Tuesday, September 15, 2015

Commodities: Oil - The Ignorance Of The Speculators

(Drivebycuriosity) - Oil is around 60% cheaper than last year, but I think the oil price has to fall even deeper. The reason: There are too many speculators in the market.

"Hedge funds added the most bullish oil bets since April on optimism that the global oversupply will disappear as producers slow output", reports Bloomberg (bloomberg). And they add: "Money managers boosted their net-long position on West Texas Intermediate by 16,855 contracts to 132,857 futures and options in the week ending Sept. 8. Traders also boosted their bullish stance on Brent crude by the most since April".

Oil is traded on financial markets like stocks and bonds. Funds and other speculators trade futures, options and other financial constructs which are backed by physical oil (or the promise to deliver physical oil in the future) and influence so the price of oil. The speculative purchases create an additional and artificial demand for oil and are driving oil prices higher. Without the "bullish" bets reported by Bloomberg oil would be cheaper today because physical supply is way higher than the physical demand.

The speculative "bias" for higher prices isn`t new, I have read news like the quoted Bloomberg report very often. There are some hedge fund managers with a large influence  - the "oil bulls" - who are betting constantly on higher prices (bloomberg). Hedge funds and other speculators who bet massively on climbing oil prices drove oil prices in the period 2012 to 2014 above $120 - in ignorance that the global oil production was already rising and production costs were already way below $100. In the first months of this years speculators ignored again the oil glut and their investments into oil futures caused an oil price rally which drove the price of Brent Crude from $45 to $67.  In August speculative buying caused an oil price spike of 27% in around 5 days.

Today hedge funds and other speculators again ignore that the world is awash in oil. They are betting that next year oil production - especially in the US -  will shrink dramatically and that the global demand will climb significantly.

I suppose that these speculators will be disappointed in both cases. The costs of fracking, the cause for the rise of US oil production since around 2006, are falling, thanks to the technological progress and the ingenuity of the driller. Maybe that US oil production will shrink if the price of oil drops below $40 but it could snap back at prices of $50 and more. The speculators also ignore that the sanctions against Iran will be lifted and this huge supplier will come back to the market. Other producers like Iraq and Russia could also expand their production. And the demand for oil is getting constantly curbed by the rising efficiency of cars and other machines.

I think that these speculators will have to sell the accumulated financial futures and options sometimes which will create additional pressure on the oil price.

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