Thursday, 22 March 2012

The speculation about speculators speculating about oil price

It's becoming a recurring theme to blame the high oil price on "speculators". This of course implies some sort of clear distinction between someone legitimately purchasing oil contracts or someone purchasing or selling them purely for profit. There is of course a difference. You might call the first one a country or a company. You might call the second a trader.

The solutions being presented suggest that all we have to do is convince Wall Street to stop trading oil! Here's a choice exert:
Saudi Arabia promises to fill in the supply gap if the Iranian crisis escalates, but there's only one place that can help stave off high oil prices: Wall Street.

Now, blaming speculators for high prices is nothing new. What is new is that one of the largest speculators in the oil markets, none other than Goldman Sachs (GS), admitting that heavy speculation does have an impact on oil prices. How much? Well, Goldman's oil analyst wrote in a note last month that every million barrel equivalent of oil futures that was net long the market adds 10 cents to the price of oil. The market is currently net long US benchmark crude, or WTI, by 258,406 contracts which is equivalent to 258 million barrels of oil. At 10 cents per every million barrels, that would mean speculation is currently adding $25.80 to every barrel of oil -- without the excess speculation, oil would trade at around $81.52.
Note the language here, without the "excess speculation". Excess. So who decides whose contracts are "excess"? ALL of the contracts are speculation but only some are "excess" speculation. Well it's simple some are probably saying, the "excess" would be those not in the market to take delivery. It sounds simple, but effectively what you are saying is that you would be entering into a non-transferrable binding contract. A country that made a loosing bet on oil for instance would not be able to trade their contracts and would have no option but to take delivery, take the losses and then put the product back on the market. Not very effective. So this is to say that if we are to have an oil market at all, it will be a speculative market.
Despite the verbal assaults, there has been little impact on global oil supply as a result of the tougher sanctions on Iran. OPEC estimates Iran produced 3.424 million barrels of oil a day in February, which is off around 5.4% from the 2011 average. Increased crude production from the rest of OPEC, namely Libya and Saudi Arabia, more than made up for this small decline in output. Meanwhile, the U.S. market continues to be well supplied. There is currently enough oil in commercial oil storage tanks to cover 57.5 days of demand, which is 4 days more than a year ago and 6.6 days more than the five-year average.

But it is the potential for a massive supply disruption that is adding a special premium to oil prices, even though such a possibility is remote. Saudi Arabia's oil minister told reporters last week that the Kingdom stands ready to "make good any shortfalls – perceived or real – in crude oil supply." This week, the Kingdom's cabinet released an official statement saying that it "alone" would supply enough oil to the markets to return prices back to what it deems to be a "fair" level for consumers. U.S. benchmark crude futures shed about $2 after the news, to end Tuesday at $106.07.
If only the futures market cared about the present. What they are telling you here is that even though there is plenty of supply now (enough to last 57.5 days) the "speculation" is being driven by fears about the future. People are paying a premium now because they are anticipating supply issues in the future. Traders are "bull" now because they anticipate supply disruptions in the future. Wall Street isn't causing the anticipation, possible supply disruptions are.

We're all speculators. Ever filled cans of gasoline because you knew or expected the price to go up? congratulations, you're a speculator. The price could possibly go down, but you made a bet it wouldn't. That it would go up and paid a premium price in the now to save money in the future.

Now I'm not saying the market isn't corrupt. It is. But if we want to do something about that, oil speculation is hardly the place to start. The reality is, if it wasn't Wall Street, it would be someone else. Like the Chinese for instance, or Japan whose imports have tripled since Fukushima. There is no shortage of demand, and speculators have nothing to do with that.

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