Quelle Surprise! Speculators May Have Had Something to do With Oil Price Runup

Since roughly February, a solid minority of commentarors, including this blogger, have questioned the thesis that the rapid increase in oil prices was solely the function of supply and demand. It was disconcerting to see what reactions this stance elicited. There was often an unwillingness to read what was written, and instead turn the post into an exercise in projection. Use of the word “speculator” is taken to mean the author 1. thinks speculation is bad (no, depends on circumstances), 2. is economically illiterate and 3. is a Peak Oil denier (a lot of vitriol here).

When oil sprinted to its $147 a barrel summit, there was plenty of commentary supporting the price as a function of fundamentals (despite quite a few oil company presidents and industry greybeards begging to differ), save some short-covering when the price rose above $140. But when I came back from Alaska and prices were continuing to fall, the explanations had at least as much to do with, um, speculative factors, like investors dumping oil and commodities for the dollar, as demand destruction.

It seems ironic that now that prices are falling, the CFTC has reclassified its data to show that some traders on exchanges that were previously designated as commercial are now classified as “non-commericial”. The role of weight of non-traditional money in the market now lends support to the notion that demand from new players looking for an inflation hedge or simply participation in a different asset class played a role in the sudden price move.

From the Wall Street Journal:

Last month, the main U.S. regulator of commodities trading, the Commodity Futures Trading Commission, reclassified a large unidentified oil trader as a “noncommercial” speculator….

As a result, the number of futures and options contracts held by traders counted as speculators….. rose to 49% of all crude-oil bets outstanding on the New York Mercantile Exchange, up from 38%….

Four Democratic senators on Thursday called for an internal CFTC inspector-general investigation into the timing of a July 22 release of a report led by the agency. That report concluded speculators weren’t “systematically” driving oil prices. Oil prices soared until mid-July before beginning a decline.

A letter by the senators asks why the report was released before full reviews could take place of trader information the agency only asked for this summer. Also at issue is whether the report played down speculators’ influence, notwithstanding the report’s finding that “the positions of non-commercial traders in general, and hedge funds in particular, often move in the same direction as prices.”….

Meanwhile, a debate is erupting within the agency….. about what the agency does and does not know about participants in this market. …..

Lehman Brothers analysts say the CFTC data, as they are now reported, fail to distinguish certain categories of financial traders from commercial traders and create “an opportunity for the activity of less-informed, purely financial investors to distort expectations.”

In recent months, legislators in Congress have demanded insight….In response, the CFTC has been collecting more data. It has pledged to report back to Congress by Sept. 15….

The CFTC is a few weeks into sorting a massive amount of data requested in June from Wall Street firms, and it is requesting additional data.

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  1. ndk

    Now that’s much more convincing data. What a spectacular climb in open interest with these revised numbers! I’m hopeful we get a chance to test the correlation between non-commercial open interest and prices on the downside to make this more than a hypothesis.

    Regarding your second shortcoming, being economically illiterate, let me offer my condolences. ;-) I’d imagine that your ignorance is related to not sharing the belief that major new buyers are unable to affect the fundamental-based pricing of a market. The story goes that the other players will adjust their positions accordingly as the new whale eases into place, so there will be only a transfer of exposure. The price of the asset will still reflect its true value.

    Is Yves an idiot, or is that a spurious argument? A word to the wise. This argument has been heavily applied in a second situation: foreign government/central bank purchases of U.S. treasuries.

  2. mxq

    “I’d imagine that your ignorance is related to not sharing the belief that major new buyers are unable to affect the fundamental-based pricing of a market.”

    Speaking of ignorant, NDK, have a look here.

    And since you obviously know the answer to most everything, you might as well explain why spot prices have a higher correlation to long dated futures vs actual supply and demand variables.

    And after you’re done helping with that…go look in the mirror and tell yourself that you’re the bomb.

  3. ndk

    And since you obviously know the answer to most everything, you might as well explain why spot prices have a higher correlation to long dated futures vs actual supply and demand variables.

    I was being sarcastic, and even threw in the ;-) for good measure. I agree with the idea that markets don’t necessarily integrate such large new sources of capital cleanly, and apologize both that it didn’t come across in text well and to anyone else I’ve offended.

    Thanks for linking the paper, but it strikes me as an exercise in overfitting. It also performs that overfitting against the same data we disparaged a couple posts back.

    I think the last few years should have taught us about applying excessive mathematical modeling to markets that involve human beings, with all our caprice and stupidity.

  4. Anonymous

    I recall Bernanke stating before congress that he firmly believed that supply and demand was the cause for oil price increases. Anyone with a pulse could see the insanity of that run-up (with the obvious absence of gas-lines) was due to speculation. He is a stooge for the Kudlow- drill-drill-drill team. It is time he resign, he is a political hack for big oil and Bush wars without end crew. Ok, you can bring back Volcker now.

    THUS IF BERNANKE WAS SO OBVIOUSLY WRONG ON SUCH A MAJOR POINT (which was about as obvious as the absence of WMDs during the run-up to the Iraq war), IT IS OBVIOUS NO COMFORT IS TO BE TAKEN ON ANY OF HIS OTHER STATEMENTS OR ACTIONS. HE IS STUPID OR LYING. YOU HAVE TO RAISE TAXES ON THE TOP 5% to 70% and chase their lazy sorry behinds out of this country. An excess of cash lent out by greedy IVY grads
    to produce an excess of home built largely by illegal immigrants padded the balance sheet of the power-elites of this country.

    Your days are numbered! We know who you are!

  5. Juan


    thanks for the paper and the Financial Week article that you had linked to in another comment, but it seems the authors of the former are treating the post-1987 oil price regime as a unit rather than recognizing the transformation within this as production and shipments of benchmark crudes fell sufficiently to force a supplanting of the physical to futures pricing channel by the futures to physical channel, something clearly marked by Saudi Arabia, Iran and Kuwait’s shift to use of IPE BWAVE and NYMEX WTI as benchmarks in 2001. The futures, not the physical, became the benchmarks from which it seems odd that short term futures would be less correlated to speculation than to supply. Oh well, perhaps only a methodological artifact.

  6. T Bone Picker

    always question authority is the rule.

    hedgies play the storage game, i.e.- if the economics indicate a profit in buying futures, taking delivery and then selling it out at a later date, no way are they going to leave money on the table like that! and my conspiracy theory believes that this was exacerbated by the chinese subsidies in oil.

    now the question is… how does the cftc classify SWFs punting in the market? commercial traders?!?!
    did you catch this story earlier this week in the “WaPo?”


    “Sovereign Funds Become Big Speculators”

  7. Anonymous

    SemGroup (now under chapter 11) is another example of sheer speculation. The 20,000 berrels per day producer amassed 5,000 days (13 years) of short positions. Do you classify them as commercial (as their business suggests) or speculatative player (as their exchange behavior suggests)?
    However such large shorts never got the coverage in the news as they do not serve any political purpose.

  8. Anonymous

    When crude hit $140 @ barrel I posted on The Oil Drum: ‘If it looks like a duck, walks like a duck, and quacks like a duck, it is probably a duck’…Meaning, at that point I thought that even a hermit living in a cave could see that crude oil prices were being influenced by speculation more than demand. I also shorted oil untill it dropped to $123.

    For my posts I received no end of negative comment on The Oil Drum, no doubt some of it from long oil posters and the remainder from cheerleaders for peak oil.

    Although I do believe that oil is a finite commodity I do not believe that we are running out of the stuff yesterday. Above ground factors are, and will remain, as much a determinate of oil pricing as demand is for some time to come, imo.

    Since I no longer post at TOD, I will use this opportunity to give my response to those who heaped scorn upon my humble opinions and remained long oil just a wee bit too long…and to all the cheerleaders for peak oil at TOD.

    Nah, nah, na, nah, na!


  9. Dave Raithel

    Different points put by three of Bernanke’s proteges and advisors interviewed by Charlie Rose last evening might be of interest (at least to those as pedestrian as me.) Marcus Brunnemeir, Wei Xiong, and Harris Hong (can’t guarantee all the spellings) converged, with some minor deviations, on these points: 1) There probably has been commodity speculation in general, not just in oil, and an increase in the capital gains tax could diminish some of that; 2) Somebody’s taxes are going to have to go up to pay for federal deficits; 3) Fannie and Freddie ARE too big to fail, the Gov had no real alternative, and the resolution should, “like taking over a bank” gut the equity holders; 4) Wall Street got us to here by applying “regionally appropriate” risk models to a nation-wide finance scheme – the slice and dice, orginate to distribute mortgage system. 5)The most interesting “big theory” point they made is that economic theory is going to have to incorporate more behavioral economics – that the biggest problem an economist has is understanding why people disagree, when disagreement is the root cause of economic phenomenae – like SPECULATION….

    There are other interesting asides, and granted, not all the above are exactly germaine here, but given the inter-connections of any fix upon other aspects of the “free market system”, I pointed them out as illustrations of what people who talk to Bernanke are telling him.

  10. Canadian Peaker

    that’s cool guys, just ignore all the reports that prove speculation is lagging prices, not leading them, and that speculation is just savvy investors taking advantage of a barrel of oil whose price will systematically keep rising forever (less some imperfect blips along the way) because of SUPPLY AND DEMAND.

    You guys are fooling yourself if you think $200/barrel oil isn’t on the way, this minor correction is just correcting the over compensation the market acheived when fear mongering came into play.

    You guys make me laugh, blame everyone but yourselves, good ol’ Americans, it’s never your fault, it’s got to be someone else…

  11. mxq

    Yves said: “The role of weight of non-traditional money in the market now lends support to the notion that demand from new players looking for an inflation hedge or simply participation in a different asset class played a role in the sudden price move.”

    This couldn’t be more right.

    FT earlier this week, quoting Greenspan:

    “The former Federal Reserve chairman said speculation was “importantly responsible” for the rapid move up in oil prices in late 2007 and early 2008…”It was classic stabilising speculation,” he said.”

    (mxq: of course, whether or not this is acceptable, remains conentious, Gspan believes (obviously) that it IS acceptable)

    G-span: “It brought forward the price increase that would have otherwise taken place over a much longer period of time, reducing demand sooner and ultimately cutting the top off the intermediate peak price.”

    I guess he’s in the creative destruction camp…at least whenever its convenient.

  12. Anonymous

    Too much either/or thinking, not enough meaningful attempt to understand the truth.

    Many people, including self posted that speculation may be responsible for some price rise and that manipulation probably was responsible for nothing.

    Several told speculation premium was in the range of max $30USD at the time of $147 oil.

    Oil is now c. $34 down.

    It remains to be seen if it’ll be down more on the short run.

    On the long run? Who knows – recession is here. All bets on demand are off.

    However, what is still missing is:

    1) Proof of how speculation actually affected the sport price of ALL major crude types

    2) Analysis how much of the recent fall had to do more with speculation unwinding and how much real demand dropping

    It is easy to claim “I was right”, when one half of one’s assumptions appears to be wrong.

    More than half of the price rise since fall 2007 is still unexplained by any claimed speculative premium.

    If the floor settles at c. $110, then the price rise was more about fundamentals than anything else.

    People should remember, that being write with one’s assumptions does not prove anything and that appearances can be deceiving.

    We need facts. Let’s wait and see if any surface.

    Anybody who is interested in the real workings of the market understands this.

    Correlation chasers can go back to their Statistics 101 books and look in the index under “inference, statistical”.

  13. Steve Jenkins

    I agree with the previous comment completely: speculation played a role in the recent run up–it is the size of that role that is yet undetermined. This dataset does nothing but give more correlative evidence–that ain’t causation.

    Even the folks at The Oil Drum, etc., would say that there was a little speculation in all of this. Of course, then we have to get into the definition of speculation, etc., etc.

    There are still questions about supply and demand either way…and energy is very cheap. Should we expect that energy will remain cheap?

    My guess: it’s somewhere in the middle, just like it usually is. Look up the central limit theorem, right after you’re done with “inference, statistical” as prompted by the previous comment.

  14. Juan

    anon 12:14 PM,

    1) Proof of how speculation actually affected the sport price of ALL major crude types

    This is a feature of the formula pricing structure put in place post-1987. This structure is one in which the prices of various grades of oil are set +/- in reference to a few (3) benchmark crude oils. From this it is not hard to understand that if, say, the price of Brent benchmark crude is pushed up, those referenced to it will also rise (even though rates of change within this can vary).

    During the first years of the above, the direction of causation ran primarily from physical trade in benchmark oils to futures, i.e. prices were still dominated by actual sales/purchases of physicals even allowing for the Gulf War spike and slightly later (1993) Metallgesellschaft hedging debacle.

    But production and shipments of benchmark oils were declining; the markets became increasingly thin, which facilitated manipulations. And it was just the latter which, in 2001, led dominant producers like Saudi Arabia to make an important shift away from pricing in relation to physical benchmarks to use of futures prices themselves as benchmarks. In this case, that meant shipments to Europe became priced relative to the Brent Weighted Average (BWAVE) as determined on the IPE (become ICE) while shipments to U.S. referenced NYMEX determined WTI lt swt.

    The primacy of price determination moved from the physical to the financial where it became, at best, only real market related. The door had been opened.

    OK, now think about what else was taking place at the same time:

    -Returns from equities were collapsing.
    -Very large IBs were recommending addition of uncorrelated investments, commodities, to portfolios, which I think also agreed with CAPM informed reallocation strategies.
    -The 2000 Commodity Futures Modernization Act, along with its greater deregulation and exemptions for electronic trading and swaps dealers, had gone into effect.
    -Reflationary policies, etc, were driving down cost of money.
    -Leveraged speculation was facilitated.

    Now, given all of the above + a credit forced expansion, it is hard to even imagine that a commodity price bubble would not arise.

    So the head of one of Citi’s commodity desks could note with confidence that:

    A flood of investment funds is driving…prices much higher than can be supported by fundamental analysis of supply and demand. It’s a bubble which could grow a lot bigger before bursting.

    mentioning as well that

    All commodities are involved. All classes of commodities – base and precious metals, energy and softs (agricultural goods), have enjoyed substantial price gains.

    Long standing investors in commodity markets (hedge funds, CTAs, etc.) are being joined by long-only funds (mutual funds, pension funds, etc.) who are implementing an asset allocation shift away from more traditional sectors.

    The growth in investment has been facilitated by new instruments, principally indices and others such as ETFs. Funds of funds are also an increasingly important means of siphoning money into a mix of investment instruments. However, direct investments on the commodity exchanges are also increasing.
    Fund flows dwarf those of commodity markets.

    The financialization of commodities, bubbling up of prices and some of the amazing rationales were more interesting than what they guaranteed, greater fragility and price drops.

    [a theoretical base for the above may not be available within neoclassic econ but, with its concept of fictitious capital, is within at least one of the heterodox traditions]

  15. mxq

    Anon 12:14

    The “real workings of the market” (for futures) are not governed by the physics of supply and demand.

    They are goverened by money flows. When one accepts that truism, it becomes impossible for a rational person to not be skeptical about futures markets signals.

    In other words, I think it is unwise to classify the spot/future correlation as spurious, as futures markets move because of money flows (aka human behavior). While not very dramatic and almost anti-climactic for peak oilers (no pun intended) — its that exact human behavior that has been responsible for turning many tried-and-true relationships into dubious ones.

    So while there is no definitive way to prove causality, the variables used in the study are as close to the fundamental movers of prices as you can get (i.e. futures contracts for futures prices and supply/demand for spot prices). And when the most fundamental variable for supply and demand (spot price) has a stronger correlation with the most fundamental variable for future supply and demand (futures prices), when in fact they should theoretically have 0 correlation, if really has to make you say “hmmmmm.”

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