Oil Futures: It's Not Manipulation, It's Stupidity 35 comments
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Bravo, Cramer! On the Mad Money show yesterday, Jim at last agreed that the oil futures market doesn't reflect oil supply/demand picture. He thinks it's manipulation. I don't agree. The thing is, the futures market became a way of investing for a lot of institutions. Organizations, which you can't call manipulators, like State of California pension fund or Harvard endowment fund, are investing a lot of money into commodities futures. They invented for themselves a new asset class and invested hundreds of billions.
There is one fundamental problem with the futures: they are not a real product. They are just pieces of paper. And when volume of futures becomes high enough, and traders on the market have no relation to a particular commodity production/consumption/trade, so the prices of futures don't reflect supply/demand of a real product. They reflect only supply/demand of the futures themselves. As a result, we had last year's boom/bust situation in oil futures. And it looks like the situation is repeating itself right now, on a smaller scale. The tail wags the dog.
Government regulation exists in all markets. It's ridiculous to think that it shouldn't exist in the markets of commodity futures. Kudos to the CFTC for looking at the regulation at last.
One note to Jim Cramer (no, he is not reading my blog, I'm sure): oil is not alone. Most of the commodity future markets have separated themselves from real products. I can't even imagine all the consequences of upcoming regulation.
Last, but not least, a note to "investors" in commodities. Stop right now, before you destroy even more capital. Paper speculation destroys capital of most market participants. Investing in commodity futures is not wisdom, it's stupidity.
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This article has 35 comments:
> jack
Hang 'em High and
Feed their bones to the vultures, their Buds!
1)world wide demand- Europe, Japan and the US represent 70% of demand. In order for the other 30% to move the needle would take serious escalations in demand all predicated on infrastructure improvements, economic stability and major economic growth. This would take generations to happen.
2)Chaos theory- Something someday will happen. Be it a hurricane, a war, some puny dictator saber rattling, a refinery fire or cold weather in Antarctica. Some basis for investing.
3)Driving "seasons"- there is a summer driving season, a winter holiday driving season, a labor day, memorial day, a thanksgiving driving season. sounds like it's pretty much all the time. Also, doesn't this "theory" fly in the face of the "global demand" story. If indeed it's global demand then what will a few extra miles in an ordinary weekend matter.
The best article I ever saw was written by two guys from Stanford who did an analysis that World Wide oil could be controlled with just $11Bln. Hum, so a market that has the power to destroy our GDP and economy can be controlled with just $11BLn. Now, I know we are all altruistic investors but what if some people got together and decided that they would sell the dollar short bid oil up and short the dow on the basis of the negative feedback loop would raise input costs to producers creating a margin squeeze then they would have to raise prices to consumers- thus killing the consumer. Now, how much money could be made off such a trade? Maybe we should ask Soros.
DUMB MONEY- we are it.
1. 80% of commodity index funds FULLY CAPITALIZE their positions. That means that margin is not an issue.
2. Futures aren't reflecting supply/demand. They show expected/anticipated supply/demand, which clearly is unknown.
3. How do you explain that the open interest in the oil markets is half of actual annual usage and 10thsof a percent of the world supply. How can someone manipulate the market by buying 1/10th of 1% of the world's supply?
4.If commodity index funds and other groups decide to treat commodities like an asset class....why is that bad? Everyone is America has Exxon in their 401k...... Just to be clear, accounting for tax changes and inflation, the equivalent cost of a gallon of gas to 1970 is $3.13 a gallon, much greater than average price over the past 2 years.
Did you not read my comment? Most commodity index funds are FULLY CAPITALIZED. They are putting up 100% of the commodity value. Are you going to make small specs pay full price (or 70%) as well or just big guys? If you make limitis on participation and I was JPM or GS I would just own a bunch of subsidaries that all had the max allowable limit. If I was the CME I would just create a new contract that was 10k barrels of crude versus the current 1k. I promise you this will make the crude oil market rally if you try to "rid" the market of specs. FUTURES are a zero sum game. Any time one person makes a dollar, someone else loses a dollar. Does no one know this???
.... What about farmers of corn or beans? They sell commodity futures and still have a hard time maintaining margin with the big price spikes we saw in corn and wheat. What about airlines? Are you going to make them fully margin their needs in the oil market? That will raise their costs and increase everyone's airfares, causing your wages have less purchasing power.
Throughout history, whenever goverment has tried to outlaw or restrict speculation it has resulted in increased volatility from the herring to the onion. Are you aware that Ford helped pushed through a law in 1958 banning futures trading on onions that still stands? Farmers complained that futures traders were pushing down the prices (instead of increasing number of farms in Wisconsin) You would think that this would limit onion price volatility correct? Onion prices rallied 400% from 10/2006 to 4/2007, then fell 96^% by March 2008 and rallied 300% in April of 08. How can this be???
want to include communist Chinese?
Here is a good link.
Energy markets are manipulated, period. If you don't buy that you underestimate the power of the large energy traders. GS, MS, Cargill are top notch futures traders with physical trading capability and unsurpassed knowledge of the marketplace. Only that no one is going to come out and say we manipulate the markets. If you are large trader you have to create the reality. (of course manipulation cannot go on forever)
- Oil cannot be substituted easily by other product in case of price increase ensuring constant demand even at higher demands.
- Oil resources are limited. So we cannot increase supply to reduce price when oil prices increase.
- Oil cannot be stored like other commodities in case the price is lower than expected. In many countries like Venezuela, the economy is dependent on oil exports. So if the price reduces, they still continue to produce which puts downwards pressure on price.
On Jul 08 02:23 PM Makey wrote:
> This is a very naive article, with some uneducated comments.
>
> 1. 80% of commodity index funds FULLY CAPITALIZE their positions.
> That means that margin is not an issue.
>
I didn't say that margin is an issue. Cramer did, but I don't agree with him.
> 2. Futures aren't reflecting supply/demand. They show expected/anticipated
> supply/demand, which clearly is unknown.
>
Lately, futures show only supply/demand of futures. Nothing more.
> 3. How do you explain that the open interest in the oil markets is
> half of actual annual usage and 10thsof a percent of the world supply.
> How can someone manipulate the market by buying 1/10th of 1% of the
> world's supply?
>
It's not manipulation, it's stupidity. Read the header, please. As for the "oil" price, it's actually defined in the futures market. Size doesn't matter, contracts do. Most oil delivery contracts are tied to the price of crude futures. Similar picture is in other commodity markets, especially metals and grains.
> 4.If commodity index funds and other groups decide to treat commodities
> like an asset class....why is that bad? Everyone is America has Exxon
> in their 401k...... Just to be clear, accounting for tax changes
> and inflation, the equivalent cost of a gallon of gas to 1970 is
> $3.13 a gallon, much greater than average price over the past 2 years.
If they bought commodities, it would be different. They'd quickly found out that storing commodities is an expensive proposition. Storing oil costs you a dollar per barrel per month. The asset class they are holding is paper, not commodities. And because it's paper, it can go up and down in price pretty quickly. Like last year. Like last two months. Like this week. Do you really think that real and expected supply/demand situation in oil market changed enough in the last 4 trading days to justify more than 10% drop in price? Funds lost hundreds of billions on oil futures last year, they are going to lose this year. They are losing right now.
for several years, the bush/Cheney/Paulson/Gov Sachs regime dupe the American People, the American Investing Community, the Media and basically, most of the global population and economies.
Their 'experts' told us that it was all supply/demand fundamentals. Yes, they hand one hand in the tub and the other on the faucett.
We didn't have a chance. From the moment Bush/Cheney walked the 2005 US Big OIL company mergers through completely around the Justice Dept. Anti-Trust did not exist in the B/C era, unless you were on their hit list...)
As gasoline has been somewhere between double to triple from just prior to the first merger in late 2004, our purchasing power has been sucked dry to the tune of over a $Trillion, going either into the pockets of Big Oil, Big Wall Street or to a favor few overseas selling us oil.
Regulators were told to 'look the other way'. Half of the Congress was told to stand and fight against truth, all the while helping themselves graciously to oil, GS and WS banks' lobbying money. Get all you can, because the "joy ride" will be over in late June, 2008! Yes, the Bush stimulus would 'pay for the last round of $4 gas' and GS would led a select few out the back door with their pre-emptive short of oil in June 2008 for the July oil contract, having made money every which way from fees to CIFs to owning a refinery and a trading arm. All the time giving 'the Street and its public mouthpiece, Kudlow and the shills at CNBC,
"their WISE and Brilliant Investment advice" - Yep, that there OIWELL am gonna go to $200, so $147 is a sure bet...better get on the BUS...we're leaving in a few...(Beware: Driver has been known to jump off after pointing bus towards cliff while joy riders party!)
Same thing just happened the last 60 days....as to the OIL and Gasoline Futures with teh same ole W/S crowd.
Friends, Stupid are those sheep (funds) who haven't learned that Government Sachs and Pals only give investment advice that serves their pocketbooks....period.
Speaking of Government - Kudlow rails that we don't need Corporate taxes - highest in the world. Almost. Let's see - in 2009, Gov Sachs made $2.3Bn, a real 'of-year'...and paid only $14 million in taxes! Let's see, they were a TARP bank too, receiving $10 BN in near 0% money, right???
The people who are against regulation and fair and reasonable taxes, etc. are those who are 'gaming' the system and know that transparency, enforcement of fair regs and markets, will only upset thier manipulative ways and 'dominance by coup', instead of excellent business instincts and practices!
sorry for the typing inversions. its 2:30 AM...
But the most direct statement I've read recently is this: He who has the oil gets to set the price of that oil. The rest of us pay.
I disagreed with some of the premises of your article, but a good deal of my comments were regarding the comments about your article.
You say that. ."If they bought commodities, it would be different. They'd quickly found out that storing commodities is an expensive proposition. Storing oil costs you a dollar per barrel per month. The asset class they are holding is paper, not commodities."
Ummmm, oil futures ARE the physical good. They are not "pieces of paper," but an agreement (hence the term contract) for the SELLER of the future to DELIVER crude to you. If I buy crude futures for April of 2010, the seller has to deliver physical crude to me. You are not right. I know crude cost a lot to store. That is why the futures market is showing that the price is higher in the future, accounting for the cost of storage.
This kind of misinformation is so one-sided, it is unreal. Very few people really understand how futures markets work.
You also said, "Do you really think that real and expected supply/demand situation in oil market changed enough in the last 4 trading days to justify more than 10% drop in price? Funds lost hundreds of billions on oil futures last year, they are going to lose this year. They are losing right now."
Good point, speculators, producers, users all can lose money in the futures markets. Yes, I do think that the expected value of crude can change quickly, so what? Alcoa lost over 450m last quarter as announced last night and their stock rallied 5%. Do you really think that their profitability potential increased 5% in 2 minutes?
On Jul 08 11:49 PM Alex Filonov wrote:
> Some responses below.
Alex, you've got the open interest thing wrong. haven't you.. Look at the listing in the New York Times, remembering that each contract is for 1000 barrels. Of course, I could be mistaken here since the last time I looked at open interest in the oil market was 20 years ago, but theoretically open interest should usually (or maybe always) be larger than physical production.
And there is nothing wrong with speculation in the oil futures market, because without that speculation there would be insufficient liquidity for optimal hedging. But as for speculators rather than fundamentals determining the oil price, well that indicates the poor state of knowledge about oil and oil futures markets.
But you are right about the oil price being defined in the futures market. I hope that everyone understands that, because I forgot about it in some of my work..
It's NOT the paper Alex, it's the INTENT to manipulate. W/O a Futures market, prices for resources would never trend normally, what would producers (the Trades) do to offset risk, throw the dice? Where you have folks wanting to hedge, you have speculators willing to gamble, that's NOT manipulation, that's COMMERCE in action!
For someone who's supposed t/b an expert, you sure do come across as dumb as a stone, get a grip, read Gartman's Letter, WAKE UP!
Ferdinand: I said the open interest thing, not the author. Open interest has nothing to do with actual production.
Global annual oil consumption 84m bpd x 365 = 30.6 B barrels of oil a year =30.6 MILLION equivalent futures contracts.
Open Interest of WTI Crude oil = 1.159 million contracts or 1.159 billion barrels, about 3.3% of total oil usage.
Another example is corn which as about a million open interest at 5k bushels a contract. - 5m bushels of Open interest versus annual crop size of 11-12 billion bushels.
Amen
On Jul 09 09:44 AM Makey wrote:
> Mr. Filonov,
>
> I disagreed with some of the premises of your article, but a good
> deal of my comments were regarding the comments about your article.
>
>
> You say that. ."If they bought commodities, it would be different.
> They'd quickly found out that storing commodities is an expensive
> proposition. Storing oil costs you a dollar per barrel per month.
> The asset class they are holding is paper, not commodities."
>
> Ummmm, oil futures ARE the physical good. They are not "pieces of
> paper," but an agreement (hence the term contract) for the SELLER
> of the future to DELIVER crude to you. If I buy crude futures for
> April of 2010, the seller has to deliver physical crude to me. You
> are not right. I know crude cost a lot to store. That is why the
> futures market is showing that the price is higher in the future,
> accounting for the cost of storage.
>
This is how you think future markets work. Reality is different. Future exchanges (NYMEX and ICE) define two types of contracts: for physical delivery and not for delivery. They also specify two types of traders: those who can deliver/receive physical product and those who can't. When contract not for delivery expires, seller and buyer just settle price difference according to settlement price. These are just pieces of paper, nothing more.
Most of current oil contracts are not for delivery. It would be OK, if those contracts were just a hedge. For example, airlines often buy such hedges. I wonder, what do pension funds hedge?
Situation when contract for later delivery priced higher than contracts for near delivery (contango) is not permament. Reverse situation (backwardation) happens too.
I understand that most futures contracts don't get delivered. The reason for is geographical, quality, ect. That is not the point. The point is that when you purchase a futures contract, you are committing to purchase a REAL commodity on some date in the future.
I also am aware that the market can move out of contango. That is because the demand for the commodity in the spot market is very high. That has nothing to do with what we are talking about or the oil market at this time.
I wish that people would educate themselves before spouting off and spreading misinformation.
On Jul 09 12:45 PM Alex Filonov wrote:
>
answer, watch the commercials run wild and make a ton on the idiots. it will back fire big time on the little guy just like all the other idiot government ideas. Nothing ever changes
As for "physically" delivered contracts, most of them are settled financially as well. As you just said. So, I wonder, how NYMEX (and ICE as well) contracts are related to crude supply/demand? I see markets trading mostly paper, and price defined by supply/demand of paper.
On Jul 09 01:53 PM Makey wrote:
> ummmm.. gosh you are misinformed!!! Yes, there are physically and
> cash settled contracts. So what. Nymex WTI oil contracts are physically
> settled and the seller at expiration has to deliver the good. It
> became physically settled in 2006 and that is where the volume is.
> They don't define who can receive or deliver contracts. I have no
> idea where you are getting this information. If I end up short a
> corn future after expiration, I HAVE to deliver the corn or the receipt
> at the elevator. You are wrong.
>
> I understand that most futures contracts don't get delivered. The
> reason for is geographical, quality, ect. That is not the point.
> The point is that when you purchase a futures contract, you are committing
> to purchase a REAL commodity on some date in the future.
>
> I also am aware that the market can move out of contango. That is
> because the demand for the commodity in the spot market is very high.
> That has nothing to do with what we are talking about or the oil
> market at this time.
>
> I wish that people would educate themselves before spouting off and
> spreading misinformation.
>
> On Jul 09 12:45 PM Alex Filonov wrote:
This is my last comment on this, as we are getting into semantics. Many people have mentioned that the market is "rigged" or manipulated and I think that the market is rigged by OPEC, and that GS and MS and other banks have more information, better research, order flow ect to make their trading decisions. BP or Shell also have more information about true supply/demand for oil and they have an advantage. So what. Life isn't fair. Don't play the game if you dont' like the rules. My point is that no group of speculators can artificially inflate the price beyond some politicians expectation of what the "real" price should be. It is not possible.
Speculators aren't to blame. Goverment doesn't help and OPEC certainly doesn't help the market find an effecient price. No one has presented even a shred of evidence or described just how these speculators magically drive up the price of oil at their will. You know why? Because they don't.
If the US govern sold the whole SPR, eliminated the DOE, and opened up all drilling anywhere on US property and we found a 100 trillion barrel oil field off the coast of Maine, where would oil go? If your answer is lower, then you have broken your own argument.