Look you don’t have to be an oil expert to know that crooks were playing and have been for years now. This started long before this summer, and saying things like while consumers felt pain for a few months is laughable. You might want to go talk to someone from the shipping industry that lost his job and had to file bankruptcy; or the owner operator that could no longer afford the gas and put food on the table. Only the privileged would post such fallacies. The bottom line is everyone has to buy fuel and food. These once small markets worked just fine for decades without the need for the supposed liquidity guise all the crooks throw out as free markets. Give me a break please, when for every 1 barrel that is taken delivery upon 27 are traded, you got major problems. Someone is making money on the backs of the poor and it’s just wrong. You probably are more then happy sitting in your ivory tower, but it’s why this country is despised and hopefully is about to change.

> I brought up other commodities because of your contention that something shady happening
> on the non-US regulated ICE was responsible for the oil boom. I said that’s impossible, because
> similar booms were going on in commodities that were entirely regulated by the US. MnZ
> accurately points out that this boom was even taking place in commodities that do not have
> active futures markets (steel, iron ore, edible beans, some livestock, etc.). Therefore, whether
> the ICE was regulated or not is completely irrelevant.

This is an instance of a ‘fallacy of composition’. You assume from a part (non-speculation in non-oil commodity markets – or so you and others claim) must apply to the whole (all commodity markets) and hence oil. Which is faulty reasoning.

But anyway this ceased being edifying for me for some time ago.

You win. I quit.

1.) I brought up other commodities because of your contention that something shady happening on the non-US regulated ICE was responsible for the oil boom. I said that’s impossible, because similar booms were going on in commodities that were entirely regulated by the US. MnZ accurately points out that this boom was even taking place in commodities that do not have active futures markets (steel, iron ore, edible beans, some livestock, etc.). Therefore, whether the ICE was regulated or not is completely irrelevant.

2.) Speculation has nothing to do with degrees or gradients. It is black and white. If you are taking risk in a commodities market, and you have no commercial interest whatsoever in the physical commodity, you are speculating. Whether it’s 1 contract or a 100,000 makes no difference.

3.) You’re still operating in the mindset that speculators (as you use the term) profited obscenely at the expense of suffering consumers. I can guarantee you that this is not the case. The speculators (again, as you use the term) got burned badly. Consumers, while they felt some pain for a few months, will be the big winners out of all of this.

4.) “doing damage to the whole of the world economy.” See #3. I suppose if you refuse to believe this bubble has helped consumers in the long run we can agree to disagree. However, history is certainly on my side. See further… http://www.wired.com/wired/archive/14.02/bubbles.html.

But you knew that already.

Something that occurred to me this morning, before I’d ventured over to the BP for the day. Going back to the original title of this topic: the topic is about speculation in oil – not other commodities. Discussing speculation in commodities in general, imo, is interesting and fair game. But I believe I started my posts in this topic speaking only as regards oil.

So again I’m busy (as we all are) and I’ll respond to just one thing:

> My original contention was/is that there was no small group of people who sat in
> a conference room somewhere and decided to engineer (and profit from) a commodity boom.

I’d call this collusion – not speculation (and I think the law would do so as well). And I wasn’t arguing for collusion. Although to the extent that GS and MS provided a very narrow bottleneck onto the ICE exchange and that they worked out how ‘a mechanism’ might function, it’s conceivable that they colluded in ‘constructing the mechanism’ whereby favored clients could speculate.

Speculation is of course more amorphous. Lots of investors try to follow price trends. So where does speculation start? It’s not on-or-off but a question of degree. If anyone has (but hasn’t always exercised) a working definition based on long experience it would be the CFTC. And according to the CFTC, each day, trades over a certain size have to be reported and outstanding interest as well.

So the CFTC too would have it too that speculation is a quantitative and qualitative distinction.

Although, like pornography, while we can’t define it, we can sure recognize it. And when you have increasing numbers of investors, with growing sizes of bets, hopping onto the oil futures bandwagon back in the summer of 2008 and doing damage to the whole of the world economy, I recognize that as pornography. Er rather speculation.

First, regarding contango…

According to my screen, the market for feb march wti is 683-684, meaning that right now you could buy feb and sell march and collect $6.83 per barrel. Since each contract is 1000 barrels, this works out to $6,830 per contract. Now let’s assume you’re our friendly oil abritraguer. You sense a profit opportunity here, so you put this trade on 1000 times. You stand to collect $6,830,000 if you can pull this off. Not bad for a month’s work.

So what happens next. Well, unfortunately, someone is going to deliver 1,000,000 barrels of WTI to you. Not only that, you have to buy it from them. Assuming you don’t have the money lying around the house, that means you’re going to have to borrow $36,000,000 from somone to buy all this. Also unfortunately, you’re going to have to pay interest on this $36mm loan, so that would start to eat into your potential profit immediately.

OK, borrowing $36mm (at let’s say 5%apr) for a month isn’t so bad…only about 100k. You’re still clearing $6.7mm. Good stuff. But now there’s another problem– you need somewhere to put 1,000,000 barrels (that’s 42,000,000 gallons) of crude oil. Unfortunately, oil storage is very expensive. No one wants a storage tank in the back yard, so they’re probably not building as many we need. Also, a small amount of oil evaporates while in storage, so you’re losing oil as you store. Also, even if you can find storage, you need to insure the oil so in case there’s some sort of diaster, you’re not on the hook for $40,ooo,ooo. Once you line all these things up, you’re not making very much money anymore.

So, the spread between the first and second month should more or less reflect the cost of storing the oil, borrowing the money needed to buy the oil outright, and insurnace costs. It stands to reason that when there is an oversupply of oil (like there is now) there would not be much free storage available, and the cost of using storage would be high. This is consistent with the current wide spread.

Grego658 hypothesizes that people are holding oil in ships, waiting for the price to rebound. Maybe, but that would be an extremely risky strategy, since holding oil is prohibitively expensive (for reasons mentioned) and you’d be foregoing the rents that could be collected using the ship for transport, not merely for storage. (Believe it or not, giant oil tankers are not free ) Anyone who has oil on ships wants to get rid of it as soon as possible.

Second, regarding “who is purchasing futures from the speculators”…

Only a very small percentage of futures actually result in future delivery. It’s clear that speculators certainly don’t want to have to deal with delivery, but it should be understood that producers and users (hedgers) don’t want to deal with delivery either. Hedgers want to insulate themselves from price risk, but don’t want to have to jump through all the hoops associated with going through an exchange’s delivery process (you have to deliver in cushing, oklahoma, a specific amount, a specific grade, etc.) If you’re pulling oil from the gulf, you don’t want to have to move that oil to cushing if you don’t have to. So you hedge in the futures market, but then you close your position (or roll it) at the end of the month. You’ve pulled your oil, and you’ve profited or lost on your futures, but hopefully that will be offset by the oil you sell in the real market.

Third, regarding USO…

It’s a common misperception that due to contango, the USO takes a hit everytime they have to roll their book. This is 100% false. USO does not roll the same amount of futures each month, it rolls the same amount of DOLLARS. So, (hypothetically) if they’re holding 100 futures at the end of the month, and the next month is twice as expensive (this would be a wicked contango), they’ll only buy half as many futures. Dollar for dollar, the fund is worth the same. Note- Although this means that you don’t get penalized for holding USO while oil’s in contango (or get rewarded if crude is backwardized), I’ve made my thoughts pretty clear about “investing” in commodity futures. This is not wise. Do so at your own peril.

The logic still doesn’t satisfy me. The tankers storing oil tie up transport of oil – so the refiners buy futures further out to ensure the delivery of that oil at the required time, even though the oil is already sitting in tankers (or storage tanks) and has been bought for future delivery. So when the futures expire, the refiners have already ensured delivery by having bought further out futures, and so the futures held by speculators should drop in price as they approach expiration, because there’s no one left to buy them. But then, refiners should see this, and choose not to buy further out futures, but wait for the near term futures to decline in price, and thus end the contango.

Honestly, I don’t think we’re that far from seeing eye to eye on all of this. My original contention was/is that there was no small group of people who sat in a conference room somewhere and decided to engineer (and profit from) a commodity boom. This is what I mean by calling it a “conscious, deliberate” act. You seem to have backed off your opposition to this idea.

I agree that copper is not the best chart. The run up in copper does take place in the spring of ’06, but the price drop takes place at the same time. But take a look at the charts of soy, platinum, and corn (links to which can be found in my 9:03 post…i was having more posting problems last night). These charts look remarkably similar to the WTI (light, sweet) chart you posted. From peak to trough, crude fell approximately 71% (over 140 to under 40). The other commodities I mentioned fell an average of around 61% using similar calculations. So while crude’s fall was more violent, it was only 13% or so more violent than the other commodities, not a multiplicative factor more violent, which you seem to imply.

So this brings us back to the discussion of “capital flows” vs. “speculators.” I think it’d be helpful to define what a “speculator” actually does. Before we get to that, yes, you are correct that in futures markets there are hedgers (who are looking to offset the economic they encounter in their businesses) and speculators (who are looking to take on risk…so long as they are compensated for doing so) Most professional speculators (in the accurate sense of the term) are trend-followers. What does a trend-follower do? He buys after prices have gone up some, and hopes that the trend continues higher, and then sells when it’s over. So imagine that you own an oil field (or a wheat farm or a cattle ranch…this example extends to any commodity). At present, it doesn’t make economic sense for you to take the oil out of the ground–your costs of operation would not be recouped by what you would get when you sold your oil. Now imagine that prices creep higher. At these new, higher prices, it makes sense for you run your well. However, if prices were to drop again, you’d be in trouble because you have to sign employees to yearly contracts, purchase equipment, build a derrick, pay the electric bill, etc. etc. So you go to the futures market. Since the price has gone a little higher, trend-followers are in the market looking to buy. You happily sell, because now, regardless of what happens to the price of oil, you can run your well, pay the bills, and make a profit. For the speculator, one of two things can happen. 1.) The price can go down, and he loses money. 2.) The price continues to go higher, and he makes money. Question- What do you think happens more often? Well, the majority of the time, prices go lower, and he loses money. Yes, that’s right, professional speculators lose money on the majority of their trades. Now, the good news is that the times when the speculator does make money, he makes enough money on his winning trades to offset all the small losses and earn a profit. So, the professional speculator, by riding out many small losses in the hope a few big gains, provides an incredibly valuable service to the rest of the economy by assuming the risk that business people do not want to take. He must get paid in the long run to take this risk, or else he wouldn’t assume any in the first place.

So that is the speculator’s side of the story. And yes, speculators (as I have defined them) did have a good year in 2008. However, there is a big difference between passively benefiting from something and causing something for your own benefit.

Now let’s look at the “other” speculator (whom I would call the “amateur” speculator). This is the return-chasing money that simply pours into whatever’s hot . Amateur speculation is when a pension fund blindly buys futures, or your local “savvy retail investor” starts loading up on USO, or your neighbor tells you he just bought 10 condo’s in miami. This type of speculation is based on the assumption that the future is knowable, and that what has happened in the recent past will definitely continue to happen. This type of speculation almost always does not include a pre-set plan of where he’s going to get out if the market goes against him or for him. This type of speculator is a captive of his own emotions, and (this is the important part) in the long run THIS TYPE OF SPECULATOR ALWAYS LOSES.

OK, so now we have an interesting paradox. Professional speculators benefited from, but didn’t cause, the commodity bubble, while amateur speculators certainly helped to cause, but didn’t benefit from, the same commodity bubble. Pat, I remember reading the same article about the calpers guy putting futures in their portfolio as “investment.” Again, this is unwise because commodities have a negative real rate of return. I can nearly guarantee you that that position did not work out well for calpers, nor did it for long-only commodity funds or retail investors who think they know what they’re doing.

Hopefully by now I’ve made this clear–if there is anyone to “blame” for the commodity bubble, don’t worry about it. These people already got cleaned out in the market. These people no longer have the capital to try again, or if they still have some capital, hopefully they now have the wisdom not to “invest” in asset classes that do no provide real returns. So, who lost? These guys. Who won? Producers who hedged, and, ultimately, the consumer.

imo its a term call contango short for “containerships full of cargo” sitting waiting for price to return by locking up transport … and it’ll work

lucky for capitalism I didn’t run for ruler of the world and win … cause this commander in chief would become a lite pirate