Wednesday, July 15, 2009

Crude Oil Speculation

I spoke about the potential for the CFTC revisiting Trade Limit Exemptions earlier.

Now we have even more info on the state of rampant speculation in the Oil Futures Market

Fewer than one out of every 10 barrels of oil traded on U.S. futures exchanges gets delivered to consumers. Remember the reason that commodity futures were invented was for price discovery and hedging, not speculation.

The head of the CTFC Gary Gensler has pledged to seek federal limits on the number of contracts that traders are allowed to hold, most notably banks, which now buy and sell the lion's share of oil and gas contracts.

BTW...Just to let you know....Gensler once served as co-head of investment at Goldman Sachs, who as a high ranking Treasury official in 2000, helped create a Commodity Futures Modernization Act exempting energy and other derivatives from regulation, helping Goldman Sachs and others to look for the next bubble to inflate.

So you can take this with a grain of salt, even though I applaud his stance.....

.....The idea is to strip out the speculation and make things more transparent.

Speculation makes up roughly 71% of buying in benchmark oil contracts on the NYMEX. This figure was at 33% 8 years ago.

Case in point - NYMEX limits traders to hold 10,000 net futures per month and a total of 20,000 for all months. But exemptions mean a bank or fund has sometimes held more than 300,000 contracts at any given time. That's more than a third of the average 900,000 energy contracts traded daily on NYMEX. essentially these guys move the market.

Of course Goldman is pleading with the CTFC that they are involved in hedging.

Its going to very difficult to figure out what is hedging and what is not hedging.

Many actively traded ETF's like USO accounted for up to 1/4 of bets taken on one month's West Texas Intermediate (WTI) crude futures earlier this year. A sister fund, United States Natural Gas Fund (UNG), held a combined 400,000 contracts on NYMEX and ICE as of July 10.
As passive-long funds, USO & UNG allow investors to bet on rising oil and gas prices.

Banks and ETF funds not producers/consumers, held most contracts last July when oil prices surged to a record high above $147 a barrel. The ensuing liquidation was very painful.

As previously stated, the NYMEX and other U.S. Exchanges (ICE) where energy derivatives are traded, set their own position limits. But traders are often exempted, and some have accumulated massive positions.

The upside is less speculation marking up prices at the pump, the downside is tighter regulations could send energy traders to unregulated foreign markets where prices and credit risk elude oversight, which is going to deprive U.S. commodity exchanges of billions of dollars of inflows.