I found Oil's Endless Bid to be a thoroughly interesting and engrossing book. This book was written by veteran NYMEX oil futures trader turned energy markets analyst Dan Dicker and published by Wiley Finance. Dicker leverages his experience throughout this book to provide unique insider insight into why oil (and other commodities) futures markets have become much more volatile and unpredictable over the past decades. Dicker also offers his own prescription for reform of the futures market.
Dicker believes that the recent evolution of oil into an investment or asset class has led to higher prices and more price instability in the markets. This leads to higher gas prices at the pump for consumers, less stability and predictability in revenues and profits for oil companies, and makes virtually all kinds of business planning more difficult. Thus he believes that the transformation of the oil futures market into “just another capital market” has greatly hurt economies, businesses, and consumers around the world. This puts him at odds with many other energy and commodities analysts who believe that the overall impact of speculation on the oil markets is minimal.
The book opens up by discussing how the futures markets operated during the beginning of the author’s career; this period includes the 1980s and 1990s, and lasted until 2001 or so. There were many interesting characters on the trading floors in those days and many of them were gamblers. By far, the biggest players in the oil futures markets were Exxon (NYSE:XOM), BP (NYSE:BP), Chevron (NYSE:CVX), and other major oil companies. This is in stark contrast to today where the biggest players are Morgan Stanley (NYSE:MS), Goldman Sachs (NYSE:GS), commodity index funds, and other financial players that have no interest in physical crude oil. This is a problem, Dicker explains, because the futures markets were never designed to handle this kind of financial interest.
The change in the futures market, that from a market composed primarily of hedgers with a legitimate business interest in physical oil to one made up of people interested more in betting on oil prices, is a central focus of the book. Dicker devotes a lot of space to discussing this progression. It is a very good read, though. The author is in a unique position to offer insight into these changes as he was trading oil contracts on the floor of the NYMEX while this evolution was taking place. There are few other authors or analysts that have this sort of experience to draw on.
The banks, hedge funds, indexers, and pension funds are not the only financial players to have gotten into the act. In one section of the book, Dicker discusses an interview that he had with Coastal Oil in 1994. This Texas oil company had been fantastically successful at handling physical oil but several executives were concerned that the company could not keep pace with all the new oil derivatives hitting the market. The company had been successful at trading with the other oil companies but the financial players eventually ate their lunch. Coastal ultimately went out of business due to trading losses and not due to any problems with their core business of finding, processing, and selling oil. The same thing has happened to other smaller independent oil companies. This is intended to serve as an example of how concerned the oil producers and users have become about the increasing focus on trading, especially that by parties that have no interest in the physical product. Others may have believed that their proximity to the physical markets gave them an advantage in the oil trade; this belief may have been true at one time but it no longer is today.
Dicker concludes with a discussion on how the markets can be reformed to bring back their proper functioning. He notes that the amount of investment money currently in the futures markets has inhibited their price discovery feature which is an essential role of any properly functioning market. The author thus clearly believes that any effective reform will need to substantially reduce the role of purely financial players without imposing undue burdens on legitimate hedgers. He does not believe that any current proposal by regulators will accomplish this. Here are the commonly proposed reforms and why this twenty-year industry veteran does not believe that they will be successful.
- Increasing Margin Requirements: The increasing volatility of the oil markets over the past decade has been consistently met with higher margin requirements. So far, the speculative money has been the least affected by this. In fact, the number of hedge funds, ETFs, managed futures accounts, index funds, and oil trading shops have increased at the same time that margin requirements have increased. While increased margin requirements may help, the levels that are needed to clean up the futures market will risk destroying it entirely.
- Imposing Position Limits: Futures exchanges have always had fairly strict position limits. The problem, as Dicker sees it, is not one participant amassing huge positions in oil. The problem has been an influx of a huge number of participants. A large number of investors or speculators, all going long, are overwhelming the futures market. Additionally, if one single player wanted to take a larger position than what is allowed, they could simply go to the unregulated OTC market to acquire a position. Even if this option did not exist, it would still be possible to set up a network of seemingly unrelated accounts all over the globe and have each of them bid up to the position limits. This would allow the limits to be bypassed if all accounts are owned by the same entity.
Dicker does offer some suggestions about what effective reform would entail. These include:
- Moving all oil futures trades onto regulated exchanges and abolishing the OTC market entirely.
- Outlaw oil futures ETFs and index funds. He suggests that it is far too easy to trade futures in today’s world of discount online brokerages.
All in all, Oil’s Endless Bid was a book that I found myself completely unable to put down. The author does an excellent job of explaining in plain language how the transformation of oil into another financial asset has led to higher and more volatile pricing for all. I highly recommend this book to anyone with an interest in oil markets, futures and commodities trading, or with an interest in obtaining an insider’s perspective into the NYMEX. I also recommend it for anyone who wonders why it costs $40 to fill up your gas tank one year and $80 the next.