By Naser:
Many factors influence oil prices such as oil reserves, strength of the dollar, and the political atmosphere in producer countries. No one would argue against the influence of speculation on oil prices, however, the extent of this influence is the subject of constant heated debate. A recent research paper examined how changes in oil contract positions of hedge funds affect oil prices. It found correlation, NOT causation; leading us to believe that the extent of oil speculation influence is limited. Yet, the research was hampered by the fact that hedge funds are notorious for their secrecy and generally do not publicly disclose their trades.
Source: The Economist
The graph above shows that whenever prices increase; hedge funds would have a net long position. Whenever that position declines or goes negative; oil prices decline.
On a related note, Tuesday’s (July 7th) Wall Street Journal headline read “Oil Speculators Under Fire.” The article discussed how France and the UK are launching efforts to crack down on oil speculation. Further, it suggested that the US is pondering a similar stance.
In my opinion, any curtailing in the oil speculation market would lead to unfavorable circumstances. Such act will limit the oil market to just the suppliers and the end users (refiners, utilities companies, etc.). It will deny companies that are dependent on oil, such as airlines, the opportunity to take on hedges to limit their exposure to changing oil prices, thus, adding uncertainty to their earnings. Moreover, it will lead to a significant imbalance in the power of suppliers and end users since it removes an important middleman. Speculation usually smooth out the changes in oil prices as it increases the pool of oil specialists attempting to fairly price oil, and trying to take advantage of any arbitrage opportunities. A possible solution that could ease Washington’s worries would be to put a limit on speculative trades as a percentage of total oil trades, as is prevalent among other commodities.
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Loading ...Tags: Hedge Funds oil positions, Oil, Oil Speculation, OPEC
I don’t think there is a practical way of closing down on oil speculators. The question is if they can cause a price shock in the oil market. I still believe there is causation. I remember last year a major oil startegist came to our offices and unveiled the most sought after chart: “Average Daily Trading Volume of Key Energy Futures & World Oil Demand. It showed the follow:
1. In 97: Trading was 3.3 times world oil demand
2. In 02: Trading was 4.5 times world oil demand
3. In 07: Trading was 12.7 times world oil demand
4. In 08 (until Oct): Trading was 15.1 times world oil demand
Not only do I believe there is correlation, but also causation.
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Good piece naser, keep the posts coming
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my first instinct is that 12 months does not make for a statistically useful time series in the oil market. why didn’t their analysis (economist?) go farther back? and i concur with the being careful about reading too much into correlation. volatility looks like its here for a while in many key financial markets however.
has seekingalpha chimed in on this report btw?
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Keynesian09:
I agree with you that there is no practical way of closing down oil speculations, we have to wait and say what the Obama administration proposes.
Oikonomia:
Thank you for the kind words
Hamstrung:
I get your point about the 12 months time frame, however, keep in mind that during this time from oil reached $150 and went down to $30. Markets were very volatile, and I believe volatile markets can magnify results during a shorter time frame.
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