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.   

 

 
 
 

Phil's Favorites

Where have all the cowboys gone?

 

Where have all the cowboys gone?

Courtesy of Joshua M. Brown

Flipping out over how awesome this new post at Michael Batnick’s blog is, which presents the career arc of history’s most important investors of all time. He takes their dates of birth, advances them 22 years for a typical career starting point, and then overlays them with the future cumulative performance of the Dow Jones Industrial Average to give you a sense of how much wind they had at their backs.

Looks like this (click to embiggen!):

...



more from Ilene

Zero Hedge

All You Need To Know About The China Boom-Bust Cycle In One Chart

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

If anyone is still confused about the not so subtle dynamics between markets and monetary policy in China, or the country's bipolar, and ever more frequent boom and bust cycles, you won't be after seeing this chart from Socgen.

If still unclear, here is SocGen's explanation:

Our economists expect China’s structural deceleration to continue over the coming years and it should thus remain a major source of...



more from Tyler

Chart School

Equity Valuations, Recessions and Stock Market Declines

Courtesy of Doug Short's Advisor Perspectives.

Note: In response to an email, I've updated the data in this article through the March month-end numbers and at the launch of the Q1 2016 earnings season.

When I initiated the dshort web page in late 2005, one of my routine topics was equity valuations, initially inspired by Nobel laureate Robert Shiller's book, Irrational Exuberance, the second edition of which was published earlier that year. I gradually expanded my focus from his cyclically adjusted price-to-earnings ratio (CAPE) to include Ed Easterling's Crestmont P/E, Nobel laureate James Tobin's Q Ratio and m...



more from Chart School

ValueWalk

Wilbur Ross discusses Donald Trump's candidacy, and his investing strategy

By Jacob Wolinsky. Originally published at ValueWalk.


Wilbur Ross discusses Donald Trump’s candidacy, and his investing strategy

The post Wilbur Ross discusses Donald Trump’s candidacy, and his investing strategy appeared first on ValueWalk.

Sign up for ValueWalk's free newsletter here.

...

more from ValueWalk

Market News

News You Can Use From Phil's Stock World

 

Financial Markets and Economy

Global Stocks Broadly Higher, Reversing Early Losses (Wall Street Journal)

Global stocks climbed Tuesday, while the dollar strengthened against the euro and yen.

Shares, dollar climb as markets play Fed waiting game (Reuters)

European shares were heading for their best day in over a month on Tuesday as the waiting game to see whether the U.S. raises interest rates again next month sent the euro to its lowest since March.

Asian shares had stumbled to near 2-1/2-month lows ove...



more from Paul

OpTrader

Swing trading portfolio - week of May 23rd, 2016

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

Kimble Charting Solutions

Gold- Two-thirds odds prices fall on a support break

Courtesy of Chris Kimble.

CLICK ON CHART TO ENLARGE

Since the peak in 2011, Gold remains in a downtrend, creating a series of lower high and lower lows.

Gold’s rally in 2016 is attempting to break this 5-year falling trend, as it is attempting to break a series of lower highs.

Over the past 6-months, Gold could be creating a rising wedge pattern. This pattern two-thirds of the time, suggests lower prices are ahead.

...

more from Kimble C.S.

Digital Currencies

The Biggest Bitcoin Arbitrage Ever?

Courtesy of Chris at CapitalistExploits

Do you remember when you were growing up and all your friends were allowed Atari game consoles but you weren’t?

Well, I do and the things seemed as foreign to me as Venus. Mostly because the little time I managed to spend on the gaming consoles when my friends weren’t hogging them I found it all a bit silly. I never “got” computer games, and to this day still have poor comprehension of things like Angry Birds.

I suspect that many people around the world view Bitcoin in the same way as I view Angry Birds: with mild amusement and a general lack of understanding as to what the hell all the fuss is about.

I was thinking of this since a buddy of mine recently started ...



more from Bitcoin

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

Biotech

This Is Why Biotech Stocks May Explode Again

Reminder: Pharmboy and Ilene are available to chat with Members.

Here's an interesting article from Investor's Business Daily arguing that biotech stocks are beginning to recover from their recent declines, notwithstanding current weakness.

This Is Why Biotech Stocks May Explode Again

By 

Excerpt:

After a three-year bull run that more than quadrupled its value by its peak last July, IBD’s Medical-Biomed/Biotech Industry Group plunged 50% by early February, hurt by backlashes against high drug prices and mergers that seek to lower corporate taxes.

...



more from Biotech

Mapping The Market

About that debate last night

Although we try to stay focused on finding and managing promising trade ideas, the comments in the comment section sometimes take a political turn (for access, try PSW — click here!). So today, Jean Luc writes,

The GOP debate last night was just unreal – are these people running to be president of the US or to lead a college fraternity! Comparing tool size? The only guy that looks semi-sane is Kasich. The other guys are just like 3 jackals right now. 

And something else – if Trump is the candidate, that little Romney speech yesterday is probably already being made into a commercial. And all these little snippets from the debate will also make some nice ads! If you are a conservative, you have to be scared now. 

Phil writes back,

I was expecting them to start throwing poop at each other &n...



more from M.T.M.

Promotions

PSW is more than just stock talk!

 

We know you love coming here for our Stocks & Options education, strategy and trade ideas, and for Phil's daily commentary which you can't live without, but there's more!

PhilStockWorld.com features the most important and most interesting news items from around the web, all day, every day!

News: If you missed it, you can probably find it in our Market News section. We sift through piles of news so you don't have to.   

If you are looking for non-mainstream, provocatively-narrated news and opinion pieces which promise to make you think -- we feature Zero Hedge, ...



more from Promotions

Help One Of Our Own PSW Members

"Hello PSW Members –

This is a non-trading topic, but I wanted to post it during trading hours so as many eyes can see it as possible.  Feel free to contact me directly at jennifersurovy@yahoo.com with any questions.

Last fall there was some discussion on the PSW board regarding setting up a YouCaring donation page for a PSW member, Shadowfax. Since then, we have been looking into ways to help get him additional medical services and to pay down his medical debts.  After following those leads, we are ready to move ahead with the YouCaring site. (Link is posted below.)  Any help you can give will be greatly appreciated; not only to help aid in his medical bill debt, but to also show what a great community this group is.

http://www.youcaring.com/medical-fundraiser/help-get-shadowfax-out-from-the-darkness-of-medical-bills-/126743

Thank you for you time!




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 >>