Summary
With all commodity prices soaring and the consumer on the street being squeezed from all sides, politicians everywhere are looking to place blame. Speculation on the futures exchanges from the long side is only one of the many reasons that have caused oil prices to rise.
Analysis
One can write several treatises on the many reasons contributing to the rise in oil prices, but today I would like to comment on a some of the trading activities that have led to the higher prices on the futures exchages.
The NYMEX has had spectacular success with its crude oil futures contract and the price of the front month contract is widely quoted throughout the day. One might even say they are becoming a victim of their own success.
Futures are traded both on the NYMEX and Intercontinental Exchange (ICE) and both report open interest figures daily. The open interest represents the number of open positions taken home over night. For each monthly contract, the number of longs equals the number of shorts which equals the open interest. The combined open interest in futures (excluding options) exceeds over 2 million contracts. A large over the counter market for swaps exists in parallel.
Much is made about the commitment of traders reports specifying commerical and non commercial activities which is interpreted as perhaps the difference between physical oil players and speculators. The difference between a commerical and non commerical in a NYMEX application is whether one is going to be a maker or taker of physical oil delivery. However the line is blurred when a non-commercial writes an over the counter swap withe a commercial entity that lays off the risk on the NYMEX.
But the fact of the matter is that the open interest has risen substantially over the years and both commercials and speculators are participating.
Oil prices could moderate as more sellers enter the market. The problem has been finding the sellers. The natural commercial crude oil sellers are the producers hedging forward production. Clearly their hedges are out of the money and in fact some producers have bought back their hedges. More ominously, those with short hedges on are feeling the pain of margin calls. The NYMEX/ICE does not care about forward physical production, their concern is margin money at the end of the day. Both small and large producers are getting daily calls to ante up more margin money to cover their hedge with consequent cash flow implications. As prices continue their march upward, producer hedges, that have been wrong the last four years, are even less inclined to sell.
Meanwhile the endusers, truckers, railroads and airlines are in buying on the long side. Some of their hedges are in over the counter diesel and jet swaps in which part of the risk is laid off in the heating oil contract. Long term hedges may be done in crude. Who are the natural sellers of products?
Note that on the fundamental side there is a shortage of diesel and by shortage I mean the point at which the retail pump runs dry. This has occurred in China, Australia, South America, notable Argentina, parts of Europe and even in Yemen. The USA has been exporting roughly 7% of its distillate production to meet overseas requirements. News stories like this make it difficult to sell heating oil futures.
Refiners may choose to sell their margins or crack spreads forward which yields a natural product seller, but also a natural crude oil buyer. With record gas cracks in 2006 and 2007, these hedging strategies showed huge losses. In 2008, many refiners wished they had locked in their gasoline margins, but heating oil/diesel continues to move on to new records. The market is losing a big source of natural sellers.
The public can enter the futures markets through an exchange traded fund such as the USO crude oil fund. This fund lays off its risk with a combination of futures and options. The public generally enters this market from the long side. If one wanted to sell this ETF short, one would find it difficult to do through the local brokerage firm, they generally don't have the shares in inventory to go short.
Meanwhile pension funds such as Calpers look to commodities to improve returns. Earlier this year, the Calpers board approved monies for commodity investment. IS Calpers an investor or specualtor at this point? I will wager the investment comes from the long side. Of course, there are those investors/speculators who have been betting against the dollar and buying everything else.
Whether one is a speculator or hedger, one has watched oil and other commodities aon a spectacular multi year rise. The question for them is " Where do you want to short the market at $100, $110, $125 or higher? Not many people are pouring money in to call a top.
