Rayden

Speculators Stabilize Oil Prices: Here's Proof

On Aug 04 10:31 AM naturallight wrote:
> This is ridiculous. Number of USO units is an extremely poor approximation to the
> numbers of futures contracts given the big swings in USO’s price. You really think
> that the bank on the other side of the futures contract looks only at the units and
> not the market value? That would be insane.

I think you don't understand how a commodity ETF works. USO must buy/sell futures when the number of units increases/decreases; except for the roll, they cannot buy/sell futures under any other circumstance. The number of futures contracts typically *does not change* when USO's price swings, only when the number of units changes; therefore the price swings are irrelevant. The other side of the contract (I think you mean a swap?) is also irrelevant.

CFTC Belatedly Discovers the Speculative Oil Bubble

On Aug 04 02:34 AM derryl wrote:

> Wow! "Price discovery", operating in a free market where supply
> and demand sets prices. Can anybody explain to me how allowing speculators
> into this equation can produce any beneficial effect at all, other
> than simply distorting the price discovery mechanism of legitimate
> buyers and sellers of this commodity?

derryl - I thought that most seekingalpha readers, being speculators, would already know the answer. apparently not, as a lot of people keep asking that exact question. maybe i'll write an article about it ;)

the job of a speculator is to help balance supply/demand over a certain time span. if they do their job right, they prevent shortages and gluts. to do that, they have to buy during gluts and sell during shortages. that's the service in exchange for which speculators make money. if they do their job wrong, ie buy during shortages and sell during gluts, thus making both worse: then they lose money, and other market participants make money off of them.

i think that about covers the speculation 101 lecture.

the popular picture of a speculator who moves prices to extremes detached from fundamentals (usually it's "drives prices up") is the picture of a speculator who isn't doing their job right it's basically a speculator who is trying to make money off of other speculators (another description is trend follower, "buy high sell higher"). that may work for some players some of the time, but if that is how speculators as a group behave they would very consistently as a group lose money: ie, they would give away money to the hedgers in the market.

if i'm an oil producer, and i believe the fundamentals of oil imply a price of $60, i would be *ecstatic* about there being a fool who would buy my oil at $150, and i would endeavor to sell them as much as i possibly can at that price. the guy who drives the price up in this case is not an *evil* market manipulator, he's a *stupid* market manipulator who is just handing his money over to me. why would i ever complain about that?

Speculators Stabilize Oil Prices: Here's Proof

On Aug 03 09:05 PM naturallight wrote:

> Isn't this chart extremely misleading because you're using number
> of units for the red line? I think you should be using AUM or some
> sort of metric that encompasses how much in dollars these ETF investors
> are spending.

Number of units is the correct measure. It is actually a rough approximation to number of futures contracts. Consider what happens normally, the fund rolls over their front month futures to the same dollar value of next month futures, which is (ignoring roll yield for now) roughly the same number of contracts. New unit creation causes more futures to be bought, and unit redemption causes futures to be sold. So, aside from changes in the number of futures caused by the roll yield, the only thing that causes net futures buying or selling is unit creation or redemption. The changes in number of units have been very much greater than the effect of the roll yield, so I have essentially chosen to ignore the roll yield in this analysis. I feel that is a reasonable approximation.

Speculators Stabilize Oil Prices: Here's Proof

dw57 - unfortunately, the facts simply do not match your statements.

"demand started tanking in 2006, and got really deflating in 2007." - that would be a resounding no: US oil consumption was 20.802 mbpd in 2005, 20.687 in 2006 and 20.680 in 2007. Sure, demand wasn't growing, but it wasn't dropping either; meanwhile, prices roughly doubled.

"supply doesn't change that quickly" - Saudi Arabia has a claimed capacity of 11 mbpd, but have been producing only 8-9 mbpd recently. So there is an "instant" supply of around 2mbpd, if you believe that.

"then there is all of that oil that ended up in tankers and any place else it could get stored" - yes, there was. However, that happened after the spike, not before.


On Aug 03 05:06 PM dw57 wrote:

> don't think its supply an demand. supply doesn't change that quickly
> (short of major bombs being dropped). and all of the so called news
> that happened in this time frame had been going on for decades. and
> then there is all of that oil that ended up in tankers and any place
> else it could get stored. or those who drove the price never ever
> took delivery. the purpose of these markets as was sold to every
> one, was to try and reduce the volatility not increase it. but it
> was really also just for those who actually will take delivery (can
> you say airline? trucking company?) and those who produce (so they
> knew how much demand there was and could project production). banks
> and other financial companies aren't in eitehr category
>
> and demand started tanking in 2006, and got really deflating in 2007.
> before we ever had that big price spike.
> what we can tell is this. a market that had maybe 9 billion before
> 2006, explodes in to closer to 200 billion?
>
> now inflation usually is defined as to much money chasing not enough
> or very much product/commodity.
> which is what happened here

Study Shows Commodities Speculators Aren't Causing Price Spikes

On Aug 03 06:11 PM Fighting Yoda wrote:

> All of us know price is determined by demand and supply. Demand can
> be come form any source – financial/speculative/... – that leads
> to spike in prices – often to bubbles. If you do not believed in
> this then probably there was no dot com bubble or housing or credit
> bubble.

What I've repeatedly asked people to explain is, how does speculative "demand" aka buying and selling futures lead to a spike in prices? Sure, I can go out and buy a gazillion barrels in the futures market, and the futures price will tick up when i do, but there are precisely two possible outcomes of that: either (a) I have to sell it back into the futures market, at a large loss, and drive the price *below* the starting point, or (b) i actually take delivery and end up with a gazillion barrels on my hands. If large players took delivery of oil and stored it as in the second scenario, that would be actual speculative *demand*. Guess what, that actually happened, but it happened in September 2008-March 2009, during the collapse in oil prices, not during the spike.

CFTC Belatedly Discovers the Speculative Oil Bubble

On Aug 03 12:14 PM Randy Miller wrote:

> Somebody show me a valid price elasticity of demand calculation that
> would show me how a very small percentage reduction in crude demand
> could produce an 80 percent price drop, from $147 bbl to $32 per
> bbl.

Actual data:

Jan 2004, oil at $32-$36, US consumption 20.479 mbpd (source: EIA)
Jan 2007, oil at $50-$60, US consumption 20.567 mbpd
Jan 2008, oil at $86-$100, US consumption 20.247 mbpd

Conclusion: over this price range, US oil demand is (was?) comlpetely inelastic: price tripled in four years without any significant effect on demand. Works both ways of course.

Speculators Stabilize Oil Prices: Here's Proof

On Aug 03 02:24 PM Paul H. M. wrote:
> We all need energy, so that needs to be tightly regulated.

Judging by Paul and Terry there is quite a bit of populist anger just about ready to boil over. I can't help but thing that if my article described who *was* responsible for the spike, rather than who wasn't, the reception might have been a lot more positive. I guess we all need someone to blame.

The problem is, there isn't necessarily anyone to blame. It could be Goldman or whoever (that seems like a popular theory), but it could be just supply and demand. I'm all in favor of position reporting for swaps similar to open interest reporting for futures, that will certainly clear the air as far as off-exchange bets are concerned.

However, if it *was* Goldman or some other evil market manipulator, then why didn't consumption decrease or production increase? Apparently, nobody was willing to use less oil just because it was expensive? Also, nobody was willing or able to produce more oil and sell it at the inflated prices? If I was Saudi Arabia, could you think of any conceivable reason I wouldn't pump and sell as much oil as possible into both the cash and futures markets as long as the price was over $100? Would you guys like to offer a theory about that?

My message is basically very simple: whatever you want to do, back off from the little guys (USO investors), they were helping stabilize the market, not yanking it around.

I see the CFTC hearings as being anti-USO, not anti-Goldman. If the rules pass in a way that pushes ETFs and funds out of the market, or forces them to use swaps, you *will* get extra volatility. Don't say you weren't warned.

Speculators Stabilize Oil Prices: Here's Proof

On Aug 03 02:56 PM Joe in Florida wrote:
> Look at Goldman's positions and timing and compare that to the price
> run up. Throw in a few of their market analyst calls. Then get back
> to us with your results.

I will look at their market calls. I don't have a source for their positions, do you? Some of that info may come out during the SemGroup bankruptcy proceedings, but that might be a while.

CFTC Belatedly Discovers the Speculative Oil Bubble

On Aug 03 12:14 PM Randy Miller wrote:

> Somebody show me a valid price elasticity of demand calculation that
> would show me how a very small percentage reduction in crude demand
> could produce an 80 percent price drop, from $147 bbl to $32 per
> bbl.

Demand for oil is very inelastic. We can arrive at that conclusion by micro observation (driving habits, asking people at what gas price they would cut back, etc), or just from the macro view which shows that as oil went UP from $50 to $147, demand was not significantly reduced. Going down that far in response to a slight oversupply is the exact reverse of it going up that far in response to a slight shortage.

CFTC Belatedly Discovers the Speculative Oil Bubble

Jack Walker: A couple of problems with what you wrote...

"... they are not long-term capital markets, they are price discovery markets" - why can't they be long-term price discovery markets? Doesn't long-term price discovery imply long-term capital participation? Is there any problem with long-term investments in commodities? I think they can basically lead to one of two things, inventory buildups or increased production. What is the problem with either of those?

"Large long-term capital participation of pension funds and trusts
raises the price level of commodities beyond what could be expected by intersection of supply and demand by produces and users." - Realy, how? Please be very specific as to the mechanism. "long-term capital participation" does not directly affect supply and demand, as these participants never take delivery. How exactly do they raise price levels?


On Aug 02 06:11 PM Jack Walker wrote:

> We suggest more attention should be directed to the fundamental role
> of commodity markets, since they are not long-term capital markets,
> they are price discovery markets intended for a completely different
> function.
>
> Large long-term capital participation of pension funds and trusts
> raises the price level of commodities beyond what could be expected
> by intersection of supply and demand by produces and users. The
> new higher indicated market-clearing price then sends unreliable
> signals to both produces and consumers alike further distorting long-term
> capital allocation decisions.

Behind the Income Tax Numbers: Top 1% Paid 40% of Total

Chris: excellent point. Taxing anything discourages it; therefore taxing earned income discourages labor. If anything should be taxed, it should be income that comes from government-granted priviledges like (to pick one at random) mining claims. Limited liability is also a good one, but much harder to quantify - how would you put a price on the value of LL to, say, Exxon?

On Aug 03 10:55 AM Chris Cook wrote:

> Taxing earned income is pretty inefficient.
>
> Taxing the unearned rents that arise from privileges like limited
> liability and exclusive property rights over land/location and knowledge
> would be a simpler, fairer, and pretty unavoidable alternative or
> complement to a much reduced tax on earned income.

Speculators Stabilize Oil Prices: Here's Proof

Missing_Link:

If no one is claiming that USO or other ETFs (or mutual funds) like it caused the oil spike, then why change the rules in such a way as to make it difficult for such ETFs to operate? Yes, uninformed people *are* claiming that.

The CFTC is not exactly talking about changing the rules in a way that would make it hard for GS, BP, Phibro et all to continue doing what they're doing; rather, they're talking about cracking down on index funds.

I have a simple proposal that would make position limits a more equitable system: any passive entity such as a swaps desk or ETF or index mutual fund should also be *passthrough* as far as position limits are concerned. How one ends up with a certain effective position in futures should not matter, just the size of the position itself. A hedge fund for example should not be able to take a larger-than-limit position using an ETF, or using swaps, or using an ETF that holds swaps, or any other combination. The position limits would thus apply to the ETF unitholders proportionately, and not to the ETF itself though. I think this is the only fair way to apply position limits. Limits are kind of a blunt instrument, it would be nice to have something more sophisticated, but the rules I just proposed are an easy way to improve the situation.

I've wondered about the link between the SemGroup fiasco and the rise and subsequent rapid fall in the price of oil myself. The timing certainly works out nicely. That SemGroup was massively short is pretty much a given; but they may have helped do themselves in by trying to cover and hence driving the price up. I think there's something there, we may find out the full story eventually as this works its way through the courts.

Incidentally, SemGroup must have been short using swaps; under my proposed rules, they wouldn't have been able to accumulate such a large position in swaps either.


On Aug 03 11:43 AM Missing_Link wrote:

> I think the problem is that no one is actually claiming that USO,
> or ETFs like USO, cause the oil price spike.
>
> Rather, it's an entirely different class of speculators that caused
> the problem ... a class known as Goldman Sachs.
>
> www.forbes.com/forbes/...
>
>
> This article is accurate word-for-word about the topic at hand but
> utterly misleading about the big picture, which is the role of speculation
> in the oil price spike.

Study Shows Commodities Speculators Aren't Causing Price Spikes

Donald Johnson: why don't you enlighten us on how that works, please? Because I don't have "skin in the game" in the sense you mean and I just don't see how anyone can affect the spot price without physical inventory buildups. Mind you, I can see how index fund speculators can indirectly cause inventory buildups, but do you have any actual evidence of that happening on any scale that can affect the markets?

Cotton is a bit of a special case, I would describe what happened there as a short squeeze of sorts: many cotton merchants were short futures and received margin calls as a result of a large up move. This just shows why hedgers shouldn't generally be naked short futures even if they are covered by physical (or, at least, they shouldn't be short futures unless they have an almost unlimited line of credit). Even so that was a very transient phenomenon.

On Aug 02 11:41 PM Donald Johnson wrote:

> Anybody who knows anything about futures and cash markets and doesn't
> have skin in the game knows long-only index fund speculators and
> institutional speculators distort the futures markets.
>
> Look at the April 2008 testimony before the CFTC by corn and cotton
> producers and merchants, which I blogged on here and on my blog last
> summer.
>
> Anyone who thinks there is no speculation in the cash markets is
> fooling himself.

Study Shows Commodities Speculators Aren't Causing Price Spikes

I'd like to add my study which pretty much arrives at the same conclusion. "Speculators Stabilize Oil Prices: Here's Proof":

seekingalpha.com/artic...

Numbers for Vilification of Oil Speculators Don't Add Up

There is another way in which the numbers don't add up: I can't definitely say this about all speculators, but at least as far as index fund speculators go, they drive up prices when prices are down, and (sometimes) drive down prices when prices are up. Which is exactly the opposite of what they are blamed for. Speculators *were* probably responsible for adding a few bucks to the oil price near the bottom this February when oil was near $30, but they sure as hell had nothing to do with the runup last summer. My article presents strong evidence of that:

seekingalpha.com/artic...