Hey, Congress, Speculators May Not Be the Bad Guys

Congress has a mind to save us all from speculators and their evil-doing ways in commodities markets. Trouble is, as the following Bloomberg figure shows, oil prices have ramped hugely over the last year despite the number of open contracts having peaked almost twelve months ago. In other words, by at least one measure the influence of speculators in commodities futures markets is down, not up.

If Congress is set to save us from speculators, who will save us from Congress?

[via Bloomberg]

Comments

[mangolfer:]

All the honest speculators got out when they saw it coming. Just the crooks are left now it looks to me....

2008 Jul 01 12:55 PM

[rjb:]

How about the Enron Loophole?

Where did the data for the open contracts come from? How about the inability for anyone to accurately track the futures contracts because of the loophole? Sometimes you need to look at the source of the data to find the problems.

2008 Jul 01 03:43 PM

[Jason Rines...:]

Speculation still weighs in mighty on the price of oil. It's still a safe bet as long as lame ducks like Pelosi and Reid argue that the bottom line is that oil and coal are bad for your health. That was Harry Reid's exact words a mere couple of days ago. I suppose people freezing because they can't afford heating oil at $5.00 a gallon doesn't way in on these mental dwarves heads. It reminds me of this South Park episode where there were these underpants knomes. Phase one of the knomes plans were to collect underpants. Phase three was profit. One of the kids in the show asked the knomes what phase two was. The knomes just shrugged there shoulders.

2008 Jul 01 03:51 PM

[bds231:]

This data implies the opposite conclusion to me:

Oil producers and consumers use futures to hedge well known and *relatively* constant demand and supply, so for them the number of open contracts should remain *relatively* constant (or at least rise predictably with the global consumption of oil).

On the other hand, when speculators buy futures contracts, they start with a dollar value and work backwards to the number of contracts -- they have $1,000 to spend, so they buy $1,000 worth of contracts. They don't say "give me 100 contracts whatever it costs." So as oil (and oil futures) go up, fewer contracts equal the same dollar value.

2008 Jul 01 04:05 PM

[jcrash:]

I think your data is lacking some crucial datapoints.

2008 Jul 01 04:58 PM

[jcrash:]

bds also makes an excellent point, your graph would go from bottom left to upper right if you graphed the value of the open contracts, if you then take into account the amount of margin required (it having increased), the margin requirements graphs would look even steeper.

2008 Jul 01 05:01 PM

[oiler:]

bds231 has a good basis. Go back to Adam Smith, who pointed out that turning over working capital earned a profit, just as a turn of a water wheel ground flour at a mill. In the present instance, a major fraction of outstanding contracts are held "long" by index funds. Each contract was sold by another party, and both buyer and seller are tied to the pool of open interest. In effect, if you hold a dominant interest, long or short, and you sell, if long, your nearby contracts as they approach settlement time (contract month), and buy a like amount of the more distant futures, the overall effect is not to enlarge the total open interest, but to bias prices into cotango, where the apparent price increases month by month into the future. As long as the funds attract new money, they can sustain higher forward prices; in some cases, part of their strategy is to have a sufficiently large treasury to permit 100% purchase of the commodity backed by the current contract.

Another observation concerns the nature of commodity markets, namely that no wealth is created by the transactions; indeed, transaction costs nibble at each contract when bought and then sold by a bull, and the converse when a bear reverses the order of service.

The longer term effect of index fund participation in the market is to price material commodities out of the reach of many would-be purchasers, particularly American produced farm products. In the case of petroleum, there is a world wide market using Globex; whoever works to keep crude prices up increases the leakage of American capital to oil producers, augmenting our imbalance of trade.

2008 Jul 01 05:03 PM

[junkyarddog:]

The author's analysis is incomplete and flawed. So many articles have already been published here (SA) that he should do his own homework. For example, what is or who are speculators?

They are necessary to bring liquidity to the market. Once educated, no one will have a problem with that. The problem is the ridiculously low margin requirements to buy oil contracts: 5%.

Don't get rid of the speculators, just increase the margin requirements. I can only leverage 50% with stocks, so why can't such traders do the same?

Again, the author needs to research this topic a bit more.

2008 Jul 01 05:26 PM

[Speedy:]

this a sign!!! We NEED another way to heat our homes,drive our cars,cook our food,the inventors our out there!!! Use your heads!! This is no joke!! Is everyone going to sit still when the oil mongers drive oil to some ridiculus price.There is nothing that states that we HAVE TO use the grid or gasoline or fuel oil or natural gas.We are HUMAN we can find other ways.If your still lost....let me fill you in....there's solar power,geothermal for cooling and heating,electricity,pe... motion generators that need little to no power to create kilowatts of power,hydrogen...hydro... everywhere people.Everytime you take a drink of water there it is.The only thing we actually need is water,we can actually grow our own food if we really wanted too.Listen,I'm not a genious but I can realize when something is no longer working efficiantly.Fossil fuels are no longer working efficiantly.Just becouse a car won't operate on gasoline doesn't mean it wont be fast of fun to drive.It'll just be different.Inventors wake up!! Start using your inventions,put our race into the 21st century like we should be.

2008 Jul 01 08:47 PM

[Speedy:]

Maybe some of you would like to read this article that I found.....
www.cnbc.com/id/237289.../

2008 Jul 01 09:01 PM

[jcrash:]

Speedy, all these peak oil people have no demand destruction in their nice little parabolic worlds.

The truth is otherwise, and you will see it develop over the next 18 to 24 months. Then oil will be back down under $75/bbl.

2008 Jul 01 09:35 PM

[maximax:]

jcrash - unlikely, given cost inflation in the upstream sector.

2008 Jul 02 06:39 AM

[john s. gordon:]

# of speculators is down ? - - hooray, let's make the # go downer.
> jack

2008 Jul 02 08:18 AM

[rdr4:]

if you want to call someone a mental dwarf, don't misspell weigh in the same sentence.

2008 Jul 02 08:36 AM

[JennH1310:]

Here we go with another blogger that has no idea what they are talking about and posts a SMALL fragment of the problem.. The fact of the matter is Speculation is a FACTOR in the oil crisis, but not the whole problem. However, our government will not admit speculation is even a contributing factor, therefore, will not do anything PROACTIVE about it.. Our government is either in denial or will not admit they have screwed up by not taking action sooner.. Its a lose lose situation and everyone and every business is paying the price.... Congress could take action on speculation and give some relief. Any relief at these levels CAN make a difference for families and small businesses... Shame on Congress...

2008 Jul 02 12:57 PM

[jcrash:]

Maximax, production costs are not the focus. If people stop buying, the price will go down, period. Then, producers will pay less to drillers, suppliers, etc. Then they will lay off people, and be hard up for work, just like all the other boom times.

Oil is boom/bust. I live in oklahoma, I've seen it. Currently, drillers have gone from bored to overworked in the span of a few short years. The demand of oil has not changed enough to justify that change in activity, what HAS changed is the price. It is more profitable now to produce oil. So, more wells come online and more oil is produced. Higher prices means MORE production and LESS consumption. At some point, when all the ships holds are full and all the storage is full, and producers have no where else to put it, the price will come down.

Is there ANYWHERE in ANY country with a scarcity of gasoline? Nope. Prices have come up. People will adjust consumption (DOWN). Period. People will adjust production (UP). Period. Neither is immediate, but both are inevitable results of the situation.

2008 Jul 02 03:45 PM

[bill d:]

rdr4 - you mean like you just spelled it ?
He didn't say "speculators" - he said "speculation".
So the error is ?
(how tall are you ????)

2008 Jul 02 05:34 PM

[Paul Killinger:]

That's right, "motion generators" will fix the problem. Don't tell the D's in Congress... We'll have a new government program for that next week while gasoline surpasses $5 agallon.

2008 Jul 03 10:21 AM