Speculation Does Not Explain High Oil and Gasoline Prices? Please!!

This is a difficult concept to get across to people who are trapped in the supply/demand thinking style when it comes to prices of commodities.  There's more at play, and speculation is a big part of it.  Dian does an excellent job explaining how speculation affects oil prices.  And if you haven't already read Phil's recent article on this important topic, read: The scam behind the rise in oil, food prices. - Ilene 

Speculation Does Not Explain High Oil and Gasoline Prices? Please!!

Courtesy of Dian L. Chu, EconMatters 

WTI (West Texas Intermediate) Crude Oil futures traded at its lowest in almost two months in New York on Thursday, May 5 in its biggest selloff in two years, plunging 8.6% on the day to below the $100 mark (Fig. 1).  Brent crude on ICE also dropped as much as $12.17, or 10%, which was the largest in percentage terms not seen since the Lehman Brothers financial crisis, and the largest ever in absolute terms, according to FT.

The epic waterfall was partly due to the combination of a strengthening dollar after European Central Bank President Jean-Claude Trichet said he wouldn’t raise interest rates, and a surging U.S. first time jobless claim that sent oil, silver and other commodities plunging. 


Big Speculators Moving Out  

There has been a long debate about how much of a role speculators play in the oil market.  However, this latest big price move in one day strongly suggests something more than fundamentals is at work. 

That is, some big players (i.e. speculators) decided to move out of commodities, either to take profits, or for risk off trades, as crude and gasoline market fundamentals have not changed much since the start of the year to warrant such a run-up of prices in recent months (Fig. 1). 

Link Between Oil Storage & Speculation?? 

Some, like Ezra Klein at The Washington Post, and Jerry Taylor and Peter Van Doren, senior fellows at the Cato Institute, have suggested that speculators are not the ones causing high oil and gasoline prices.

For example, in this article, Klein partly quoted Michael Greenstone, an energy economist at MIT, and concluded that: 

“Speculators make money by pulling oil off the market, putting it in inventory, and selling it later…So if you’re seeing speculation, you should be seeing a massive run-up in inventory. And we are seeing a bit of an inventory bump, particularly in recent weeks. But not enough of one.”

Taylor and Van Doren also drew a similar conclusion in an article at Forbes stating that since there’s not a massive increase in oil storage to cause a physical supply shortage, so do ‘put away the torches and pitchforks’ as speculators are not to blame for the rise in oil and gasoline price. 

Reality Check - Shorts & Paper Barrels

I guess all four gentlemen live right next door to the U.S. Fed in the ivory tower and just as detached from reality. 

First of all, taking a long position, as in Greenstone's 'store then sell' scenario, is not the only way to 'speculate' in the oil market.  Another way is by placing short bets, or a combination of long and short positions.  Short bets could cause huge price spikes and volatilities if those speculators have to cover their positions due to an unexpected and sudden rise of the underlying commodity price.

With the current price momentum, more short speculators will be piling in to put even more downward pressure on crude oil.    

As for the notion that the only link between speculative activities and oil market is with oil storge, here is a quick lesson on the modern art of speculation. From Bloomberg:

“Less than 1 percent, or 3,248 crude futures contracts, was delivered in 2010, compared with the average open interest of 1.34 million contracts during the same period, according to Nymex and data compiled by Bloomberg. There is no physical delivery against Brent oil futures contracts traded on the London-based ICE Futures Europe Exchange. “

While there are some long speculators (typically big players) doing the good old contango trade--'store now and sell later'--as described by Greenstone, there's a whole brave new world via oil ETFs such as USO and BNO to party in speculation. 

These commodity ETFs are futures-based that takes no physical deliveries, but may accumulate huge long positions due to investment fund inflow, thus influencing market prices, particularly during their monthly contracts rollovers.  

Everybody's A Speculator! 

So this is the New World [Paper] Order of Crude Speculation….no physical ‘putting in inventory’ necessary.  Furthermore, there is this tip bit from FT.com dated May 5: 

“CME Group, operator of the Nymex exchange, touted open interest records not only for crude oil but the dull world of natural gas, where a flood of new supply has kept prices listless. This, along with a plunge in silver this week, suggests a wall of investor money flowing indiscriminately into and out of commodities.”

In essence, Crude, along with almost all other commodity markets, has become such a huge paper palace that almost every participant is a speculator, long or short--where you can buy, sell, speculate, and could ‘own barrels’ without them being actually ‘stored’. And through that process, speculators bid up prices, take profits, on any kind of market event—be it real, hyped, or 'rumored'--but no one has to really put anything  in inventories. 

Rising Crude Inventories

The Greenstone/Klein and Taylor/Van Doren conclusion also implies that crude oil and gasoline markets are reflecting true market supply/demand fundamentals as there’s no suggestion of speculative activities. 

Well, on the supply side, that “bit of an inventory bump’ pushed inventory level at Cushing, Oklahoma, which is the delivery point of NYMEX WTI futures contracts, to around 41.9 million barrels the week ending April 08 (Fig. 2). That was the highest ever since the EIA started tracking Cushing inventory in 2004. Crude oil storage at Cushing remained close to the record high sitting at 40.5 million the week ending April 29. 

 


Crude stockpiles are also rising in other U.S. regions as well. The latest crude inventory report from the government showed stockpiles rose 3.42 million barrels to 366.5 million the week ending April 29, the highest level since October.

Sliding Gasoline Demand

On the demand side, gasoline demand in the U.S. has been on a steady decline since last August (See Chart), and dropped another 2.2% in the week ended April 29 to 8.94 million barrels a day, according to the U.S. EIA data. On a four-week average, gasoline consumption was 1.9% lower than a year earlier. 

RBOB Chasing Brent

RBOB gasoline futures on Nymex, on the other hand, had gained 35% this year through May 4, far outpacing WTI as speculators bid up petroleum product futures mimickingmovement in the Brent marker (Fig. 3), which flipped into a premium to WTI. That premium reached a record of $18.50 in February, 2011. Brent is traded on ICE—a speculator haven as it is essentially unregulated, relatively opaque, and less liquid (although this is in dispute between ICE and CME) market.  

 
 


More Pain From RBOB To Gas Pump

According to AAA, as of May 6, the national average gasoline price is less than 2 cents shy from $4 a gallon, while 14 states are already paying $4 or more a gallon at the pump.  Since it typically takes about two to three months for the RBOB gasoline futures pricing to hit the gas pump and consumers, further pump price increase and demand destruction seems inevitable (Fig. 4). 

 


QE2 Added Speculation

To sum up, the recent irrational run-up of oil and gasoline prices could be attributed to the following major factors, and all of them, with the exception Fed’s QE2, which is the culprit of adding jet fuel to the speculation fire, could be traced back to speculators:

  • U.S. Fed’s QE2 liquidity flooding the market and inflating asset prices
  • A weak dollar (largely brought on by QE2) as commodities are mostly priced in dollar. Dollar has dropped 11% this year, partly exacerbated by traders doing the trade of short the dollar and long commodities. 
  • Funds flow - Institution and hedge fund managers pour money into commodity for better investment returns, and as a dollar and inflation hedge, further reinforcing rising commodity prices
  • Geopolitical unrest in the Middle East and North Africa (MENA) region has been used as justification by speculators to add ‘risk premium’ to oil and gasoline prices. .

Speculation vs. Excessive Speculation

These are pretty much the same forces, and most likely the same speculators, driving oil up to $147 a barrel less than three years ago in 2008.  A certain degree of speculation is acutally essential and healthy for a normal capital market, however, excessive liquidity and speculation leading to an abnormal market like we have right now would only kill demand, and hurt the global economy.  

Saudi Arabia recently estimated that about $25 a barrel of speculation premium has been added to the current oil price.  Separately, a study co-written by a CFTC commissioner, Bart Chilton noted that about 64 cents a gallon can be attributed to over-speculation,reported The Seattle Times. 
  So while quantifying the ‘speculation premium' may not be an exact science, it is entirely premature to dismiss the significance of speculation in the current price of oil and gasoline using pysical oil storage as the main thesis.   

 

 
 
 

Kimble Charting Solutions

Doc Copper; Time for it to out perform the S&P 500?

Courtesy of Chris Kimble.

Some feel the price action of Copper is important to watch, because it could send important macro messages, about world wide growth or lack of.  Since 2011 Ole “Doc Copper” has been very weak, no question about it. During this weakness, the S&P 500 has continued to move higher. So is the price action of Doc Copper not useful or relevant anymore?

Below looks at ratio of Copper to the S&P 500-

CLICK ON CHART TO ENLARGE

Doc Copper has clearly been ...



more from Kimble C.S.

Zero Hedge

Limo Destroyed By Anti-Trump Rioters In DC Belongs To Muslim Immigrant, Fears Livelihood Lost

Courtesy of ZeroHedge. View original post here.

Images of so-called anti-Trump rioters breaking Starbucks' windows, busting trash cans, and burning bourgeois limousines in the streets of Washington DC really exposed the reality of the alt-left's tolerance and 'stuck it to the man'. The only problem being, in the case of the limo, 'the man' was Muslim immigrant Muhammad Ashraf whose small business now faces $70,000 losses and an injured employee.

...



more from Tyler

ValueWalk

Mohnish Pabrai Speaks to University of Puerto Rico MBA Students On Charlie Munger latticework of mental models

By VWArticles. Originally published at ValueWalk.

Published on Jan 23, 2017

September 2016, San Juan, Puerto Rico Museum of Art, Raul Julia Theater
Mohnish gives a completely new talk.
He discusses the Charlie Munger latticework of mental models and the work of David Hawkins on Power vs. Truth.

]]> Get The Full Series in PDF

Get the entire 10-part series on Charlie Munger in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

We respect your email privacy

More text and video below

ALso see

...

more from ValueWalk

Phil's Favorites

Smart Shoppers Wait for Sales (Ross and Costco)

 

Smart Shoppers Wait for Sales (Ross and Costco)

By Paul Price of Arrow Loop Research

In recent years retail's sweet spot has been "off-price" merchandise. That means high-quality, yet deeply discounted goods. People want nice things but are insisting on bargain prices.

Ross Stores (ROST) and Costco (COST) are businesses that have prospered along with that trend. Both companies appear on track to post all-time record earnings in their current fiscal years. Shares of each have risen significantly since the end of The Great Recession.

These firms make money because educated consumers know what things are worth and appreciate getting them at marked-down levels.

...

more from Ilene

Chart School

RTT browsing latest..

Courtesy of Read the Ticker.

Please review a collection of WWW browsing results.



Date Found: Thursday, 30 June 2016, 11:51:18 PM

Click for popup. Clear your browser cache if image is not showing.
Comment: Bullion Banks Are Starting to Lose Control of Silver youtu.be/lxZBYK1eN00



Date Found: Friday, 01 July 2016, 03:30:33 PM

Click for popup. Clear your browser cache if image is not showing.
Comment: Cashin - Market Beats Fed



Date Found: Friday, 01 July 2016, 11:06:14 PM

Click for popup. Clear your browser cac...



more from Chart School

Market News

News You Can Use From Phil's Stock World

 

Financial Markets and Economy

Dollar on defensive, Asia stocks subdued amid U.S. trade unease (Reuters)

The dollar was under pressure in Asia on Tuesday as U.S. President Donald Trump's focus on trade protectionism fuelled suspicions his administration might seek a competitive advantage through a weaker currency.

The head of the biggest exchange group in the world on Trump, China, and handling $1 quadrillion in trading (Business Insider)

Terrence "Terry" Duffy is a popular man.

Upon visiting the CME Group office in New York on January 11 to speak with Duffy, chairman and CEO at the $40 billion exchange group...



more from Paul

Promotions

Phil's Stock World's Las Vegas Conference!

 

18 people have signed up, but it's not too late to join in!

Learn option strategies and how to be the house and not the gambler. That's especially apropos since we'll be in Vegas....

Join us for the Phil's Stock World's Conference in Las Vegas!

Date:  Sunday, Feb 12, 2017 and Monday Feb 13, 2017            

Beginning Time:  9:30 to 10:00 am Sunday morning

Location: Caesars Palace in Las Vegas

Notes

Caesars has tentatively offered us rooms for $189 on Saturday night and $129 for Sunday night. However, we have to sign the contract ASAP. We n...



more from Promotions

Digital Currencies

As China Slaps Fees On Bitcoin Trades, Japan Monthly Volumes Soar by 8,900%

Courtesy of Zero Hedge

There is one reason why bitcoin quickly became the darling of HFT and various high speed algo traders operating out of China and the rest of the world: domestic transactions were "frictionless", as there were no fees on buys or sells. Until last night, that is, because as China's three largest bitcoin exchanges, BTCC, Huobi and OkCoin, all said in separate statements on their websites late on Sunday, starting Tuesday they will charge traders a flat fee of 0.2% per transaction. This is only the latest fallout from the recent crackdown on Chinese bitcoin exchanges whose activities have drawn increased scrutiny from the centra...



more from Bitcoin

OpTrader

Swing trading portfolio - week of January 23rd, 2017

Reminder: OpTrader is available to chat with Members, comments are found below each post.

 

This post is for all our live virtual trade ideas and daily comments. Please click on "comments" below to follow our live discussion. All of our current  trades are listed in the spreadsheet below, with entry price (1/2 in and All in), and exit prices (1/3 out, 2/3 out, and All out).

We also indicate our stop, which is most of the time the "5 day moving average". All trades, unless indicated, are front-month ATM options. 

Please feel free to participate in the discussion and ask any questions you might have about this virtual portfolio, by clicking on the "comments" link right below.

To learn more about the swing trading virtual portfolio (strategy, performance, FAQ, etc.), please click here ...



more from OpTrader

Members' Corner

Secular Stagnation and Pension Crisis?

Courtesy of Nattering Naybob.

From Jeffrey Sniders The Denominator Prevails...

PSS57 - "There is absolutely no data supporting a premise of demographics. "

Bingo, the vile filth known as "Secular Stagnation" emanated from Larry Summers, and was given an unqualified Fed benediction.  Voila, no real data, no proof, an MSM narrative and repeated URBAN MYTH.  The Flatworld Society has a more promising premise than this intellectual claptrap.

Its another "boogey man" same as the "pension crisis", which will be utilized to take away all forms of private and public pension, and have everybody forced into fee laden 401K/IRA. They will also force Social Security into the same fee laden hole using...

more from Our Members

Mapping The Market

If we try it enough, it will work.

Via Jean-Luc

Brownback wants Trump to emulate what he did in Kansas because it worked so well:

Sam Brownback Calls on Donald Trump to Mimic His Kansas Tax Plan

By RICHARD RUBIN and  WILL CONNORS

Sam Brownback, the Kansas governor whose tax cuts brought him political turmoil, recurring budget holes and sparse evidence of economic success, has a message for President-elect Donald Trump: Do what I did.

In 2013, Mr. Brownback set out to create a lean, business-friendly government in his state that other Republicans could replicate. He now faces a $350 million deficit when the Kansas legislature convenes in January and projections of a larger one in 2018. The state’s economy is flat and his party is fractured...

...

more from M.T.M.

Biotech

The Medicines Company: Insider Buying

Reminder: Pharmboy and Ilene are available to chat with Members, comments are found below each post.

I'm seeing huge insider buying in the biotech company The Medicines Company (MDCO). The price has already moved up around 7%, but these buys are significant, in the millions of dollars range. ~ Ilene

 

 

 

Insider transaction table and buying vs. selling graphic above from insidercow.com.

Chart below from Yahoo.com

...

more from Biotech

All About Trends

Mid-Day Update

Reminder: Harlan is available to chat with Members, comments are found below each post.

Click here for the full report.




To learn more, sign up for David's free newsletter and receive the free report from All About Trends - "How To Outperform 90% Of Wall Street With Just $500 A Week." Tell David PSW sent you. - Ilene...

more from David



FeedTheBull - Top Stock market and Finance Sites



About Phil:

Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...

Learn more About Phil >>


As Seen On:




About Ilene:

Ilene is editor and affiliate program coordinator for PSW. She manages the site market shadows, archives, more. Contact Ilene to learn about our affiliate and content sharing programs.

Market Shadows >>