Syed Rashid Husain
Speculation is back in business. And is extracting a crude price!
Although, in the immediate run it was the result of the British referendum that impacted the oil markets adversely, yet prices were already on a slippery mode when the UK result hit it. Markets had hit a one-month low, during the week ending June 17. What made the oil markets slip-even before the Brexit? It was not mere fundamentals. Investors were seen pulling out - impacting the markets adversely - underlining the strong connection between the two.
Futures market traders and large oil speculators reduced their overall bullish bets in WTI oil futures the week before, for a fourth consecutive week, Commitment of Traders (COT) data released by the Commodity Futures Trading Commission (CFTC) said.
The non-commercial contracts of crude oil futures, traded by large speculators, traders and hedge funds, totaled a net position of +312,585 contracts in the data reported for June 14. This was a change of -12,597 contracts from the previous week’s total of +325,182 net contracts for the data reported through June 7.
For the week, the standing non-commercial long positions in oil futures fell by -2,156 contracts and combined with the short positions (selling) that rose by +10,441 contracts to total the overall weekly net change of -12,597 contracts.
Hedge funds and other money managers cut their combined net-long position in the three main Brent and WTI futures and options contracts from a near-record 633 million barrels to 570 million.
The combined net long position in WTI on Intercontinental Exchange and the New York Mercantile Exchange was cut by 46 million barrels, 19 percent, to 198 million barrels.
The net long position in Brent on the Intercontinental Exchange was cut by 17 million barrels or 4 percent to 372 million.
Hedge funds' bullish long positions were cut by 34 million barrels in the week to June 14 but short positions increased by 30 million barrels.
The one-week reduction in the net long position was the largest since July 2014, analysis of data published by the US Commodity Futures Trading Commission and the Intercontinental Exchange said.
Aggressive shorting of oil prices has been most noticeable in the NYMEX WTI contract, where the number of hedge fund short positions increased by 19 million barrels in the week to June 14.
Over the 14-day period, hedge fund short positions in NYMEX WTI rose by a total of 43 million barrels, more than 80 percent, from the previous low of just 53 million barrels.
Consequent to all this, as hedge funds tried to take some of their profits, from the big rise in prices during the first five months of the year by liquidating long positions, crude prices slumped.
This is not new. This issue of speculation has been under the hammer for some time now. Most now do concede that speculation does play a role and impacts markets. The recent slump is just one candid example of that. Yet only a few years back, most especially in OECD, did not agree. Credit for this change in thinking and attitude towards speculation goes largely to the former Saudi oil minister Ali Al-Naimi and his team.
One could recall, way back in summer 2008, while the crude prices were touching new heights, day after day, all the fingers were pointing to Saudi Arabia and its allies within the OPEC - as the main culprit. In those tumultuous days, minister Naimi held his fort, underlining, rather in bold terms, that speculation, and, not fundamentals, were responsible for the oil market woes. There was no dearth of oil - he continued hammering despite insistence from the likes of Secretary Samuel Bodman and Gordon Brown that supplies were insufficient - unable to satiate the galloping global crude demand. And that the producer needed to open taps to cool the markets.
Pointing to the role of speculation, minister Naimi then argued: ‘Weak equity and bond markets, besides others, have encouraged investors to move their capital into commodities like oil. Consider that the bond and equity markets in the US alone are valued at roughly 50 trillion dollars and that if money managers decided to reallocate a nominal one-half-of-one percent of those assets into the oil commodity space, the resulting $250 billion influx of funds would equal the value of the entire NYMEX WTI markets.’ The minister definitely had a point. After all, oil is the world’s largest traded commodity.
And the minister was not alone in highlighting the role of speculation. In a write-up way back in 2008, William Engdahl, the author of "A Century of War: Anglo-American Oil Politics and the New World Order," also shed light on the role of speculation in the energy markets. Not shy of challenging the established theories, Engdahl claimed then that as much as 60 percent of today’s crude oil price has been pure speculation, driven by large trader banks and hedge funds. Since the advent of oil futures trading and the two major London and New York oil futures contracts, control of oil prices has left OPEC and gone to Wall Street, Engdhal underlined in his paper.
The development of unregulated international derivatives trading in oil futures over the past decade or more has opened the way for the present speculative bubble in oil prices, he asserted. Today’s oil prices are determined by a process so opaque that only a handful of major oil trading banks such as Goldman Sachs or Morgan Stanley have any idea about who is buying and who is selling oil futures or derivative contracts, that set physical oil prices in this strange new world of “paper oil,” Engdhal argued in the paper.
The large purchases of crude oil futures contracts by speculators have, in effect, created an additional demand for oil, driving up the price of oil for future delivery in the same manner that additional demand for contracts for the delivery of a physical barrel today drives up the price for oil on the spot market.
Goldman Sachs and Morgan Stanley today are the two leading energy trading firms in the United States. Citigroup and JP Morgan Chase are major players and fund numerous hedge funds as well as the speculators.
In June 2006, oil traded in futures markets at some $60 a barrel and the Senate investigation estimated that some $25 of that was due to pure financial speculation. One analyst estimated in August 2005 that US oil inventory levels suggested WTI crude prices should be around $25 a barrel, and not $60.
That would mean today that at least $50 to $60 or more of today’s $125 a barrel price is due to pure hedge fund and financial institution speculation, Engdahl argued in his 2008 summer paper.
Speculators have been fiddling with oil markets for long, swaying it one way or the other. And fundamentals have taken a back stage in this ongoing drama.
Price slump in recent weeks candidly augments the theory!
