Short Covering Helps Fuel Oil Price Rise to $135 a Barrel

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Not only do recent trading patterns suggest short covering played a role in the recent oil price spike, but declining open interest also says new money is holding off entering after such a fast runup.

From Bloomberg:

Oil’s rally to a record above $135 a barrel came as traders bought crude to cover wrong-way bets that prices would decline, according to data from the New York Mercantile Exchange.

The number of outstanding futures contracts, known as open interest, fell 8.1 percent in a week to 1.36 million at the same time that prices rose 2.6 percent, the data show. Falling open interest and rising prices are signs that traders are buying to exit so-called short positions that would profit if oil fell, and lose money as they rose.

“In a market like today, which is trending higher while open interest is falling, it’s a sign that money is moving out of the market,” said Stephen Schork, president of Schork Group Inc. in Villanova, Pennsylvania. Open interest in Nymex crude futures peaked this year at 1.5 million on March 13….

Open interest has been sliding for months, after the number of outstanding crude futures reached a record 1.58 million on July 16, 2007.

“It is not a growing market, it is a shrinking market in terms of open interest,” said Olivier Jakob, managing director of Petromatrix Gmbh in Zug, Swizterland. “It is also facilitating the move upward.”

Oil prices have closed at record highs on 27 days so far this year, prompting OPEC oil ministers including Saudi Arabia’s Ali al-Naimi to declare that the rally is led by investors, rather than a shortage of supply.

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  1. Eric

    Why is it called “short covering” when it could be called “profit taking”?

    I guess “short covering” sounds better to the masses paying $5/gallon for gas, since that means the spec having to cover got crushed, while “profit taking” might sound like someone stole money from Joe SixPack.

  2. Petey Wheatstraw

    Wall Street would never sacrifice its reputation and patriotic responsibilities for the mere taking of profits.

  3. Anonymous

    Regarding eric’s post, it’s called short covering because the price went up. That means people were more aggressive about buying than selling. With profit taking people are more urgent about selling and the price goes down. People were more urgent about buying because they were closing out shorts. We know they were closing out shorts because open interest went down.

    The reason people were anxious to close out shorts is because the production losses due to the strikes in the UK and Nigeria (April 27ish to May 7ish) hit the inventory reports this week. The effect of this should last at least another week.

    Prices would then normally drop as the return to production hits the inventory reports, but I don’t think we’ll see much of a correction because there is pent up demand in both China and India: and

    Both have been dragging their feet about buying, but clearly can’t wait much longer. So prices will probably stabilize for a while. Exactly how stable the stable period is will depend upon the timing of China’s and India’s buying.

    Moe Gamble

  4. Anonymous

    If there truly is a global shortage in crude oil, then what sort of alternative “cheap energy” will fuel the fantastic projected growth rates in developing economies such as China and India that are suppose to lead the world into a new era of global prosperity. At least that is what I keep hearing the free trade gurus preach?

    Surely, these price levels will put a serious dent on economic growth in these countries.

    Avg Joe

  5. Anonymous

    Short covering comes in many flavors. Does this really mean that these were naked shorts that got caught on the wrong side of the trade or were hedgers unwinding positions before they made delivery?

    If I’m a producer and I see $110 a barrel when I have a cost basis of $30 or lower, then I want to lock in some of that profit.

    When did financial reporters become cheerleaders instead of, well reporters?

  6. Anonymous

    Regarding Avg Joe’s post, price levels are supporting increased consumption in the Gulf States and Russia. Russia’s oil production is down roughly 1% yoy, but Russia’s oil exports are down roughly 3.3%. The decline in exports from the Gulf States is even worse relative to production.

    China and India are subsidizing gasoline and diesel consumption, and China has enough savings to seem to be able to do that for an extended time. The U.S. is also continuing to subsidize gasoline consumption through high ethanol subsidies. Eventually price rises have to affect demand, but demand has remained surprising inelastic. It is easier to destroy the demand of poor people–after you take care of the easy demand destruction, people with more discretionary money have a lot more money to bid.

    I believe it was Krugman who recently wrote that he wasn’t that worried about the energy crisis because Europe was doing quite well on about a quarter of the per capita oil consumption of the U.S., and he’s right. People in Europe own cars, but they are highly fuel efficient cars, and public transportation is far better in Europe. Also, France is getting a huge percentage of its electricity from nuclear power.

    In the U.S. we need to convert as fast as possible to highly fuel efficient cars, high fuel efficiency public transportation (local and intercity electric rail), and a lot of solar and wind power where it makes the most sense. Also, if we’re going to be installing solar concentrating power plants in the Southwest, and wind power on the Great Plains, we are going to have to upgrade the grid to carry this power to where it’s needed, when it’s needed.

    Moe Gamble

  7. Anonymous

    Regarding anonymous 11:21 a.m.’s post, we won’t know for sure until next week’s Commitment of Traders report who was covering the shorts, but usually in these situations it turns out to be commercial traders. Commercials are still roughly 80% of the oil market, as they have been for years.

    Commercial traders will definitely short oil with no intention of delivering the product when they consider the price high.

    And I agree that producers with a $30 production cost will probably be happy to lock in a sale price of $110. But you have to remember that new production costs at least $90 to bring online, and that all that great old $30 heritage production is declining at rates of 3%-16%, depending on the well. Producers know full well that they are not replacing these reserves. They are essentially liquidating, and they want as much money for their reserves as they can get.

    But the price of oil is not really determined by the cost of production (unless the price drops below $90 plus profit, in which case new production will not be brought online). The cost is determined by competition for limited supply. The most efficient users of energy will tend to win the bidding over the long run, and the U.S. is a tremendously inefficient user of energy overall.

    Moe Gamble

  8. Anonymous

    People shouldn’t bitch too much about high oil prices. It’s those high prices that OPEC is recycling back into OUR treasuries, saving OUR asses from higher rates.

  9. Anonymous

    Really simple guys. Crude oil supply 85 million barrels/day, demand 87 million barrels/day and growing.

    Unless Europe and the U.S go into a severe recession, dragging the rest of the world with it, oil prices keep heading higher.

    It has and will remain a bad time to invest in U.S stocks and bet for the U.S economy. If the U.S fails to enter a recession, we will deal with growing inflationary pressures. Yet only if we endure a severe recession will inflationary pressures recede.

    Neither scenario is favorable for U.S stocks.

    Yet the VIX is under 18 and everyone is talking about a bottom in stocks.

    Very funny indeed

  10. Anonymous

    WASHINGTON (Reuters) – Treasury Secretary Henry Paulson on Thursday said that a rise in oil prices is a reflection of tight supplies and growing global demand and is not driven by market speculators.

    Hanky panky Paulson, Say’s it’s supply demand although he doesn’t mention that all wars are inflationary, the FED has cut interest rates to the bone to bail-out insolvent banks and individuals or the 536 boneheads in DC that think the US can borrow and spend forever which leads to currency devaluation. The US government is why oil prices are high don’t buy into the denial BS.

  11. Juan

    anon @ 1:26 PM

    World production of conventional crude oil hit a new _all time high_ in January at 74.5 million barrels/day (EIA). That is, world oil production has never been 85 million/day, a figure which bears more relation to what is called total liquids that, for this year’s first quarter, was running at 87.3 million barrels/day (IEA).

    I’m not sure that the EIA has full production data for that period yet but does indicate a roughly 2 million barrel/day increase between mid 2007 and January.

    My point is simply that when someone like Pickens announces world oil production will never surpass
    85 mmb/d, he is not talking about conventional crude oils but total liquids, which have broken above the never-to-be-surpassed level.

    And doing so even as global growth cools.

    There may be a term for this combination.

  12. Anonymous

    juan– If we really want to be petty, we would say it is natural gas liquids production that is included in the total crude oil supply figure of 85 million.

    Global conventional crude oil should peak at 79.9 million barrels in the year 2012. In 2008, conventional crude oil demand is expected to be 77.8 million barrels. So between now and 2011, we better pray incremental demand does not increse by 2.1 million barrels a day.

    Whether it is this year or four years from now, conventional crude oil supply will fail to fully satisfy demand.

    THe world better pray for a deep U.S and European recession. At least this will by the world 5-7 years to find a commercial solution to peak oil.

  13. tom a taxpayer

    Thanks to the posters for sharing their knowledge about oil. A special thanks Moe Gamble who has made several eye-opening posts above. Thanks for the education.

  14. Juan


    clarification does not strike me as being ‘petty’; not everyone is aware that total liquids does not = oil but (oil +).

  15. Juan

    just noticed the reiteration of ’85 million’ [barrels/day], which contradicts Oil Drum Europe’s April 2008 Oilwatch Monthly:

    …IEA. In the first three months of 2008 an average of 87.34 million b/d was produced. The EIA in their International Petroleum Monthly puts the average global 2007 production at 84.60 million b/d and January 2008 production at 85.80 million b/d.

    Whether the rise over a roughly two year plateau is sustained remains to be seen but I’m tired of hearing all the ‘never to be surpassed’ type claims.

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