Oil prices revisited..

The 60 Minutes show on CBS looked at the role of speculation in influencing recent spike and downturn in oil prices. Of note here is that there still seems to be little evidence that the markets were manipulated.
Nari has a couple of articles on this issue.
Opinion: Oil Prices Depend on More on Speculation than assumed previously
Speculation in Crude Oil, Middle men and prices

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Oil Roundup : 09/11/08

(Disclaimer: This article has no information related to September 9/11 attacks. I plan to do these "oil roundups" more frequently, and the timing was merely coincidental.)

Oil today closed at ~101 $/bbl, down from its July highs of 147 $/bbl. Meanwhile, gas prices in the gulf coast are rising, in anticipation of Hurricane Ike's landfall later this week. More from the AP's Money Minute


In related news, Petroleo Brasileiro (PBR) also reported a significant offshore medium crude-oilfield discovery, sending the prices of its shares up 6% (on the US markets) while oil was falling. A study by Masters Capital Management found that oil prices were indeed linked to speculation by large financial investors. I do not find anything wrong in speculation; some risk-taking is always good for the markets. However, I will read the report in greater detail to find whether they uncovered evidence for market manipulation.

Summing up, although crude prices seem to be falling because of institutional investors/stronger dollar/weakening oil demand, analysts believe that market fundamentals indicate an upward trend in oil prices.

Previous articles by Nari on price speculation:

• Opinion: Oil Prices Depend on More on Speculation than assumed previously
• Speculation in Crude Oil, Middle men and prices

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Opinion: Oil Prices Depend on More on Speculation than assumed previously

New data released by the Commodity Futures Trading Commission (CFTC) last month (I picked this up from the recent article on the Wall Street Journal) gives more credibility to the idea that speculators had a substantial role to play in the oil futures markets.

By Ann Davis

Data emerging on players in the commodities markets show that speculators are a larger piece of the oil market than previously known, a development enlivening an already tense election-year debate about traders' influence.

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.

The move changed many analysts' perceptions of the oil market from a more diversified marketplace to one with a heavier-than-thought concentration of financial players who punt on big bets.

... (Click here for entire article)

Continued... (Graph showing noncommercial positions is courtesy of Wall Street Journal, www.wsj.com)

As a result, the number of futures and options contracts held by traders counted as speculators -- those who don't have a commercial need to mitigate the risks of energy prices in their business -- rose to 49% of all crude-oil bets outstanding on the New York Mercantile Exchange, up from 38%.

However in a July 22 release the agency had concluded speculators weren't "systematically" driving oil prices. Oil prices soared until mid-July before beginning a decline. US senators (some Democrats) have questioned the agency's timing of the earlier, incomplete report which painted a different picture. The issue here is that normally the positions taken by hedge funds (who incidentally are not hedging the fuel for any consumption) and other financial firms are in the same direction as the price movement. As far as I know, you cannot short commodities, you can purchase futures contracts.

As I had mentioned previously, additional middlemen are going to drive the price pressure upward. With the release of new data, and with the recent substantial drop in oil prices, the meteoric rise in oil prices over the last 1 year seems to be fueled more by irrational trading demand, rather than organic demand by the new and growing consumers of oil (namely China, Russia, India and Brazil: CRIB, pun intended).

Of course, pure economists and free, free market proponents might still stick to their arguments that oil prices are due to demand, but come on really, stock prices and commodities prices do not reflect their true and fair values on many occasions. A lot of hype (aka " expert opinions) and panic (see below) influence prices on short time scales.

(Cartoon courtesy: http://www.photodarkness.com/blog/astrology/?p=129)

Thankfully over long term, sanity prevails, but who lives for tomorrow, yeah?

Post script: I had to quote Lehman Brothers' opinion, just could not resist!

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."

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Speculation in Crude Oil, Middle men and prices

Here is one (my) perspective on how speculation was affecting price of crude oil , but profit margins of refiners (solo refining companies like Valero, Sunoco, etc) have not really gone up. Of course for the common public, the face of gasoline are companies like Valero/Sunoco/LukOil in some markets in US. The presence of "speculators" in the energy futures markets has just added more middle mento the path the crude oil takes from the well to the refinery and then to the gas station (petrol pump).
The addition of middle men is going to increase the cost of the goods at the final step. This is NOT any kind of value addition. But it was merely was an artificial way to increase the demand on a given contract of crude oil. The addition of speculators (who cannot be prevented in a truly free market) definitely puts an increased "Phantom Demand" for crude oil-which is merely a dirty oily raw material.

But wait, I dont think we are done when it comes to the price increase of crude. It will rise again but in a more gradual way and climb towards $250 within 3 years. If that does not happen, you can fry a donut in crude oil and serve it to me.
The increased demand due to actual use (of newly added vehicles, increase in vehicles in India and China, SUVs and pickups in the market all over the world) is a totally different factor.

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