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

asiablues's picture

By 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 in the coming days, particularly after QE2 ends in June, and no more stimulous on the horizon.   

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, 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 mimicking movement in the Brent marker (Fig. 3), which historically traded at $1-3 discount to WTI, has flipped into a premium. 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 a less liquid market (although this is in dispute between ICE and CME). 

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 actually 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 physical oil storage as the main thesis. 

Related Reading - Profitable Trade Setups for the Coming Gold, Silver and Dollar Reversals

EconMatters, May 6, 2011 | Facebook Page | Post Alert | Kindle

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Clowns on Acid's picture

Sgt doom...nice high level timeline. Add to this the guys that were the architects of the debacle and have taken their profits a long time ago. Bill Clinton, Sandy Weill, Bob Rubin, Franklin Raines, just to name a few....  

r101958's picture

Sure. (sarc=on) Events in the past week have nothing at all whatsoever to do with the fact that TPTB are desperate to maintain some semblence of the status quo. Nada (sarc=off).

mayhem_korner's picture

Silver was the target last week.  The rest of the commodity complex, including oil, was pulled down as a veil for the fledgling store of wealth that broke away from the peleton.

Oil has not followed its own supply-demand fundamentals for years.  It's a currency in its own right, and is a buttress to political leverage and FX wars.

Refining capacity is the bottleneck with crude derivatives - especially in the U.S.  Prices are set on in-transit, water-borne cargoes based on netbacks at major delivery hubs (London, Seoul, Newark, Houston, Rio, etc.).  The seas are full of spec shipments at all times, literally able to "turn" and head for one port over another based on bidding at the choke points.

Bottom line: there is nothing to be found in following rig counts, demand indicators, etc.  The price is totally decoupled from those mechanisms.



r101958's picture

Sure. (sarc=on) Risings costs have nothing at all whatsoever to do with finite/scarce resources. Nada (sarc=off).

sgt_doom's picture

To better understand the underpinnings of now institutionalized ultra-leveraged speculation, please see below:

The Devil’s Timeline

1993:  The Group of Thirty confers with JP Morgan and several other banks on policies as regards credit derivatives.  The G30 then distributes a favorable report on the expanded adoption of credit derivatives but with the caveat that “legal risk” should be removed.  (Please recall this was after the S&L debacle, when slightly over 1,000 banksters were convicted and jailed.)

1994:  Next, a group is formed of the major Wall Street investment firms: Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Bros., Salomon Bros., Credit Suisse FB, called the Derivatives Policy Group, which will begin to lobby congress.

1996:  After conferring with the Group of Thirty, JPMorgan Chase issues the report, Glass-Steagall: Overdue for repeal, which is distributed to members of congress.

1999:  After several failed attempts, the Gramm-Leach-Bliley Financial Services Modernization Act is finally signed into law.  This effectively repeals Glass-Steagall, and allows for the establishment of financial ultra-monopolies (although it is a bit after the fact, given Citigroup’s merger with Travellers).

2000:  The Commodity Futures Modernization Act is signed into law, killing oversight and financial anti-fraud potential which allows for ultra-leveraging by financial ultra-monopolies.

(Taken together, the Gramm-Leach-Bliley Act and the Commodity Futures Modernization Act removes all "legal risk" in response to the Group of Thirty's dictate.)

Of course, the usual congressional yard sale occurs, as detailed within the excellent report below:



 The Group of Thirty (G30) was created and originally financed by a Rockefeller Foundation initiative in 1978.  It is composed of the top international financiers and members of the world’s central banks.

On JPMorgan Chase and their credit derivatives:  Gillian Tett’s Fool’s Gold is a superb example of a Wall Street-financed (and pre-financed) misinformation trope ostensibly explaining how, although JPM was responsible for a variety of CDO constructions and the credit default swap, it wisely stepped away from the precipice and avoided all risk.

Of course, this is pure fiction and complete nonsense.  Otherwise, JPMorgan Chase wouldn’t be the leader of the pack with regard to credit derivatives, allowing for the bulk of its profits and ability to control markets.  Goldman Sachs averages a nifty $80 billion a year in profit from credit default swaps activity.

Kayman's picture

Yeah, making money is a cake walk, when you've fobbed off your leveraged risk to the public.

Clowns on Acid's picture

Of course ZIRP is a large part of it, and more specifically anticipated real interest rates.

"Hoarding" oil....wait until the hoarding begins for food. Rice...it will become the new meat in Asia.

topcallingtroll's picture

To paraphrase nixon " we are all speculators now."

When owning a three year CD or cash under the mattress carries speculative risk then how can we be blamed for giving in to the darkside?

Clowns on Acid's picture

Inflation protected assets  = pm's , farmland, diamonds, artwork...guns and ammo. Probably in that order.

topcallingtroll's picture

You forgot a gas or oil well.

I think natgas will make a very good inflation hedge priced right now. Give oil time to wash out a little mania first.

Clowns on Acid's picture

How come all the make up caked on, talking heads on CNBC (Cramer -"I'm here not to make friends but to make myself $ front running your positions") and socialist / fascist morons...never blame the Speculators when the price of oil (or any commodity) goes down, becomes inexpensive?

If the US just announced that they are opening up oil exploration within the US, oil would plunge to $80/bbl. Of course regulation and "green" special interests (Soros, Gore, et al) would not want this to happen as it would stop the contributions into their Non profits from the Saudis.  

Tracerfan's picture

Middle East, Middle East, Middle East.

Crude can go to $150 or $200/barrel in the space of hours if a shooting war starts in the "wrong" places.  This is likely to happen, in my opinion, the question is when.


When you add in rising demand from Asia (the U.S. is not as important as before) and depletion, it is apparent that oil is UNDERvalued on the futures strip going out several years.

PulauHantu29's picture

What a great time to load up and add more oil and silver. I read over 80% of investors in the EU now invest with serious inflation in mind and are buying "inflation protection assets"...

"Inflation protection assets?"....What could those be?



Imminent Crucible's picture

"Inflation protection assets?"....What could those be?

They were probably thinking of TIPS.

tom's picture

Nope, Klein is right and you're wrong. Futures markets only anticipate the price of oil. The price of oil is set in physical markets according to supply and demand.

One can definitely manipulate the pricing process by hoarding physical oil, although that is a very expensive amd risky thing to do. You must be very sure the market will accept your manipulation and not suss you out, as your potential profits will be reduced by the cost of storage, which isn't cheap. If you are sussed out and are forced to sell into a weak market, those same storage costs will amplify your losses.

The minor ups and downs of futures markets aren't even noticed by the physical markets. The major ups and downs are driven by the direct consumers - the refineries. When they're hedging against a possible supply shortfall, futures spike. When they realize the market is oversupplied at current prices, they walk away and futures plummet.

The speculator in futures is just guessing which of these scenarios will develop. Unless speculators are willing to pay for the storage to take oil out of the market, they do not affect the quantity of oil supply available, and they do not affect the real demand from real consumers, ie refineries and behind them consumers of oil products. If the speculators don't hoard the oil, then they must sell it, ultimately to the refineries, who will pay whatever it's worth according to supply and demand.

Only extremely powerful speculators have the power to move the physical oil price through the futures markets, without hoarding physical oil. A very large campaign of buying futures by a major speculator will be understood by refineries as a threat by that speculator to hoard the physical oil, and will prompt the refineries to hedge, if they believe the speculator has the wherewithal to make good on the threat. It's like a game of poker: if you want to raise the stakes, you've got to have the cash to back yourself up. The owners of refineries have deep pockets and they are rarely the weak hands at this table.

Kayman's picture

"The owners of refineries have deep pockets".

Beg to differ.  Most of the major oil companies have spun off their refineries.

The major players in oil are the OPEC cartel, the corporate oil cartel and the financial cartel.

Oil is not completely fungible, so each refinery has its unique needs.

An independent refinery is a bit player in the oil game.

sun tzu's picture

What is it that allows the speculation? ZIRP Fed policy. It's funny how they cracked down on the evil precious metals speculators but hardly touched the oil speculators. The margin requirements for oil speculators should be 50%.

Franken_Stein's picture


Here's a perfect example for paper oil speculation:


Rogue trader could have cost PVM Oil £400m.


The "rogue trader" who is suspected of moving the price of oil by up to $2 on Tuesday would have cost his employer $650m (£400m) if the trade had not been discovered and closed, according to sources.





You really have to be a total dumbass or a person with vested interest in order to claim that there is no oil speculation.


Not even speaking of the shenanigans going on at Goldman Sachs' owned ICE futures exchange in Atlanta, GA.


Shylockracy's picture

Like most Hofökonom, Paul Krugman is both a total dumbass and a person with vested interest.

JustACitizen's picture

Yeah - it's just supply and demand...billions of interest free dollars demanding a yield from the "peasants".

Quintus's picture

"...a surging U.S. first time jobless claim that sent oil, silver and other commodities plunging. "

Really?  Silver raid started Sunday May 1st, Jobless Claims printed on Thursday May 5th.  Hard to take any analysis seriously that claims that markets reacted to events 4 days in the Future.

speedy's picture

The question is what exactly sets the spot price for the day?

Is it what the futures price is for next month, or is it what someone is willing to pay for oil ( and take delivery) on that day?


Or, is it because the speculators bid the price up/down for sometime in the future, that can affect what people are willing to pay for oil today on the spot market?


So many questions, who knows the answers?

Jasper M's picture

Marvelous and rigorous docnstution of the sillier elements of recent Durdenism. GOOD job!

Seasmoke's picture

are people still filling up their tanks every other day so they can drive to their low paying jobs and then are thankful for having that miserable job ?

Weisbrot's picture

in Orwellian 1984 speak if you disagree with the Gov-ment it could go badly for you. thankfully things have become that bad here....at least not yet.

Seasmoke's picture

everyone said $4 was the tipping point , now we will see

falak pema's picture

yes bully for u on Ag! You got flacked for that! 

akak's picture

He/she did not get flacked for their prediction on the price of silver, which was fairly accurate (at least in the short term since), but for his/her arguments against holding silver for both the short AND the long term, which were weak, shallow and in points outright specious and disingenuous --- indeed, little more than a litany of vapid, PM-bashing "mainstream" talking points.

falak pema's picture

stop feeling sorry for yourself...its an obsession!

akak's picture

Well, that was a total non sequitur.

I have no idea what are you talking about.

jm's picture


#1. Excellent call on silver last week.

#2. I always thought that gasoline just followed the price of the input-- oil + refinery capacity.  Just because demand goes down, refinery capacity can come down more, right?

#3. Can you talk down sugar next time?

sgt_doom's picture

Instead of B.S. postings like this blog post, simply open the books of trading on ICE Futures by Goldman Sachs and Morgan Stanley, and Phibro's (Citigroup) speculating activities.

Also, throw open the books of all those hedge funds' speculation.

That would prove your most specious thesis, Diane-in-their-pocket.

Kayman's picture

Yeah, gas is up 40% in the past 6 months.  Of course the multi-billion dollar postions taken by Goldman and their criminal cousins have nothing to do with the price of gas at the consumer level.  sarc/off.

Puke/ on.

asiablues's picture


Speculation is a factor in gasoline prices because of RBOB future contracts, which takes 2-3 months typically to impact the pump. 

The fundamentals like refinery run rate, inventory levels do play a part as well.  Refinery utilization is already down to around 83%, which is one of the reasons there are consecutive weekly draws in gasoline inventories.  It will take some time to replenish the stockpiles, and with the summer driving season, it will be interesting to see how gasoline price will react.  

Will get back with you on sugar.