Wednesday, September 9, 2009

Are Speculators Driving Up Oil Prices?

The Economist published an article Data Diving discussing new data that allows closer analysis of whether speculators are responsible for driving up oil prices.  The short answer according to the speculators is probably not.  And, even if they were, in the Economist's opinion, the critical importance of liquidity overwhelms any effect on higher prices.

The regulatory question is whether the Commodity Futures Trading Commission should limit the positions that speculators such as banks, hedge funds, and others take on oil because of the harmful influence that speculators have on the market.

... whether speculation has really been responsible for spiking prices is a controversial issue. In 2008 the Commodity Futures Trading Commission (CFTC) issued a report dismissing the role of speculators in last year’s startling run-up in prices. But banks, hedge funds and others who bet on oil (without a use for the stuff itself) still face limits on the positions they can take, if Gary Gensler, the new CFTC head, can show that their influence in markets does harm.

New disaggregated data show more clearly the role of speculators in the market:

On September 4th the CFTC added more evidence to the debate by releasing what it said were more transparent data on market positions. Before this month, the CFTC simply classified traders as “commercial” or “non-commercial” in its weekly report on the overall long and short positions in the market. Now it has started to disaggregate them further, into producers and buyers, swap dealers and “managed money”. The third category includes hedge funds.

The new data indicate that speculators (swap dealers and managed money) were long on oil in the week to September 1st, with managed money holding a net long position by more than a 2-to-1 ratio. Those actually involved in the oil business (producers and users) held positions that were net short by similar ratios.  And the swap dealers and managed-money players are bigger in the market, both in terms of the contracts they hold and their own sheer numbers.

So, the speculators constitute the largest amount of the market and they take dramatically opposite positions in the market as compared with producers and users.  Still, the speculators' analysts discount the ability of speculators to affect the market.  I'm not market savvy enough to understand the speculators' analysis proffered by the Economist so would someone out there explain how this tells us that speculators are not influencing the market?

But analysts at Barclays Capital note that long swaps accounted for just 6.4% of total futures and options contracts, not enough to drive prices up on their own. Physical traders held more of the outstanding long positions (10.3%) and held even more short positions. This one set of numbers, in other words, does little to prove that speculators are overriding market fundamentals to drive prices. New quarterly data also released by the CFTC show that money flows to exchange-traded funds (ETFs) in commodities failed to correlate strongly with last year’s price surge.

Maybe some more numbers will help us sort this out (in favor of the speculators):

There are more disclosures to come. The CFTC says it will soon release the newly disaggregated data going back three years. If those numbers, like the quarterly ETF data, are equally unconvincing on the role of speculation, the case for limiting positions will be weakened.

And the Economists' speculator-friendly bottom line:

And a strong counter-argument remains: that speculators provide crucial liquidity. Even if they also have some effect on prices, taking them out of the game could well do more harm than good. It is tempting to look for scapegoats when high prices hurt consumers. But the real culprits for oil-price volatility may be much more familiar: supply, demand and global instability.

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