Traders can no longer pretend that supply and demand alone are responsible for driving the oil price
Daniel O?Sullivan
THROUGHOUT the great oil price bubble of 2008 ? which saw black gold first touch $100 per barrel on 2 January, soar to $150 by July but then collapse to $30 by Christmas ? those who argued financial sector speculators rather than physical supply and demand fundamentals were responsible were hamstrung by one thing. The weekly data on Nymex oil trading released by the CFTC, the US commodity futures regulator, was simply not up to the job of proving the case one way or another.
The CFTC has traditionally lumped investment bank ?swap dealers?, into the category labelled ?commercial?, alongside genuinely commercial oil futures market players such as oil producers, refiners and traders. It then grouped all other participants in a catch-all ?non-commercial? category.
PATTERNS OBSCURED
Thus, the trading patterns of two of the most obvious sources of speculative pressure, swap dealers and hedge funds, were completely obscured. Throughout the 2008 US Congressional hearings examining sky-high oil prices, the same complaint was heard repeatedly from industry analysts.
Belatedly, the CFTC has responded. In late October, Nymex published oil trading data in a ?disaggregated? format, showing distinct commitments for genuinely commercial market participants, swap dealers and hedge funds. The CFTC has also released historical data in the same format stretching back three years, including the 2008 price bubble. This clearly shows that speculation primarily fuelled oil?s rollercoaster ride.
The chart to the right shows the actual price of oil from the start of March to the end of September. It also shows several ?predicted? oil price lines constructed from the new historical CFTC data, combined with external data such as weekly EIA figures for crude oil and gasoline inventories in the US ? the most keenly observed ?fundamental? indicators for the Nymex oil trade ? and non-fundamental factors such as dollar strength and the gold price, factors driving speculative financial sector interest in oil.
The brown line shows physical supply and demand fundamentals, combining changes in the EIA stock figures plus changes in market positioning by the genuinely commercial Nymex market participants. This line bears no relation to what the oil price actually did through this period.
The pink line includes the market positioning of the swap dealers, hedge funds and other non-commercial players, plus the dollar-euro exchange rate and the price of gold. This is much closer to the actual price. There are still large gaps, but the overall direction of price movements is similar. The positioning of the non-commercial elements in the market plus shifts in the financial sector shibboleths of gold and the dollar explain far more of the oil price movement than actual physical fundamentals do.
The green line, however, adds in three specific speculative trading patterns which anecdotal evidence says drove the oil price higher at key points through this period, and for which the disaggregated data allows us to construct workable proxies. These are 1) a bias on the part of swap dealers to placing long positions in large chunks; 2) the unwinding of speculative ?timespread? trades; and 3) speculative players calling large volumes of oil options for physical delivery, causing a scramble by option sellers to buy actual futures contracts. This line is extremely close to what the oil price actually did.
Of course, some will say there are lies, damned lies and then statistics ? but this exercise should put the onus firmly back on those who claim speculation is a ?red herring? to argue exactly why they think this chart does not show what it seems to show.
The new data allows us to create a model predicated on speculation dominating the market, which also predicts very well what the oil price actually did through that feverish summer of 2008. This gun is not just smoking, it is still loaded and pointing at those who persist in denying the obvious.
Petromania: Black Gold, Paper Barrels and Oil Price Bubbles by Daniel O?Sullivan is published by Harriman House and priced at £20
