The Dynamics of Oil Prices

Sometimes, price action in financial markets really is a consequence of news in the real world. Cause: Hurricane Katrina takes out a huge amount of refinery capacity. Effect: Oil prices rise. Simple. But journalists aren't having such an easy time of it with Gustav. Oil futures are hitting new lows in the $105 range, well below where they were trading before anybody even knew a hurricane was coming. Can hurricanes cause oil prices to fall?

Surely not, that would be silly. On the other hand, it wouldn't be much sillier than the stated reason for today's price action, fears about "slowing global economic growth". After all, there's been precisely zero news on that front over the past few days.

Sam Jones has a smarter take on the dynamics of oil prices: When trades get crowded, they can unwind quite violently. And in recent weeks the short financials/long commodities position has been very popular. If a lot of people are scrambling to get out of that trade at the same time, that's much more likely to explain plunging oil prices than vague notions of traders speculating on Chinese demand growth.

Or maybe it's just that hurricanes in the Gulf always send oil prices towards $100. Seems about as plausible as anything else.

Comments

[Chris B:]

You're right that this was a trading-related event, but not for the reasons you suppose. I think lots of traders were expecting Katrina-like damage and buying long options. When the damage didn't happen, these positions got squeezed. Doh!

So much for using the past to predict the future.

2008 Sep 02 11:13 AM

[whidbey:]

It does not matter greatly what loosed the mornings selling spree. The OPEC monitors will notice the price drops and they will make adjustments, not necessarily official decreases in oil for sale, but decreases nonetheless. We are at or near an equilibrium point which will be artificially maintained by the Club. The random noise of traders attempting to play in the traffic will not be important until some of us notice that the supply of oil really is - long run - less than the demand for oil long run, then the scramble with be unsightly I fear. I am holding some longs based on that belief. Z

2008 Sep 02 04:51 PM