandoitdon wrote:
First, some education... from the World Oil January 2009 issue:
"In July 2008, the deepwater rig market was looking rosy. The rapid run-up in oil and gas prices resulted in a rush of Final Investment Decisions (FIDs) as previously marginal deepwater projects suddenly became economically viable. Although initially tentative, the growth in the rig sector gradually gained momentum as upstream operators jockeyed to contract new-build capacity for their ambitious deepwater drilling campaigns. By September 2008, around 100 new deepwater rigs (semis and drillships) were under construction or planned, a historically unprecedented level of construction. However, just when $200/bbl looked in sight, the unstoppable finally stopped. Since July, the oil price has fallen over $100/bbl, from its high of $147/bbl, to $40/bbl (December 15, 2008), significantly lower than the current marginal development cost for deepwater and close to the cash cost."
So, indeed yes, a lot of projects that would be marginal except at relatively high oil prices did get started during the period of high prices... including a massive expansion of the deepwater rig fleet btw. These projects are ongoing and will gradually expand supply for years, mostly regardless of where prices go. Anyone in the industry sees that.
What I am trying to tell you (but is apparently not penetrating) is that the oil market was NOT distorted. People (very many different people, not a few big players) saw a likely shortage coming and made a bet on it; as a result other people started drilling like crazy; result: shortage averted, lots of cheap oil, lots of new rigs, and the people who made the bet on shortage lost a bunch of money. That's how it's supposed to work. Which part of that exactly do you have a problem with, please?
"is as arrogant as it is simplistic" - no, it is correct. The speculator is someone who, in a good crop year, says "store some for next year when the crop may not be as good". Or in the case of oil, someone who says "continuing the present trends of production and consumption will result in a shortage in a few years, increase production and reduce consumption". If they are wrong in that, they lose money; if right, they make money. By natural selection, the guys who stay in the business tend to be right a lot of the time.
"oil is a critical resource" - which is exactly why we can't afford the inevitable shortages that will result if you mess with a system you do not understand. A) What makes you think you can make better decisions about what oil should be doing that the market collectively does? B) If you can actually make better decisions, you stand to make tons of money in the market, so I invite you to speculate in oil as much as possible. Go wild. The trick is, you have to risk your money on being right. You don't get to influence the price without risking your own money ;) You think oil is too expensive? Sell some. Too cheap? Buy some. Too volatile? Sell a straddle... and so forth. Ah, but you want to make decisions for others without any risk to yourself, right?
"the way to do it is to raise margin requirements to 50%. how many contracts could you afford to trade then?" - the same as now; it would make no difference to me. Anyone who uses the full leverage that margin allows is seriously undercapitalized and unlikely to keep trading for long.
"hedging is worthless in such volatile conditions" - really? Suppose I am an airline. My hedging strategy might be something along the lines of buying calls which are 20-30% otm covering the next 5 years worth of estimated fuel use. Expensive up front, but the realized avg oil price for the past decade following this method would be right around 40. Totally worthless ;) If you mean most people are doing it wrong, well, I might agree.
I am bemused by the fact that here at seekingalpha, which is presumably a place for speculators to exchange ideas, we find such lack of understanding of the role and value provided by speculators, along with a virulent hatred of speculators ("self-serving jackals", was it?), hatred of markets and probably capitalism in general (you would prefer a planned economy? how is the oil industry in Venezuela doing lately?). "They" are manipulating prices; LOL. That is what everyone who is persistently on the wrong side of the market uses as an excuse. There is no "they", there is only "we", and the only kind of price manipulation that makes money in the long run is to move prices towards equilibrium. Well, I've said enough.
i suspect you would also deny that there was a speculative technology bubble at the end of last decade; or that we didn't have a housing bubble or that we're currently in the midst of a bubble in treasury securities. or maybe you also think that the infamous "tulip bubble" of the 1600s was just misunderstood and that tulips were appropriately priced given market conditions at the time. we're all free to believe what we choose, whether logical or illogical, or based on fantasy or facts. even alan greenspan, dottering old fool that he was, believed that speculation-induced bubbles existed, notwithstanding his myopic aversion to spotting them.
no, i'm afraid it isn't penetrating. by your logic, speculators can never distort markets because any market price is the "correct" price, even on a futures exchange that permits 90% leverage. had oil gone to $500 a barrel before crashing back to earth, that price would have been "appropriate" wouldn't it? simply absurd. and let me take issue with your characterization of the "fall" of oil prices of 75% in about 9 months time...they didn't fall...they crashed, because the hot money left faster than it came in, as it always does in speculative bubbles. i don't know what the price of oil might have been absent the existence of low-margin futures trading but i suspect that price volatility would have been far more tame than what we went through and that the world would have functioned just fine. i would also make the point that the energy "security" of the united states is in no way dependent on the existence of speculation in oil futures. here is why:
what you fail to see is that markets do not need speculators to set market prices. the futures markets are less than 40 years old and commodities have been traded on world markets a hell of a lot longer than that, with no trouble setting spot prices as conditions affected supply or demand changed. tell me why that wouldn't work today?
i don't object to futures markets as originally designed...which is to provide a vehicle for commercial producers and users to hedge their production and consumption activities. let them be licensed to trade at low margin. anyone lacking a license is a speculator. no need to ban them. they can trade too if they want to post 50% margin. and if you actually think that wouldn't affect your ability to trade i assume you wouldn't object to a higher margin requirement. many would object because it would price them out of the game....and that's the whole idea.
you may have the last word if you choose...