If heggies & investments banks are the reason for the run up...

Right, but as long as there is some open interest at delivery time on expiration day the price has to settle to where real buyers and sellers agree to exchange oil. C will not sell to A if C wants oil and $70 is lower than spot. And if A has oil to sell, he won't cover his short if $70 higher than spot. So doesn't this mean the impact of "speculation" is driven out of the front month contract by expiration as long as there are some traders who can make/take delivery?

 

Of course not. The producer who wrote the contract is then is buying it back. (Allowing the hedgies to roll into next month).

That's the genius of it.

 

I would say the real genius is the way the democrats have invented this theory that specs are responsible for high oil prices without a shred of evidence to back it up.

 

And why do the couple % of total outstanding open interest that do goto delivery get settled at a price that is exactly the price of the current month future? Why isn't the future price imploding in the last couple minutes on the last trading day each month?

 

I have a simple question. We have seen hundreds of bubbles throughout the last hundred years or so, right? So my question is when these other bubbles were forming did they meet all of these criteria you speak of? Like when silver sky rocketed, did the price of silver fall back to true value at the end of each month because all the speculators had to sell their long positions. Or with any of the other commodities spikes. From what I can tell they did not follow the rules you are outlining for them to be a speculative bubble. Yet they were. Bubbles wouldn't be bubbles if everyone agreed that they were. So what is keeping the same from being true for Oil?

 

Sounds logical to me, but the question is, how are the specs any more to blame this time around than in any of the other hundreds of parabolic moves?

if it is no different, then what do you do about it? Limit actions of speculators in all markets, and then completely screw the commercials in the long run as liquidity would plummet?

only allow small specs to play?

allow hedgies to play, but no off exchange swaps, etc (which dwarf the size of exchange only speculation, although I've never looked into exactly how this works. just read the stats)

or just leave it alone?

 

Why do markets go up? New influxes of money. Why do they go down? Money is flowing out of that market. It's really as simple as that.

Let's just assume that we have a new set of participants in the oil markets who are driving up the prices. I assume this because the evidence is screaming at me from the charts. The price of oil has TRIPLED in one and a half years.

If you removed or limited this new type of participant, would you totally destroy liquidity? Or would you simply have the type of liquidity we had before these new participants entered the markets? And is it even possible to remove these new participants?

These are all important questions, and I'm not saying I'm qualified to answer them, but if you believe this market is all business as usual, I have some great beachfront property in northern Saskatchewan to sell you.

 

Silver was different. The Hunts played in actual silver as well as the futures. We are assuming the evil oil speculators only trade in the futures and swaps market and don't have a way to store real oil.

That still doesn't mean oil is not a bubble, just that the footprints we think we would see if it was a particular type of bubble are not there.

 

This is really good thread on oil. Finally. Anyways I dont have the understanding you all have, but im trying to follow along.

The consensus here is that the run up is not to to specs b/c they arent taking delivery of the oil, and selling the contract back into the market? Making them neither bullish or bearish? I could be oversimplifying. Could it be that the contracts themselves are in more demand b/c more investors want to take advantage of what they see as demand > supply? I know my understanding=squat, but hey it costs me $75 to fill up too.

 

Not true.


"A number of high-profile economists, like Paul Krugman, have recently been making the argument that trading in oil futures can’t really influence the price of physical oil because it doesn’t remove any oil from the market. Here’s a classic statement of this argument by Jon Birger, a staff writer from Fortune:


Here’s a suggestion: The next time a Congressional committee wants to hold a hearing on how "speculators" are driving up oil prices, each committee member should first be required to demonstrate - preferably in their opening remarks - a basic understanding of the mechanics of futures trading.

Even better, they should be required to explain in detail how it is that investors who never take delivery of a single barrel of crude - and thus never remove a drop of oil from the open market - are causing record high oil prices.




I will now provide that explanation, and in the process show that both Krugman and Birger are grossly misinformed about the way physical crude is actually priced in the global oil market.

Most crude oil is traded based on long-term contracts, and the prices in those contracts are set by a system known as "formula pricing". In this system, the price of delivered crude is set by adding a premium to, or subtracting a discount from, certain benchmark or marker crudes, namely: West Texas Intermediate (WTI), Brent and Dubai-Oman. Generally, WTI is used as the benchmark for oil sold to North America, Brent for oil sold to Europe and Africa, and Dubai-Oman for Gulf crude sold in the Asia-Pacific market.

Originally, the benchmark prices were spot prices, but over time problems began to arise due to the depletion of the benchmark crudes:


In the early stages of the current oil pricing system which emerged in the period 1986-88, crude oil was priced off the spot market quotations of these benchmarks (namely dated Brent, spot WTI and Dubai) as assessed by oil reporting agencies such as Platts and Petroleum Argus. In the last few years [i.e. since the early 2000s] however, there have been some serious doubts about the ability of the spot physical market to generate a price that reflects accurately the margin of the physical barrel of oil. One of the main problems is that very little actual trading occurs in these crudes which makes the process of price discovery very difficult.



The rapidly declining size of spot markets for the benchmark crudes led to chronic problems with speculators cornering those markets with a technique called the "squeeze":


Low volumes of crude oil available for spot trading make price discovery problematic and increase the vulnerability of markets to squeezes, distorting prices and undermining market confidence. A squeeze refers to a situation in which a trader goes long in a forward market by an amount that exceeds the actual physical cargoes that can be loaded during that month. If successful, the squeezer will claim delivery from sellers who are short and will obtain cash settlement involving a premium. It is true that all markets are prone to squeezes and in the last few years there have been occasions on which the Brent market was subject to successful squeezes. But it is also true that it is easier to squeeze thinner markets.


The Brent spot market in particular was plagued by frequent squeezes in the early 2000s, and this is well attested to by numerous sources.

Here’s an interesting tidbit on the subject:


Dated Brent, which acts as a price marker for many international grades, is physical crude traded on an informal market, rather than a regulated futures exchange. This lack of regulation poses problems for oil producers and consumers seeking a fair price, said Robert Mabro, director of the Oxford Institute for Energy Studies and a leading Brent expert.

"There are regular squeezes in the Brent market," Mabro said. "In the trading community, people are fed up. This general view that you can do whatever you like in an informal market is okay, as long as you regulate the market a bit. But if it’s a free-for-all, you’re back to the cowboy age."

A typical Brent squeeze involves a company quietly building a strong position in short-term swaps called contracts for difference, or CFD’s, for a differential not reflected in current prices. The company then buys enough cargoes in the dated Brent market to drive the physical crude price higher, which boosts the CFD differential, Mabro said.

The company may lose money on the physical side, but it’s more than compensated from profits on its offsetting paper position in the short-term swaps market, Mabro said.

"The whole trick is to collect more money in CFDs than you lose on the physical squeeze," Mabro said. "People seem to do it in turn. It depends on who’s smart enough to move in a way that nobody notices until it happens."


To deal with this problem, many key oil exporters shifted away from the spot market, and began to use futures prices as the benchmark in formula pricing:


The declining liquidity of the physical base of the reference crude oil and the narrowness of the spot market have caused many oil-exporting and oil-consuming countries to look for an alternative market to derive the price of the reference crude. The alternative was found in the futures market. When formula pricing was first used in the mid-1980s, the WTI and Brent futures contracts were in their infancy. Since then, the futures market has grown to become not only a market that allows producers and refiners to hedge their risks and speculators to take positions, but is also at the heart of the current oil-pricing regime. Thus, instead of using dated Brent as the basis of pricing crude exports to Europe, several major oil-producing countries such as Saudi Arabia, Kuwait and Iran rely on the IPE Brent Weighted Average (BWAVE).11 The shift to the futures market has been justified by a number of factors. Unlike the spot market, the futures market is highly liquid which makes it less vulnerable to distortions. Another reason is that a futures price is determined by actual transactions in the futures exchange and not on the basis of assessed prices by oil reporting agencies. Furthermore, the timely availability of futures prices, which are continuously updated and disseminated to the public, enhances price transparency.

[11] The BWAVE is the weighted average of all futures price quotations that arise for a given contract of the futures exchange (IPE) during a trading day. The weights are the shares of the relevant volume of transactions on that day. Specifically, this change places the futures market, which is a market for financial contracts, at the heart of the current pricing system.


As you can see, Krugman and Birger are profoundly confused about the way the international oil markets actually function. Futures aren’t a paper bet on the direction of prices determined by some independent process. Futures themselves *determine* the price of most physical oil traded today. The futures price (+ or - the differential) literally *is* the price of oil."

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