One Method to Flush Out Oil Speculators: "Liquidation Only" Restriction

Daniel Dicker, a former oil trader writing at, contends that there is a way to test the hypothesis that speculation is influencing oil prices (a view that Dicker supports). Exchanges could impost a “liquidiation only” requirement, which was last used to break the Hunt brothers’ attempted corner of the silver market in the early 1980s (hat tip reader Michael).

Note that while we believe that oil prices will inevitably move higher as supplies become more scarce, we have trouble believing a 50% price appreciation in five months is solely the result of fundamental factors. Reader Juan provided this quote from presentation by Frank Veneroso last year to the World Bank:

[O]ne may ask, is it a bubble? Two years ago the noted money manager Jeremy Grantham posed this question in an interesting way. He presented a chart of the real inflation adjusted oil price going back to 1875.

He then noted: “Over the years we have asked over 2000 professionals for an exception to our claim that every asset class move of 2 sigmas away from trend had broken, and not one of the 2000 has ever offered an exception! This should be scarier than the fact that GMO has tried so hard to find one and failed. But we always have said that intellectually you can imagine a paradigm shift in an asset class price, even if we have been unable to document one yet in history. …

However, one must note that some of these two sigma moves took a while to revert. Juan reports that a two sigma move of oil in the late 1990s did not fully correct (it saw only a one sigma fall). But the general premise is worth noting.

Dicker has mixed feelings about this idea but believes it is likely to be implemented.


I’ve been a strong advocate for the position that the price of oil, while under fundamental upward pressure, contains an enormous speculation premium…I’ve always argued that the speculation in the market has not been manipulative but just a rush to improve gains in commodities…

The futures markets, however, were designed as simple price discovery mechanisms…Because of this, the rush to invest in oil and other commodities has had a geometric effect in price that you would not witness with other asset classes…

Unfortunately, some problems do not lend themselves to simple solutions..Two instruments are called upon to rein in excessive speculation: position limits and margins. Let me add two more that will surely be called upon soon: a ban on pension and indexed investment in commodities. Let’s take all four and describe why they’ll be less than useless.

Margin increases will have a very limited effect on the commodity markets, because the leverage on them is so high to begin with. …Position limit tracking would be practically impossible and even less useful; those who wanted to skirt them could easily…avoid all invented limitations on positions….

More interesting is the idea of limiting pension and indexed investment in oil. But here too, the managers of those funds would be easily able to access the over-the-counter markets domestically…

You see, all the solutions that I have heard proposed require that you define the motive of the participant — that you somehow figure out which contract of oil is initiated as a true hedge or as a speculative investment, and in this, even the participants themselves would be hard-pressed to know.

That is the environment we have created. Everyone’s a trader — very little in the futures markets is “purely” hedge or “purely” speculation anymore…

In one instance, however, the speculation premium was “successfully” tested – in the silver markets in 1980 when the Hunt brothers attempted to corner the market. As silver approached $50 an ounce in January 1980, the commercial participants asked for relief from the enormous margin calls from ever-rising prices. The CFTC and the Comex (the predecessor to the Nymex) responded effectively by imposing “liquidation-only” trading — traders were allowed only to close existing positions and not permitted to initiate new positions.

This forced purely speculative positions to be closed rapidly, as they could no longer be “rolled” into future months at expiration. This caused the price of silver to drop by $12 the day after it was imposed, a decrease of over 20%! Over the course of the next three months, as contract months expired, the price dropped over 50%.

While I do not advocate such a move,…I believe that in an election year this will inevitably be suggested and implemented. The effects would be astonishing and immediate. Energy funds would be buried, and commodity-biased portfolios hurt badly…

One thing is for sure: A “liquidation-only” market would settle finally and for all time the argument about speculation premium in the oil markets

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  1. doc holiday

    Flush this:

    Barclays warns of a financial storm as Federal Reserve’s credibility crumbles money…barclays127.xml

    Barclays Capital has advised clients to batten down the hatches for a worldwide financial storm, warning that the US Federal Reserve has allowed the inflation genie out of the bottle and let its credibility fall “below zero”.

    “We’re in a nasty environment,” said Tim Bond, the bank’s chief equity strategist. “There is an inflation shock underway. This is going to be very negative for financial assets. We are going into tortoise mood and are retreating into our shell. Investors will do well if they can preserve their wealth.”

  2. Kidder Reports

    This comment is too naive for me: “Margin increases will have a very limited effect on the commodity markets, because the leverage on them is so high to begin with.”

    It depends on how much cash is required. For instance, require 20% margin as of Aug 1 unless oil falls below $100. Further, warn that, unless oil is below $100 on Sept 1, the margin requirement will raised to 50%.

    This amount of cash margin should fix the problem without undue interference — and probably fix it before Aug 1.

  3. manmoth


    I enjoy your blog very much. This talk of speculation brings to mind something that’s been troubling me for a while. Sorry if you’ve commented on it.

    A few weeks ago, you mentioned you’ve never shorted a stock. Fine, me neither! I did, however, own some proshares short funds and decided to sell them, as I was uncomfortable with the instruments used to back them.

    This brings up a relevant question, I think: can one be critical of all the shenanigans of Wall Street and still take part in these funds? I personally don’t think so, but I would certainly appreciate your and others’ opinions of the matter.

  4. John Haskell

    “Liquidation only” worked when two Hunt brothers were trying to corner the silver market. Who exactly is trying to corner the oil market? “Index speculators”? Pension funds? Every institutional investor in the US?

    Let’s ban American financial institutions from instituting winning positions. They can make it up by underwriting more mortgages, I guess.

    If that doesn’t work, it doesn’t matter, as Bernanke is printing so much money that he won’t mind if a trillion or so are diverted to recap the entire banking system.

  5. Scott

    @ manmoth

    Begs the question of what the alternatives are. Long oil? I think that has been the answer of far too many people at this point. That will get fixed up.

    Money market account? Read the fine print … most allow “temporary borrowing” within the fund family to meet liquidity needs. So those in “cash” need investigate what their liquidity might look like under market stress circumstances. You want a Treasury ONLY money market account that is prohibited from lending to anyone under any circumstances. Then you just have to worry about the value of the Treasuries. But good luck FINDING such a fund. Believe me, I’ve tried. A few years ago, the terms of substantially all money market funds, including Treasury funds, to permit temporary lending to other funds under the same roof.

    Some accounts can’t short, but can buy ETFs that achieve the same effect. There may be uncertainty around the underlying instruments, but your loss is definable. Liquidity is great in most of them, so if you have appropriate stops in place you are likely to get out under any reasonably foreseeable circumstance short of complete and sudden systemic collapse. You just need to have a plan in place as to what you are getting out TO. There are not very many good rocks to hide under these days.

    Also ETFs can be used to go ultra long or ultra short for the more adventurous who are unable to play the options or futures markets directly (e.g. retirement accounts).

    ETFs also provide relative ease in investing in foreign markets and currencies.

    ETFs have their place. It’s good to understand them a bit before wading in. Everything has risks and limitations.

    I don’t think there is any moral fault associated with investing in ETFs, but would also be interested to hear other points of view.

  6. Anonymous

    It was OPEC saying that upping production is futile because there is no one to sell it to. Which means that above ground storage is limited.

    If speculators are betting on the futures and if the only way prices can come down is by using less oil or more supply in the system then it looks like more of the same in oil pricing as ways of reducing price is is not in the equation yet.

    The bubble money is finding commodities as the only rate of satisfactory returns in an otherwise slowing world market(s). Constricting use of the futures just prolongs the fix which is alternatives to oil. Let it rise to $200 a barrel and let innovation take over as necessity is the mother of invention.

  7. Anonymous

    The author fail to grasp that the world is larger than the US, and international entities can move their speculative position from one country to another rather quickly.

  8. Gregor

    The Silver example is a poor one, because Silver is absolutely not equivalent to Oil. And visa versa. Silver and Gold do not feed into a 100% user-oriented market like oil. All oil that is taken for delivery is used. Stored oil is strategic, mostly stored by governments. So let’s get the first serious problem with this argument out of the way: Silver is not oil. I would add that part of the huge misunderstanding here begins with rampant failure to understand that oil is its own beast. It’s not corn. It’s not gold. It’s delivered to real world users and the world HAS to use it. Gold and Silver simply do not equate.


    Liquidating the speculators from the oil market would do enormous damage to the critical process already underway, that promotes production of oil and gas. Namely, 100’s of oil and gas producers sell their production forward 6, 9, 12, 18 and 24 months and they bank the proceeds and use that capital as part of their capital base to do acquisitions, and increase production. No, I’m not talking about the majors like XOM and BP who are having trouble increasing production. I am talking about the hundreds of global independent producers–everyone from Devon to XTO, to OXY to BG group–who are. Investors in commodities, along with real world users like towns, cities, governments provide this capital to the producers. You take “the speculators” out of this market and wyou will do nothing to prices. This whole discussion is so incredibly naive and moronic it’s like listening to children talk about ghosts. You take the liquidity out of this market and you will see huge volatility, producers who have increased trouble raising capital, and worst of all–deprivation of information. Speculators are among the first to see supply waves coming, driving the price down. They are among the first to see spare capacity tighten, and push up prices.

    Let me give you a simple, time-tested concept: The function of price is to ensure there are NO shortages. Have their been shortages in this entire bull market since 2000, in oil? No. Do you know what is worse than high prices? Yeah. Shortages. Shortages cause panic. You wanna see high prices? Just see what the feedback signal of shortages do, to the price of oil. Oh my. The role of the futures market is to diversify supply across TIME. The futures markets have done this for 1000’s of years. The first futures markets that we know of were in the Greco-Roman era. They served to ration olives, olive oil, and olive press supply.

    There is no “investment demand” that hits the futures markets and “drives up prices” the way so many are asserting. Futures markets don’t have existing supply that “gets hit with demand.” Futures markets are composed of contracts that are opened at will. Do people not understand? You can create supply of Futures contracts to infinity. If the CEO’s of Shell, XOM, BP, OXY, PetroCanada and Conoco truly, truly believe that 140 dollar oil is “insane” then they can get on the phone every day, and open up contracts that did not exist before they got on the phone and sell a literal Wall of Oil to “speculators” for every contract month in 2009. And then laugh like hell as oil “crashes back to the true value” below 80 and take the capital.


    Only in America, where we are like toddlers in our ignorance and compplacency about energy and energy supply–where we import 65% of our oil–would mythology of speculation in the futures market catch traction. Sheesh. Even Warren Buffet gets it–that it has zero to do with speculation.

    The price you see on your screen is what real world users are paying to take delivery of oil. End of story.

  9. Juan


    Perhaps my earlier comment was unclear, no doubt that happens with some frequency, but
    there was a two sigma spike up in the early 1990s (Gulf War), a one sigma down move in the late 1990s which, by 2005, had ratcheted up two std. dev. relative to the inflation adjusted 1875-2005 avg. price.

    The chart I’m looking at is on page 16 of Frank Veneroso’s Reserve Management Part I and IIt, which may be available at:
    under the heading: … speech as presented to the World Bank April 2007 Updated and Revised!!

  10. Max

    Only in America, where we are like toddlers in our ignorance and compplacency about energy and energy supply–where we import 65% of our oil–would mythology of speculation in the futures market catch traction.

    Not sure what exactly are you saying – that it is _impossible_ to speculate on commoditties via the futures market? Then how come 60% of the current oil futures contract don’t deliver?

    Please, clarify your point. The idea that the price we see is the price “the market pays” could just as well be applied to the past housing bubble, and we all know how that turned out. Be more specific.

  11. Juan

    Anon 5:41 PM; ‘Let [oil] rise to $200 a barrel and let innovation take over as necessity is the mother of invention.’

    Yes but innovation does little good unless brought to scale production and used, i.e. unless it becomes generalized. Production and generalized use of new tech is not divorced from conditions in the overall real economy. $200 oil, by exacerbating weaknesses, would not likely bring about desired results but delay the shift from innovation to generalization.

  12. Anonymous

    “It depends on how much cash is required. For instance, require 20% margin as of Aug 1 unless oil falls below $100. Further, warn that, unless oil is below $100 on Sept 1, the margin requirement will raised to 50%.”

    So you’re sticking a gun to people’s head and forcing them to lose money, even if their honest participants.

    If there were ever an American version of Soviet communism on the stock market, I think that would be it. You cannot call yourself a capitalist if you believe that is the way to do it. And if you also think that is the way to do things, I wouldn’t participate in the stock markets at all. What’s to say in the future the government takes this new-found power and applies to other stocks or commodities where they want prices at certain levels? Isn’t that price fixing?

  13. Juan


    Thanks for bringing up the delivery percentage.

    What I take to be the current NYMEX “Energy Complex” brochure does not break crude out but does state that, for its core energy futures, deliveries represent less than 1% of trading volume.

    In 2005, the IMF claimed that: “Given that only about 5 percent of futures contracts are ever delivered as a physical product…” (Structure of the Oil Market and Causes of High Prices, September 21, 2005)

    I’m not sure anyone can really know but 60% seems high.

  14. Freude Bud

    I think it is curious that an oil trader would consider this a meaningful possibility.

    The open interest on light sweet crude (futures only) alone = 1.3 billion barrels … that is 15 times the amount of all crudes consumed daily worldwide. Light sweet crudes represent about 20-25% of total American consumption which by itself = about 5-8% of world consumption.

    If I understand correctly, 80-90% of oil actually delivered is contracted for via private long term (1 year) contracts. These contracts usually are tied to some spot market price, plus or minus some differential, and often have a ceiling and floor, which means that a percentage of the wet barrels delivered are being paid for at a price largely divorced from the various boards.

    That would mean that an 1.3 billion barrel open interest for light sweet crude over 8.6 m/bd actually contracted for delivery over the boards.

    It’s a price discovery mechanism, but as one of the other–rather rude–commentators pointed out, taking so much of the volume out of the market would likely make it that much more volatile. I suspect forcing so many currency hedgers, etc., out would precipitate a sharp drop in the price of oil for a short time because they would be desperate to sell. But I suspect that it would rebound quickly.

  15. Andrey Subbotin

    One thing to remember is that both hedging and speculation can be done with either futures or OTC swaps. For hedging futures are cheaper, while swaps are more precise (if you deliver to NY, WTI is a perfect hedge, if you deliver to, say, India no future is a good hedge and you’ll likely look for swaps).

    Start making futures more expensive, and you could just drive even the honest hedgers into the OTC market.

    Re: physical delivery for futures
    Futures hardly ever result in physical deliveries. The physical delivery clause is only there to bind paper prices to reality (so if prices diverge, somebody will buy a future, refuse to sell it and get a delivery of cheap oil).

    Normal hedging process it 1) somebody buys Gulf oil, loads it on tanker and carries to USA 2) he buys offsetting futures to hedge 3) when tanker arrives, he sells oil and closes futures.

  16. Anonymous

    It’s interesting to see people argue that (a) the increase in prices is not due to speculative demand, and (b) a liquidation-only restriction would punish speculators who are long.

    If the presence of the speculators hasn’t affected the price, then why would the restriction affect the liquidation value of their positions? At least in absolute form, these statements cannot both be true.

  17. Gregor

    It’s interesting to see people argue that (a) the increase in prices is not due to speculative demand, and (b) a liquidation-only restriction would punish speculators who are long. If the presence of the speculators hasn’t affected the price, then why would the restriction affect the liquidation value of their positions? At least in absolute form, these statements cannot both be true.

    Excellent point. There are people making arguments across the entire spectrum. I agree with you. That is a poor argument.

    I argue differently–see my post above. I argue that flushing all traders ex-commercials from this market will hurt society. It will damage the ability of actual, real world producers to buy undeveloped properties, raise cash to develop them/hedge the purchase of them for the following reason: there will be less capital in the two year forward market to give to those producers. In the last 3 months, there have been a number of oil and natural gas producers who have bought properties, hedged the deal by selling oil and gas forward for 24 months, and then who set about the process of getting those properties into production.

    Flushing specs or investors from the market will have the following effect on price: it will make the price more volatile, and eventually will make price even higher. It will hurt no speculators. They will simply take their money at expirations and go home, passing off the contracts to real world users.

    The crude oil and natural gas futures curves are real world mechanisms by which producers are enabled to bring undeveloped oil and natural gas into production. The capital is provided to them by airlines, cities with huge fuel needs, and yes, investors.

    Anyone who wants to mess with one of the most ingenious inventions in history, the futures market, simply doesn’t know their stuff.

  18. leftback

    Demand destruction will flush speculators out of this market as it does with all commodity markets.

    Clearly this is beginning in the US, the question is: when does the hyperinflationary scenario playing out in Asia bring consumption there under control?

    My guess is this suumer will see the peak in oil prices, but the Keynes quote about solvency and irrationality is appropriate here.

  19. mxq

    Supplemental to what this blog has already covered (which is a perpetual occurrence for old media), here is an interview of Dan Dicker from 7/1.

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