Could There Actually Be Another Reason Why Oil Prices Are Falling?

Last August, economist Robert McCullough examined the volatility in the crude oil market surrounding the price spike on July 3, 2008 and the subsequent fall in energy prices. In his final report McCullough examined the many events and announcements that had the potential to impact oil prices over this period. He found that fundamental factors of supply and demand were not statistically significant, but found (on page 13 of the pdf):

The proxy for the short-lived Commodity Markets Transparency and Accountability Act of 2008 was highly significant. Interestingly, this was the only variable that would have affected excess speculation as opposed to supply and demand fundamentals…. One conclusion to be drawn from these statistics is that the news stories cited by pundits to explain the dramatic spike in oil prices have little or no explanatory power.

In other words, the prospect of regulation of the futures markets had a statistically significant impact on prices. Let’s fast forward to the steep drop in crude this month. While there’s certainly been negative news on the economy, we had some negative news at various points while oil doubled from February. It is at least worth noting that the recent drop in oil coincided with a period in which Washington is seriously considering constraints on excess speculation in the energy markets.

To the degree that excess speculation is a factor in artificially inflating oil prices, it needs a constant inflow of new money to sustain those prices, just like a Ponzi scheme needs new funds to keep the game going. It’s hard to imagine money managers continuing to commit capital to commodities at the risk that they might be forced to liquidate if position limits are imposed.

Comments

[john s. gordon:]

i'm so glad somebody finally recognized this factor.
> jack

Jul 12 08:54 AM

[hermanbrut:]

I agree with this article. Also, once speculators get out due to regulation, oil price will drop like a stone due to supply and demand.
Does any rational person really think that cash-strapped economies like Venezuela and Iraq will withhold supply so prices for Saudis will go up?
And demand? China consumers aren't going to buy Hummers either.
Lower oil prices will be good for everyone except the speculators.
Buy DUG.
But then again, hey, what do I know? I'm just a simple, small-time investor trying to think for myself.

Jul 12 09:04 AM

[relaplan1:]

I am a speculator. If I think the value of a commodity is going to increase, I buy. If I think it is going to decrease, I sell.

I also believe if suppliey-demand of a commodity tightens, prices will increase exponentially.

Jul 12 09:25 AM

[Ferdinand E...:]

"The prospect of regulation of the futures markets...."
That's the kind of statement that I used to hear when I was on the econometric circuit in Sweden and Australia, and the reason why I 'aint' on it no more. Because it's bunkum.

Let me add something. In economics, empirical work like that can NEVER take the place of theory.

Jul 12 09:34 AM

[T.Stamps:]

This kind of thinking is the same as price controls. Been tried
before. Doesn't work.

Jul 12 10:29 AM

[User 353732:]

The pejorative term "excess speculation" is a semantically empty slogan, not a description of market behavior or transactional activity.
1. What does "excessive " mean? compared to what? how can anyone know what the right level of speculation is ?
2. How does one realistically and reliably distinguish an "investor" from a "speculator"; is every act of buying something in the hope it will increasing in financial worth an act of speculation or is it an investment or a hedge? Before someone can be labelled a speculator(by which, i take it , means greedy, crooked, market manipulator) you have to know the person's thinking and motive: you must be able to read hearts and minds, which is not possible.

It seems to me that what we call prudent, insightful , clever risk taking and investing when we do it ourselves, esp, when it pays off big, we call excess speculation when somebody else does it and wins. Confusing envy and resentment with sound market analysis is not helpful.

Jul 12 10:50 AM

[The Greates...:]

Phil Gramm
It is called consumer protectionism, not price controls, I think everyone has seen what happens when the middle class shuts down on spending today. The commodity laws that were on the books from the first Great Depression were implemented to protect the consumers and prevent another over inflated market. Particularly the commodities, that affect’s everyone. This was all undone in 1999-2001 by Phil Gramm and the Commodity Futures Modernization Act, I am sure that speculators world wide would certainly not want to see some of the teeth put back into these laws. This reversal also was the sole reason for the Enron mess.
For more on this subject check out:
losangeles.injuryboard...

Jul 12 10:59 AM

[Vuke:]

It is surprising anyone may have interpreted it otherwise.

"Regulation" of the futures market will, counter intuitively, hand more pricing power to producing countries. If this proposal doesn't flame out prepare for much higher prices.


On Jul 12 08:54 AM john s. gordon wrote:

> i'm so glad somebody finally recognized this factor.

Jul 12 11:27 AM

[Jimbo:]

I am uncertain about the differing viewpoints on regulation of commodity markets, but I am convinced that the repeal of Glass-Steagall was a contributing factor to our current economic debacle.

Jul 12 11:59 AM

[HS1:]

Also worth considering is that China seems to have slowed their abundant loading of commodities.

Jul 12 12:07 PM

[hermanbrut:]

Some folks who are commenting here might want to actually read the report cited. We aren't talking about regulation of oil prices here as was tried in the 70's. Everyone agrees that would be bad.

What this article is discussing is the need for transparency about who is trading oil futures. When hedge funds, etc., are able to purchase large futures contracts without disclosing their buying and selling, the market price can be easily manipulated by a few large players. (recall the Hunt brothers trying to corner the silver market back in the 70's)

Especially read pages 13 to 15. The speculators- 4 or 5 large players- caused the price to rise and fall in 2008, not supply and demand. Without regulation requiring these players to disclose their positions, we small guys will never know whether prices are being determined by big market players or REAL supply and demand.

Some folks who really want a free market here seem to be having a knee-jerk reaction to the word "regulation" without understanding what needs to be regulated.

Jul 12 12:58 PM

[pansyed:]

I agree with hermanbrut if regulation is meaning transparency and only transparency. However, I wonder if the regulators would stop at that point.

Jul 12 01:43 PM

[guardmanavc:]

Seems like "hermanbrut" has shut up all the Republicans trying to justify the "NO REGULATION" agenda that they have gotten filty rich with at the expense of all gasoline users, and they have the audacity to say the Obama is going back on his promise not to tax the Middle class because he wants to put a tax of alcohol and soda pop. From what I understand, there are as many high income people that would also be contributing, they drink as much or more than anybody else. Thank you for your insightful explaination that the adminstration is not talking about regulation, but transparency.

Jul 12 01:46 PM

[Gadz:]

What about real estate? People buying and selling madly in that market drives prices up beyond the normal. Nobody complains when that is happening and nobody wants to curb it. Why should oil be any different? If we're going to regulate oil, we might as well regulate everything else too, because everyday people buy things as a hedge against future price increases or in the expectation that it will rise in value and bring them a profit..it's called capitalism.

Jul 12 02:06 PM

[The Greates...:]

It would not help speculators if the government re-installed the de-regulation that Phil Graham and the Commodity Futures Modernization Act passed in 2001. That 262-page bill led to the Enron mess, the sub lending disaster, and opened the door to the “Dark Energy” speculation trading.
For some good reading on this subject check out this site.
Global Research.
www.globalresearch.ca/...

Also read more about it at this site:
losangeles.injuryboard...

In 1933, a few years following the stock market crash, Congress passes the Glass-Steagall Act, in hopes that regulating banks will help prevent market instability, particularly amongst Wall Street banks. The purpose of the act is to separate commercial banks that focus on consumers from investment banks, which deal with speculative trading and mergers.

Jul 12 02:32 PM

[guardmanavc:]

Gadz is comparing apples and oranges, another typical Republican ploy. In real estate you do not bid up the price of the property, the seller and buyer agree on a price and if one party does not agree, the deal fall through, you get that concept? Unlike the oil futures contracts that can be bid up within themselves without acknowledging who is doing the bidding. Why?, BECAUSE THERE IS NO REGULATION that says they have to disclose who they are, so they can bid it up as much as they want on a daily basis. I guess you must be rich enough that you don't care how much you get ripped off for, or must be profiting from it, or maybe you had not figured it out??? Just blindly following the party political agenda, even if it hurts you.

Jul 12 02:42 PM

[dcb:]

You could buy a derivative product based on the price of oil which would not effect the commodity markets. make the contracts such that you have to take delivery or a certain percentage of the product you trade. While not perfect, it would do something. Or you actually have to be in that industry to trade on it directly. Not wall street banks or hedge funds.

Jul 12 03:00 PM

[dcb:]

Things in abstract do not work often in reality. the idea behind communism is beautiful, it doesn't work to well. the idea that unregulated markets are great is also an abstraction. it is theory. recent events have shown that it they are very destablizing. Additionally few players can control those markets, which means the market isn't really free. the invisable hand argument may work when all people have equal say, it doesn't work when one party has a 30 % say, or a computer program that can control the market, or a former associaite who is the head of the market.

To imply that our markets are free and fair is silly. they are clearly crony, effected by favortism, etc. why is regulation that ensures "evenness" worse than cronyism that passes for a free market.

I suggest you read some of the classical economists. even those who advocate free markets realize they can fail and should be adjusted.


On Jul 12 02:06 PM Gadz wrote:

> What about real estate? People buying and selling madly in that market
> drives prices up beyond the normal. Nobody complains when that is
> happening and nobody wants to curb it. Why should oil be any different?
> If we're going to regulate oil, we might as well regulate everything
> else too, because everyday people buy things as a hedge against future
> price increases or in the expectation that it will rise in value
> and bring them a profit..it's called capitalism.

Jul 12 03:07 PM

[hermanbrut:]

No one here who has a brain is talking about regulating oil prices here except you. We are talking about regulating the futures market traders in oil. All we want is for owners of large positions and their actions to be made public so people can know when the market is just being bid up buy big funds as it was in 2008.

Don't you believe in a free market? If so, then why would you not want supply and demand to determine prices, instead of market manipulators?

Capitalism without regulation is like playing football without rules, or running the US government without paying attention to the Constitution.

Do you really think the oil price spike in 2008 was caused by supply and demand? READ THE ARTICLE!


On Jul 12 02:06 PM Gadz wrote:

> What about real estate? People buying and selling madly in that market
> drives prices up beyond the normal. Nobody complains when that is
> happening and nobody wants to curb it. Why should oil be any different?
> If we're going to regulate oil, we might as well regulate everything
> else too, because everyday people buy things as a hedge against future
> price increases or in the expectation that it will rise in value
> and bring them a profit..it's called capitalism.

Jul 12 05:02 PM

[darrenlobo:]

On Jul 12 05:02 PM hermanbrut wrote:
>
> Don't you believe in a free market? If so, then why would you not
> want supply and demand to determine prices, instead of market manipulators?
>

If you believe in a free market then you don't want the govt regulating it. They are the manipulators.

>
> Capitalism without regulation is like playing football without rules,
> or running the US government without paying attention to the Constitution.
>

Capitalism with regulation is the US government not paying attention to the Constitution. Another name for it is fascism.

Jul 12 08:33 PM

[Fighting Yoda:]

Yes the oil price spike was nothing but a mass speculative activity. Demand for derivative products from the financial community was many times above historical levels - that is what is speculation. This kind of speculation- call it irrational exuberance or whatever else - it can hugely distort prices. Bubbles do ultimately burst and cause huge harm to investors and misallocation of capital.

Lot of people keep coming up with arguments that "hey it’s my money I will do whatever I feel like". These are the same people that ultimately cry foul and beg for bailouts. If not for reckless speculation we will not have the dot com or the housing bubble or the tulip mania.

Markets are neither perfect nor participants rational - that has been proven over and over again. Yes markets need suitable regulation and controls - else it is the rule of the jungle and mayhem.

Jul 13 01:28 AM

[johnnybigsp...:]

the Fed has accomplished (at least in part) what it set out to do (with out actually doing anything... (yet?)).

just by introducing the possibility that energy futures could become regulated, they have introduced 'risk' that any current or potential investor must take into account before placing their bet.

this will serve to dampen the speculation by eliminating some number of investors. speculators will look to other unregulated trades instead.

Jul 13 01:35 AM

[Tom Colangelo:]

The market will continue to move sideways based on the numbers and guidance given this week BECAUSE:

1) FIRMS will say nothing or say that the outlook looks better than the recent past. It would be a SELF-FULFILLING PROPHESY if companies with weak Q2 results give negative guidance for Q3. A literal death wish for any firm saying that they won’t improve their numbers even though the economy is beginning to level out and the stimulus is still gaining momentum.

2) The banks will report good numbers because they talk to Geithner EVERY DAY about how they are doing. He is protecting the $1 trillion we have given to banks and financial institutions and for his own sake, must know how the banks are faring. If they were in trouble, we would know about it already because nobody likes surprises.


3) Q2 earnings will be presented as improving month-to-month versus the less favorable Y-O-Y. You will be sold on how things are improving and to forget about t he Y-O-Y because it is not valid in this recession.


The market will meander until Q3 reports. In the mean time, get dividends while you wait for the market to move. Take advantage of this by getting into a strong position in some of the things that we CANNOT DO WITHOUT like:

OIL – BP (Yield = 7.43%), RDSB (Yield = 7.11%), etc.

UTILITIES - ATT (Yield = 7 %), VZ (Yield = 6.4%), VOD (Yield = 6.2%), NGG (Yield = 5.9%), CHL, etc.

FOOD - ADM (Yield = 2.1%), MOO (Total Return = 23.7%)

BANKS - NYB (Yield = 9.3%)

I hold positions in all of the mentioned stocks.

Good Luck.

Jul 13 06:33 AM

[MartyT:]

I guess I am just being a simpleton... It seems to me that it shouldn't have surprised anyone that the price of oil went up when a Texas oil man was the President of the US. Then on the other side of things it shouldn't have surprised anyone that the price of oil has gone down since the Texas oil man left office.

Please not that I am not judging GB, I am just making an observation.

Jul 13 09:47 AM

[Responsibility:]

There are regulations on utilities, communications, public transportation, - - and even medical care.

Responsible governments should put reasonable regulations on oil, the lack of regulation is because there had not been such needs.

Such needs have been well known by now and appropriate regulations should be expected, like many of the other items mentioned above.

Because of the high entry level for the oil industry, governments have spent lots of resources to safeguard the oil industries, similar to providing something like monopoly for the industry, as for utilities, communications, public transportation, - - - medical care.

These industries are so important that they have often become state owned in many of the supplier countries. Regulations are needed for the industry and for the financial markets related to oil.

Jul 13 12:47 PM