Wikinvest Wire

Hayward and Butler on speculation in oil markets

Thursday, June 12, 2008

There are two new views today on who to blame (or who not to blame) for the recent run up in oil prices that has galvanized the country and the world, citizens across the globe prodding their lawmakers to take action, to do something - anything - to stop energy prices from rising.

In conjunction with the release of their Statistical Review of World Energy, BP chief executive Tony Hayward characterizes the blaming of speculators for pushing crude oil prices higher as "a myth".

He says it all comes down to supply and demand - too much demand and too little supply.

According to the annual review, total production fell by 130,000 barrels per day last year paced by production cuts of 350,000 barrels a day by OPEC. This was a decline of 0.1 percent, the first drop in production since 2002.
On the demand side, world-wide oil consumption grew by 1 million barrels a day in 2007, slightly below the 10-year average.

Demand increased by 2.3 percent in the Asia-Pacific region with oil-exporting regions of the Middle East, South and Central America, and Africa accounting for two-thirds of the world’s overall demand growth.
Simply put, the world is consuming more oil than it can produce and when supply (production) exceeds demand (consumption), prices rise and will continue to rise until this imbalance is corrected by either increased production or demand destruction.

Don't let anybody tell you that the trillions of barrels of "proven" reserves around the world are going to do anything to affect the near-term price of oil unless those reserves can be pumped out of the ground and brought to market in a timely manner.

Correctly Identifying the "Right" Speculators

In his weekly commentary at Investment Rarities, long-time silver analyst Ted Butler weighs in on all the talk about "index speculators" driving the oil price higher. He seems to think that the recent fervor to stop the "speculators" in their tracks is well-founded, as long as the right group of speculators is identified.

But before the index funds are tarred and feathered and run out of town on a rail, let’s clear up a common misperception that it has been a sudden influx of index fund buying that has caused the recent dramatic increase in the price of crude oil. That is simply not true. The index funds are holding the same size, or smaller, long position in crude oil than they held 10 months ago, when crude oil was $70/barrel. Ditto for the large long speculators and smaller (unreported) traders on the NYMEX, according to CFTC data in the Commitment of Traders Report (COT). The data clearly shows that long traders on the NYMEX have not been buying aggressively and running up the price of crude. Well, if speculators are behind the recent sharp run-up in oil prices and the long-side traders haven‘t been buying, then who has been buying oil?

The answer is painfully obvious - the speculative shorts have been doing the buying. Public COT data proves this. The buying back of previously sold short futures contracts, primarily in the commercial category, account for the bulk of the buying over the past eight months or so, when oil was trading at $70.

There is always a short for every long position in every commodity futures contract. When enough longs panic and sell aggressively, prices plummet. When enough shorts panic and buy back their short positions aggressively, prices soar. Oil prices didn’t jump sharply because many new longs came into the market. They jumped because, at the margin, enough shorts panicked and bought back contracts they previously sold short, to prevent their losses from getting larger.

So while I agree that speculation caused oil prices to jump sharply, at least we should correctly identify which speculators did the buying. It was the shorts, not the longs. In fact, the data shows that the longs were selling. That’s not to say that oil prices won’t plunge in the future. They will, when enough longs panic and sell. To a large extent, this is the trading pattern of most markets.
Neither of these views should make things any easier for Congress.

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Tim said...

Interestingly, if you look at the production and consumption data in the charts above and in the Statistical Review, crude oil consumption has exceeded production for the last ten years, but it wasn't until the gap started growing beyond a million barrels a day or so that prices began to rise. The gap last year was almost four million barrels a day.

Anonymous said...

Since when did low fuel prices or low anything prices become an entitlement. People need to grow up first. Then, they might catch on to what is really sucking on their purses.

jesse said...

Great graph. Production flatlined since '04.

Anonymous said...

The stated "fact" that consumption has outstripped demand is obvously and provably false. Fact: there is no shortage of oil. Nowhere in the world is oil being rationed. Period. End of argument.

In a true market, when demand outstrips supply, prices are bid up and only those willing to pay the higher price wins the commodity. Those without the money get nothing. But with oil, EVERYONE is getting their deliveries.

The charts in this article are obviously wrong. It is IMPOSSIBLE for consumption of oil to be above production. That would only be possible if there were some massive tanks filled with previously pumped oil (like the US Strategic Oil reserve) which was being drawn down to support the additional consumption. However there is no such storage. In fact total world storage capacity is negligible-- a supply measured in days.

The bulls**t argument that demand is outstripping supply is such utter crap, yet gets repeated ad nauseum without supporting fact, both in blogs and the mainstream media. The truth is that the entire runup in oil prices is due to speculation and/or collusion. Those are the only factors in a market economy that can affect price when actual supply and demand are more or less in balance (LIKE THEY ARE RIGHT NOW!)

So who are these speculator and/or collusionists. Well... speculators, of course. And OPEC. When prices were low OPEC countries cheated on their production quotas, pumping more oil to make more money. Now that prices are artifically high, the reverse is happening. Countries are CUTTING BACK production to sustain the windfall profits, and to maintain their reserves. We're stuck in a spiral that needs to be broken.

Now that the facts are done, let me throw in my 2 cents as to what we should do. The US should announce a crash Manhattan-style program to replace oil with wind/solar/geothermal energy production. We should dedicate whatever money/tax breakes is necessary to get off oil in 10 years. Not only could we tell OPEC to go screw themeselves, we go back to being an oil exporter, like in the good old days.

Dan said...

We've got plenty of oil.

We don't have plentiful oil production. Oil is much harder to reach which makes it more profit prohibitive than it has been in the past. Prices have to rise to justify the risks and costs to get it out of the ground.

PUD (Proven Undeveloped Reserves) mean nothing - they're kind of like repackaging junk loans into AAA tranches - if its not developed, it's not making its way to the market. Even a PDR (Proven Developed Reserve) doesn't necessarily mean that the oil is flowing out of the ground.

Iraq is not producing what it should.

There is a squeeze in the market, but methinks this is mostly caused by OPEC crimping supply. I'd do the same thing if I had fears that my country's only major export was a finite resource that is rapidly becoming depleted.

Fear of running out of oil will drive the market. That fear is fueled by rising worldwide demand.

Oil is also a political tool as well.

I've got to side with Ted Butler that the speculators are the shorts. The market has got to run its course. Too much money has been created... it has to go somewhere.

Anthony said...

Oil relates to gasoline and diesel prices and that is what the entire conversation is in regards to. Take a look at GasBankUSA, located on the web at They discuss fixed price gas and how you can lock in a price even if gasoline prices go up. Interesting concept.

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