Oil Trading Firm Under Investigation for Causing Oil Price Spike With Computer Trades
The minute-by-minute and day-by-day effects of Infinium's "haywire" algorithm on the crude oil market in early February of this year. (image: graphics.thomsonreuters.com)
CME Group, owner of energy commodities market the New York Mercantile Exchange (NYMEX), has announced it will investigate how a company using a sophisticated oil trading computer algorithm allegedly caused the price of crude oil to jump one dollar in a matter of minutes. The Wall Street Journal reported on Thursday that on February 3 of this year, trading company Infinium Capital Management unleashed an electronic trading formula known as an algorithm on the NYMEX that was intended to execute complex transactions involving crude oil futures contracts. But less than a second after it was switched on, the algorithm malfunctioned and issued thousands of buy orders for crude contracts, driving up the price by a full dollar per barrel in the blink of an eye. Only five seconds later, operators shut down the faulty algorithm, but not before it executed thousands of trades, drove up the price of crude, and lost the company $1 million. All of this took place just four minutes before the NYMEX oil-trading floor closed at 2:30 pm. The confusion over the sudden last-minute price spike led to a 5 percent drop in oil prices the next day. The Journal detailed the outsized effect the algorithm had on the market:
At 2:26 p.m. in New York trading on Feb. 3, four minutes before the end of Nymex floor trading, volume spiked in the light, sweet crude futures contract. The March contract shot up 51 cents in a matter of seconds. Volume also surged—from 963 March futures contracts traded at 2:25 p.m. to 8,410 at 2:26 p.m.
The incident is something of a worst-case scenario for high frequency trading, the practice of using software to execute thousands of market transactions per second. Increasing numbers of traders are using high frequency trading to turn big profits on tiny price differences on commodities and other products. Concerns over the practice are twofold: that individuals or companies engaging in high frequency trading gain an unfair advantage over traders without access to the sophisticated and expensive software it requires, and that making many times more trades than would be humanly possible could seriously disrupt markets and cause protracted price volatility. The second concern seems to have been realized with Infinium’s February 3 debacle.
A similar technical error is suspected as a partial cause of the May 6 “flash crash” that sent the stock market plunging for no apparent reason. The results of an investigation into the causes of the flash crash are expected out next month.
Infinium said that they notified CME Group of the algorithm malfunction and resulting trades immediately after they occurred, and that they have fired the designers of the algorithm. There’s no sign that the company will be accused of intentional wrongdoing.
Regardless of Infinium’s intent, the incident made abundantly clear the power that high frequency trading and similar practices hold over markets. Earlier this week, oil analyst and author Raymond J. Learsy made a forceful argument that new technology-based speculative practices like high frequency trading are the main forces behind inflated oil prices.
Hopefully newly-enacted financial regulation and oversight well help curb the influence of new speculative techniques over oil prices and prevent sudden increases in crude and heating oil prices that are the result of a trading firm trying to squeeze more profits out of a few minutes of market activity.
Analyst Learsy: Speculation, Manipulation Continue to Artificially Prop Up Oil Prices
According to commentator Raymond J. Learsy, more sophisticated computer-based trading of oil investmet products is empowering speculators and driving up oil prices. (image: miltchtrading.com/eng/)
When we discuss crude and heating oil prices around the HeatingOil.com newsroom, our conversations frequently end with the phrase, “it just doesn’t make sense!” Author and oil market commentator Raymond J. Learsy, continuing on his tenacious fight to expose unethical (and in some cases, illegal) market manipulation by oil speculators, began his latest piece on the Huffington Post with a derivation of that refrain: “It makes no sense.”
Learsy goes on to explain that what makes no sense are recent oil prices. Despite losses over the last week, oil prices have been increasing steadily for the last year, while supplies continue to increase and the economic slowdown has kept oil demand remarkably low. In March of this year, I wrote an opinion piece that drew on previous writings by Learsy and made the case that speculative activity on oil markets was clearly the main determinant of prices, and that fundamental forces supply and demand had for months (maybe years) occupied a distant second place on the list of influences over crude and heating oil prices. Since then, Learsy argued on Monday, little has changed. The US is so flush with crude oil that millions of barrels of the stuff are in floating storage off of our coasts—high supply. Unemployment and general economic weakness have kept demand historically low. According to the basic premise of free market economics, these two circumstances should make for consistently low oil prices. But since it hit a low point of $33 per barrel in February of 2009, the price of crude has been on a pretty consistent upward track.
So if fundamental forces are not driving oil prices, what is? According to Learsy and many others, the answer is speculators. Investors with no interest in buying physical oil have flooded the commodities market in the last decade, and many believe that the massive amounts of money being funneled into energy products like crude oil have essentially disconnected their prices from the realties of the physical world. After recounting his opposition to the outsized influence of speculators over the oil market, Learsy brings up a new point—that technology has made new kinds of speculation easier, and that investor dollars can now flow more freely between commodity and stock markets. Quoting an article in the Wall Street Journal, Learsy provides a summary of the new market dynamic he believes is behind artificially-inflated oil prices:
“In recent years commodity exchanges have built up their technologies to allow easier access for computer based traders which have become a dominant force in some markets”. That traders “tend to do the same thing at the same time not because of the fundamentals rather because there is so much money under management that they have become the markets.” According to another trader quoted in the article, “Whatever is producing this phenomenon is growing in force not waning in force.”
Indeed, technological advancements in derivatives trading (some of which are based on oil futures contracts) have fundamentally changed how markets operate. These new advancements, Learsy argues, only augment the considerable power over oil markets already held by big money investors and other speculators. As proof, he refers to the recent fine the Commodity Futures Trading Commission (CFTC) levied against a trading group for manipulating the market in pursuit of the “first print” of a $100 per barrel oil contract. If one trading group has the power to create, in the CFTC’s words, a “non-bona fide price” for oil, Learsy posits, what’s to stop any other group from doing so on any given day?
To fight speculators’ manipulation of oil prices, Learsy urges “Congress [to step] in to restrict participation by computer-based traders,” and “bring some rationale, some sanity, some semblance of fair play back to the oil trading pits.” He subsequently laments the unlikeliness of such an occurrence, citing the power of investment interests and the sway they hold over politicians in the form of massive campaign contributions.
Although Learsy’s conclusion sounds a bit cynical, it certainly contains some truth. While the financial reform bill did confer increased power to the CFTC and set new limits on speculation, phenomena such as technical traders gaining new access to oil contracts will no doubt continue as long as investment banks, hedge funds and other Wall Street interests hold money-backed power in the political system. The only force strong enough to combat moneyed interests in the battle for political support from Washington is the outrage of Americans tired of paying too-high prices for heating oil and gasoline.
Judging by Learsy’s belligerent tone, that’s the exact force he is trying to build up.
Oil Market Analyst Sees Crude Prices Falling Below $60
The price of crude oil on the NYMEX as been following the S&P 500 stock index closely since May of this year, and the S&P is set for a big fall, according to analyst Wayne A. Corbitt. (image: seekingalpha.com)
The financial world is full of professionals who predict oil prices. Some focus on supply and demand, others focus on geopolitical factors, and others base their predictions on patters, correlations, or other mathematical clues.
An oil price prediction published on the financial blog Seeking Alpha on Friday used this third type of analysis, generally referred to as technical analysis, to predict that the price of crude oil will soon drop below $60 a barrel. The prediction, from market technician and analyst Wayne A. Corbitt, looks closely at the strong correlation between crude oil prices and the US stock market, as represented by the S&P 500 index. Corbitt illustrates that crude oil (West Texas Intermediate, or WTI grade crude oil) prices and the S&P have been moving more-or-less in tandem since August 2008 and concludes that recent declines on the stock market will soon lead oil prices lower. He also declares,
crude oil has been tracking very closely with equities for the last two years and is being controlled only by traders and investors seeking risk.
This evaluation clearly falls in line with observations by HeatingOil.com and others that fundamental factors like supply and demand have less influence over oil prices now than perhaps ever before. Instead, stock markets, the value of the dollar, and other financial considerations seem to be the more influential determinants of oil prices.
Corbitt also based his prediction on recent patters within the oil market, specifically open interest (the number of open contracts—contracts that can be re-sold—held by traders) and volume (total trading activity). He showed that open interest in the crude oil market has been declining steadily since oil hit its nine-month low in May of this year, meaning that traders’ interest in crude oil has been falling for the last four months. As fewer traders buy crude contracts, demand for the contracts declines and price increases, especially in the form of rallies, become less likely. Looking at crude’s trading volume, he noticed a downward trend since May and interpreted that as a sign of prices dropping in the near future. In his words,
When volume is in an obvious decline as prices advance, however, that is a sign once again that the necessary support structure for higher prices is absent, thus opening the door for sellers to take control.
In conclusion, Corbitt chalks up recent increases in oil prices to outside (non-fundamental) factors, writing, “Crude oil’s inability to trade on its own merits has no doubt helped sustain its higher price level.” With oil prices’ tendency to follow stock prices, and expectations of stock market declines to come soon, the product of Corbitt’s analysis is an outlook that includes falling crude oil prices in the near to medium term. According to his vision, the per-barrel price for crude will dip below $60 well before surpassing $100.
As with all oil price predictions, the accuracy of the one described here is impossible to pin down. That being said, Corbitt’s simple and direct analysis (supported by fairly straightforward charts) makes a compelling case. His technical analysis also gets support from fundamental factors: a weak US economy is keeping down demand for petroleum products, and fuel supplies (including heating oil) are at record-high levels. If he’s right, and crude prices fall below $60 in the next month or two, that would go a long way toward knocking five cents per gallon or more off of current retail hating oil prices right as the heating season kicks off.
Speculators Betting Big on Rising Oil Prices; Experts Predict Price Downswing
Tropical storm Bonnie threatened to disrupt oil refining operations in late July, but faded quickly. Encouraged by Bonnie, investors made big best that the price of oil would rise. (image: NOAA via aolnews.com)
Hedge funds and other major speculators in the oil market increased their bets that crude oil prices will rise to the highest level in 13 weeks. At the same time, a poll of energy market experts found a majority belief that oil prices will decline over the next week.
According to two reports published Monday morning by Bloomberg, the discrepancy is due to an unusual combination of factors currently influencing oil markets. Hedge funds and other institutional speculators increased their long positions (bet that prices would rise) on crude oil last week in anticipation of supply disruptions that tropical storm Bonnie would bring to refineries along the Gulf Coast. But Bonnie’s threat to the refining industry quickly dissipated, and was overshadowed by a worse-than-expected employment report released on Friday that showed 131,000 US job losses in July. The second consecutive month of unemployment increases showed a slowdown in the economic recovery and gave further support to fears of a double-dip recession. A weak economy means weak demand for oil and falling prices. This reality was no doubt on the minds of energy analysts surveyed by Bloomberg—28 of 42 analysts polled believed that crude oil prices would fall through August 13. One analyst saw a bit of humor in the unexpected reversal:
“This is Wall Street at its finest,” said Hamza Khan, an analyst at the Schork Group in Villanova, Pennsylvania. “They knew stocks were going to decrease because the refineries had their supply routes shut down for Tropical Storm Bonnie. Really, the joke was on them.”
For heating oil, however, the commodities market is more bullish. Although supplies of distillate fuel (heating oil, diesel, and other petroleum fuels) are well over the five-year average in the US, demand is strong in Europe and South America, making for a robust export market that is supporting heating oil prices on the NYMEX. According to Bloomberg, “Exports in May of distillate fuel, including heating oil and diesel, were 17 percent higher than a year earlier, the Energy Department said July 29.” A power outage that shut down a major South American refinery is supporting higher distillate fuel demand in Mexico and further south.
Somewhat ironically, oil prices headed upward again on Monday after the employment-report-induced downswing on Friday. A weak dollar and gains on US stock markets were the main causes of the rally, according to Bloomberg—meaning that non-fundamental forces trumped the fundamentals of supply and demand once again and put many investors in an optimistic mood about the economic recovery.
So what does all this mean for short-term oil prices? As usual, it’s anybody’s guess. One point of view is that economic indicators (like stock markets and currency values) can have short-term effects on oil prices, but the clearly weak fundamentals will prevent any huge price spikes or medium-term upswings. Heating oil users can expect more of the same for the next few weeks: some ups and downs, but a mostly flat trajectory for heating oil prices into 2011, as forecast by the EIA last month.
Like Oil Speculators, Cocoa Speculator Could Drive Up Product Prices
A company in London bought 240,000 tons of cocoa, which could give it control over the price of cocoa in the retail market. (image: thechocolatelife.com)
Crude oil and heating oil aren’t the only commodities traded on futures exchanges. There’s also cocoa. And just like in the oil market, people are worried that financial interests are leading to artificially high prices.
As NPR’s Planet Money blog reported on Monday, “Somebody bought almost all of the cocoa registered in European warehouses last week.” A company called Armajaro bought contracts for 240,000 tons of cocoa on the London market, worth about $1 billion. That’s about 7 percent of the total global supply of cocoa, which could give the buyer enough influence to raise the price of cocoa around the world, which would hit consumers any time they bought chocolate.
In the US, groups that want to curb speculation on energy commodities have called for position limits—caps on how many contracts any one trader can have. Now some in the cocoa business are asking for the same thing, says the Wall Street Journal:
Trade groups have criticized the exchange because it hasn’t implemented limits on the number of contracts a single trader can hold, which in the U.S. is regarded as a key check on participants’ ability to manipulate prices.
Whether it’s heating oil or candy bars, prices climb when large financial institutions buy up as much of the commodity as they can.
Oil Spill Curbing BP’s Oil Trading Operations
Stock traders at the NYSE, with BP CEO’s Senate testimony on television in the background. In addition to its status as one of the largest producers of oil in the world, BP has powerful operations in the world’s commodities markets, but their power is waning due to fallout from the oil spill in the Gulf of Mexico. (image: Brendan McDermid/Reuters via nytimes.com)
Early investigations point to BP’s aggressive, fast-paced, profit-driven approach to offshore drilling as at least a partial cause of the catastrophic oil leak in the Gulf of Mexico. Now it appears that the fallout from that catastrophe is seriously diminishing the power and influence of BP’s trading division, which takes the same approach to commodities markets, the New York Times reported on Friday.
BP’s trading operations in crude oil and refined products at commodities markets around the world has gained a reputation for being bigger, more aggressive, and more successful than their competitors. This reputation was perhaps best embodied by a $303 million fine levied against BP by the Commodity Futures Trading Commission (CFTC) in 2007 for illegal manipulation of the propane futures market in 2007. According to government documents, BP traders bought up 5.1 million barrels worth of short-term futures contracts on propane stored in Texas pipelines, which represented 800,000 more barrels than were actually in storage. By snatching up such a huge portion of the short-term propane market and refusing to sell any propane contracts, BP traders drove prices sky-high before finally offloading the contracts and making a killing. One trader pled guilty to this illegal market cornering, and four other BP traders’ indictments were thrown out by a judge who determined that they were exempt from federal regulations because they took place in barely-regulated over-the-counter markets. The Times reported that investigators found evidence of BP attempting a similar scheme that involved moving crude oil around its storage facility in Cushing, Oklahoma, but could did not prosecute due to an almost-expired statute of limitations.
The days of BP throwing its massive weight around commodities markets may be numbered, however, as the effects of the Gulf oil spill are rapidly draining the company’s financial and personnel resources. Every billion dollars BP pays out to the US government or Gulf Coast residents is a billion that can’t be paid out to commodities traders. As a result, rival international trading companies are already poaching BP traders. Depleted coffers at BP also limit the company’s ability to secure short-term bonds that allow its traders to increase their buying power.
Although its financial assets may be seriously reduced by oil spill-related costs, BP retains a huge advantage in the oil trading game: its massive network of oil extraction, refining, and storage facilities. With control and knowledge of a huge portion of the world’s supplies of crude and refined products, BP can use its own data to accurately predict when prices will move up or down. While this advantage seems at least a little unfair, it is fully legal.
Levering the advantages afforded it by its huge share of the world’s physical oil market and its seemingly infinite stores of capital to further increase profits on the world’s commodities markets has been an immensely successful endeavor for BP. From the Times:
Analysts estimate that BP’s trading profits have remained in the $2 billion to $3 billion range since then, which would be slightly less than 20 percent of the company’s $16.7 billion in earnings in 2009.
Responding to the Times article, oil market commentator Raymond Learsy argued in a column for the Huffington Post that the trading maneuvers employed by BP to maximize its profits usually involve driving the price of crude and other petroleum products like heating oil up and not down. And when prices on commodities markets increase for commodities traders, they increase at gas stations and heating oil racks as well—meaning that as BP drives up the prices of its own products on commodities markets, they drive up the prices that average Americans pay for those products as well.
The financial hemorrhaging inflicted on BP by the Deepwater Horizon oil leak and cleanup have already begun to erode the company’s influence on commodities markets, which could have an ever-so-slight cooling effect on petroleum product price volatility. However, the company’s trading operations will march on, and continue to make significant (though somewhat smaller) profits for the oil giant.
So if you needed a non-oil spill-related reason to be ticked off at BP, there you have it.
Drunk Oil Trader, Banned in the UK, Lands New Job in Switzerland
Help wanted: oil trader. Banned from work in the UK? No problem!
On Tuesday Stephen Perkins was fined £72,000 (US$108,00) by Britain’s Financial Services Authority (FSA) and banned from working in the financial services industry for five years for driving up the price of oil through unauthorized trades while blacked-out drunk. On Wednesday he was in Geneva meeting with the commodity broker Starsupply Renewables SA to talk about joining the firm, reported the UK’s Daily Telegraph. Apparently making illegal trades while drunk and then lying and trying to cover it up is a minor hiccup on the path to a successful career as a commodity trader in Switzerland.
Perkins lost his former employer, PVM Oil Futures, $10 million with his unauthorized trades, and the price of Brent crude oil gained about $1.65 in two hours as a result of his trading. According to the FSA, Perkins “is not a fit and proper person to be involved in regulated activities and his behaviour posed a risk to the proper functioning of the market,” but the British regulator can’t prevent Perkins from trading elsewhere. The agency has informed Swiss regulators of Perkins’s history.
Perkins says he has received treatment for his problem with alcohol and has stopped drinking. The Daily Telegraph interprets his quick recovery from disgrace as proof of “how valuable top brokers are to commodity companies,” which raises a question: If the guy who got drunk and lost his company $10 million is a “top broker,” what are the rest of them like?
Don’t Drink and Trade: London Oil Broker Fined for Drunken Oil Futures Trades
An oil trader’s drinking problem pushed the price of Brent crude oil to new highs in 2009. (image: muchomartiniglasses.com)
Oil prices are determined by a number of different factors: supply, demand, currency values, global stock markets, and weeklong drinking binges by oil traders. Steven Noel Perkins, a former oil trader, has been fined £72,000 (US$108,000) for the unauthorized purchase of $520 million worth of Brent crude oil futures contracts—some 7 million barrels—while in the middle of a bender.
Perkins worked for PVM Oil Futures Ltd. and traded on the ICE Futures Europe exchange in London. PVM trades on behalf of clients, but Perkins’s trades of June 29 and 30, 2009 were made without any authorization from clients and, according to the British financial regulator FSA, “As a direct result of Perkins’ trading, the price of Brent increased significantly.” Reuters reports that Perkins’s trades pushed the price of Brent crude to a 2009 high of $73.50 a barrel.
Bloomberg reports the full story of the illicit trades, which began on Monday, June 29, 2009. A weekend drinking jag that included a golf trip with PVM lasted into Monday for Perkins, and he phoned in eight trades—only one of them authorized by a client—to a PVM broker that afternoon. The trading continued into the early morning hours of Tuesday, June 30, at which point Perkins had accumulated contracts for 7 million barrels of oil, though he was in no condition to know it. According to a statement from the FSA:
He drank heavily throughout the weekend and continued drinking from around midday on Monday 29 June….He claims to have limited recollection of events on Monday and claims to have been in an alcohol-induced blackout at the time he traded in the early hours of 30 June.
Perkins has since stopped drinking and been to rehab, and his firm, PVM, lost about $10 million closing out the unauthorized trades, but there’s no recourse for consumers who may have paid higher prices for oil products as a result of drunken and unauthorized trades that drove up the market price for Brent crude oil. It’s not the first time we’ve heard of oil traders’ gaffes affecting oil prices and hurting consumers—sometimes mistakes in basic geography drive up prices, and just a year ago another oil trader in London got fined for trades he made after he got drunk at lunch, apparently something of a pattern in the London markets.
Perkins won’t be trading for at least five years—the FSA has banned him—but his case provides some insight into what people mean when they talk about the “complexity” of commodity markets.
CFTC: Speculators Cut Bets on Rising Crude Oil Prices Again
Fewer traders who represent oil speculators are betting on higher future crude oil prices. (image: Nicholas Whitaker for HeatingOil.com)
Hedge funds and other speculators have reduced their bets that oil prices will rise, reports Bloomberg Businessweek. According to a report by the Commodity Futures Trading Commission (CFTC), long positions in crude oil futures declined by 30 percent in the week ended June 8 to hit a 10-month low.
Taking a “long” position refers to buying a futures contract or option that will pay off if crude oil prices increase—essentially, betting that the price of oil will rise. If speculators believe that the price of oil will fall, they will take “short” positions. Long positions have been falling rapidly since January, when investors held a record-high 135,669 contracts on the New York Mercantile Exchange (NYMEX) that took a long position. In May the CFTC reported that speculators had cut long positions on oil commodities by about 40 percent. After this latest weekly decline of 30 percent, only 17,457 contracts took long positions on crude oil, an 87 percent reduction from January’s high point.
According to one analyst, the steep drop-off in long positions is nearly the mirror image of the sharp increase in long positions (and oil prices) in January:
“Unwinding long positions makes a lot of sense given the uncertainty about global economic growth, the end of the uptrend in prices and the relatively weak euro,” said Kyle Cooper, a managing director at energy consultant IAF Advisors in Houston. “We saw the same factors at work in reverse at the beginning of the year.”
Oil prices have fallen roughly 15 percent since early May, dragged down by the uncertain prospects for economic recovery in Europe and the US. The diminished appeal of long positions on crude oil means that oil speculators think prices are unlikely to rise much higher, even after the recent slump in prices.
If the investors are right, that would be good news for heating oil consumers, even though speculators have not cut their long positions on heating oil—at least not yet. The price of crude oil is the most important factor that determines the price of heating oil; while trends in heating oil prices can occasionally diverge from trends in crude oil prices, the price of heating oil will eventually be forced to reflect the price of crude.
Oil prices will undoubtedly go through many twists and turns before the next heating season arrives, but right now the people who make their living by trading oil don’t see a spike in oil prices in the months ahead.
Record Surplus in US Oil Supplies Cuts Gasoline and Heating Oil Prices
Oil prices have been sinking under the weight of a surplus of crude oil and refined oil products. (image: neftegaz.ru)
Inventories of crude oil and refined petroleum products hit their highest point in at least twenty years, reported Bloomberg Businessweek. For the week ending May 14, total oil stockpiles reached 1.81 billion barrels, the highest figure for this time of year since at least 1990, the earliest date in the Energy Information Administration’s online data.
This supply glut has depressed oil prices across the board in recent weeks. The price of crude has fallen, but the prices of refined products such as heating oil of gasoline have fallen even faster, reducing the crack spread between the price of a barrel of crude and the price of a barrel of finished oil products. The crack spread is the profit margin for refiners, so a lower crack spread lowers the incentive for refiners to process crude oil.
But even though the incentive to refine crude oil into gasoline is falling, the surplus of oil supply is not limited to crude oil. Gasoline and distillate (heating oil and diesel) inventories are also above their five-year averages, and high supplies of petroleum products have an even greater impact on oil markets than high crude inventories, according to at least one trader:
“Surplus inventories on the product side are more bearish than surplus inventories on the crude side,” said Tim Evans, an energy analyst at Citi Futures Perspective in New York. “If we have surplus inventories all the way around, there’s not much of a credible risk of market tightness.”
Demand forecasts from the EIA and the International Energy Agency still predict oil demand to increase from 2009 levels, but it may not be enough to whittle away existing supplies. Crude oil and heating oil prices have tumbled in the last three weeks, and record supplies could hold prices down for the foreseeable future.
CFTC: Speculators Abandoning Bets that Heating Oil Prices Will Rise
The reduction of long positions held by speculators is part of a steep downward trend in heating oil prices over the last ten days. (image: ft.com)
Looks like the recent downswing in crude, heating oil, and gasoline prices is the real deal and that prices may actually stay low for a few weeks or even longer. Last week, the Commodity Futures Trading Commission (CFTC) found that speculators significantly reduced their bets that the prices of heating oil and other petroleum commodities will rise, according to a BusinessWeek report published on Sunday.
Hedge fund managers and other major institutional speculators reduced their long positions in petroleum commodities by about 40 percent during the week ending May 11, according to the CFTC. Speculators take “long” positions when they believe the price of a commodity will rise in the near future. “Short” positions are bets that prices will fall in the near future. After months of rising on the hopes that global economic recovery would come soon, it appears that the tide has turned and sluggish recovery along with weak demand and huge surpluses of petroleum products are beginning to seriously depress oil prices. Crude and heating oil prices plunged on Friday, bringing a major drop in retail heating oil prices on Monday. The flight from long positions by large speculators last week may have helped contribute to oil prices’ downward momentum. Long positions on heating oil dropped by 46 percent and as of Monday at 10:54 am Eastern Time, the price of heating oil was still falling, having lost 1.9 percent in morning trading.
One analyst explained to BusinessWeek that the reduction of long positions made sense in the bear market of petroleum commodities seen in the last two weeks:
“What we really see across the board is a fairly aggressive reduction in net long positions held by money managers,” said Tim Evans, an energy analyst at Citi Futures Perspective in New York. “This wouldn’t be surprising given the market’s been under selling pressure over the last week or two.”
For heating oil consumers and dealers, the recent downward trend in prices is great news. Despite supply and demand factors that pointed to lower prices, heating oil prices had been on the rise for most of the spring. This recent downward trend reflects a more realistic view of energy prices in a slowed-down economy as hopes for a swift and powerful recovery from the global recession fade.
Heating oil prices will no doubt increase from time to time in the coming months, but if the current trend holds and world demand for oil products remains weak, prices will likely fall further than they rise until autumn.
New Documents Highlight Rift Within CFTC on Position Limits
Newly uncovered documents reveal divisions within the CFTC. (image: wikimedia.org)
Ever since the Commodity Futures Trading Commission (CFTC) first floated the idea of imposing position limits on energy commodities in order to curb price spikes caused by speculation, critics have insisted that there was no clear link between speculative investment and the price swings of 2008, when crude oil soared to $147 a barrel only to collapse and hit $33 a barrel. Now the Wall Street Journal reports that the CFTC faces critics among its own staff.
Through a Freedom of Information Act request, the Journal has obtained internal documents demonstrating that a number of CFTC staff members disagree with the CFTC Chairman Gary Gensler’s claim that speculation caused volatility in commodity markets.
In one instance, two CFTC economists wrote a memo in August 2009 saying that there was “little evidence” that removing position limits in 2000 had led to volatility in energy or agricultural commodities. That same month, the CFTC’s deputy chief economist, James Moser, wrote an email that said, “we have no statistical evidence of a problem.” The final document acquired by the Journal was the draft of an interagency report, led by staff at the CFTC, on the role of commodity index funds, which remove any risk that investors would have to actually take physical delivery of oil. Gensler has specifically attacked commodity index funds for their contribution to a speculative bubble in energy prices. The interagency report came to the starkly opposite conclusion:
There is not enough evidence to support the argument that the commodity index funds cause price spikes in commodities.
The Futures Industry Association (FIA), a group of commodity traders that has already spoken out against position limits, cheered the release of the report. However, end users of energy products, such as airlines and heating oil dealers that were hurt by skyrocketing oil prices, overwhelmingly support position limits and have called on the CFTC to enact even stricter regulations than are currently under consideration.
This is not the first indication of a difference of opinion within the CFTC—as the Journal notes, three of the five commissioners have already expressed reservations about position limits—and it remains unclear whether or not the proposal to establish position limits is going to be carried out. Commissioner Bart Chilton, an advocate of position limits, was unconvinced by the conclusions of the interagency report: “I think it was political and the spin on it was political.”
Between Chilton’s easy dismissal of the report and the CFTC’s recent aggressiveness in clamping down on illegal trades, there is some indication that the CFTC is serious about taking a more forceful role in overseeing commodity markets.
The true test of position limits and other potential CFTC regulations on the trading of energy commodities will only come if and when such regulations are implemented. If steadier and/or lower crude and heating oil prices come about weeks or months after implementation, there’s a good chance that critics will silence themselves.
Afternoon Price Check, May 7: Biggest Weekly Drop in Oil Prices in 16 Months
The price of crude oil dropped on Friday to cap off the biggest weekly decline in 16 months. (image: ft.com)
The same factors that have been dragging down oil prices since Tuesday of this week continued to do so today, bringing about the biggest weekly decline in the price of crude oil since December 2008. Although the German parliament today approved a plan to help bailout the Greek economy, stock and commodities traders in the US still feared an economic meltdown spreading outward from the Mediterranean nation. Germany’s action helped strengthen the euro, but the US dollar also rose again, making commodities like crude and heating oil less attractive to speculative investors. The slight upswing in US unemployment announced on Thursday and continued low demand for oil worldwide helped push prices lower.
Today’s closing prices on the NYMEX
Crude oil (June 2010 contract): Down 2.6 percent, $75.10 per barrel.
Heating oil (June 2010 contract): Down 1.6 percent.
Demand for Diesel Pushes Heating Oil Prices to 18-Month High
Growing demand for diesel—caused by increased trucking, among other factors—pushed the price of heating oil to its highest point in a year and a half. (image: lehighvalleylive.com)
The price of front-month heating oil futures increased by more than 1 percent on Monday, supported by positive economic news. Monday’s rally put the price of heating oil at its highest point in 18 months, reported Bloomberg. Inventories remain plentiful, and demand for heating oil is shrinking as spring advances, so what’s behind heating oil’s recent surge? Demand for diesel.
On Monday, the Institute for Supply Management released a report showing that the US manufacturing sector was growing rapidly. More manufacturing means there are more goods that have to be shipped all over the country, and that means there will be more trucks on the road using up diesel fuel. Demand for diesel affects the price of heating oil futures because, as Bloomberg says, “Heating oil is traded as a proxy for diesel.”
Because there is no diesel contract available on the NYMEX, end users of diesel fuel who want to hedge their risks in the futures market have to trade a contract for a different commodity. They could trade crude oil futures, or gasoline futures, or soybean futures, for that matter—anything that they thought would allow them to compensate for a change in the price of diesel. Since diesel and heating oil are both distillate fuels, the prices of each are affected by similar factors (the price of crude oil, rates of refinery activity, etc.) and any change in the price of diesel is likely to be closely reflected by a change in the price of heating oil futures on the NYMEX. For that reason, end users of diesel typically hedge with heating oil futures. Other participants in the heating oil market are aware of this, so expectations of increased diesel demand have much the same effect as expectations of increased heating oil demand—it drives up heating oil prices.
To see how this works, imagine that you owned a trucking company. You would look at Monday’s manufacturing report and conclude that your business was about to pick up. But with all your trucks on the road—and everybody else’s trucks—driving up demand for diesel, fuel prices might rise. If you wanted to hedge against the possibility of rising prices you couldn’t buy diesel futures, but you could buy contracts for a different oil product: heating oil. To protect yourself from high diesel prices in July, you could buy heating oil futures for July delivery. That wouldn’t change the amount you paid for diesel in July; if diesel prices did increase, you would pay more for the diesel you used. However, if the price of heating oil increased by a similar amount, you could sell your heating oil futures for a profit and make up for the extra money you’re spending on diesel fuel. In the short term, if you and enough other people reach the same conclusions following the manufacturing report, demand for heating oil contracts will rise and the price of heating oil will increase.
The relationship between heating oil and diesel in the futures market could soon reverse. The CME Group, which owns the NYMEX, has announced that it will discontinue its heating oil futures contract after August 2012. That contract will likely be replaced by a contract for ultra-low sulfur diesel. While that may seem like a significant change—heating oil is out of the market, diesel is in—there will likely be a smooth transition and the same people could trade the contract for the same purposes. Instead of heating oil futures being a proxy for diesel, diesel futures could be a proxy for heating oil.
Heating Oil Weekly Roundup: Derivatives Trading, Peer Pressure Failure, and the Gulf of Mexico Oil Spill
(image: nydailynews.com)
While financial reform proceeds in the Senate that would regulate the over-the-counter derivatives market—which, before it toppled the global economy, was worth about $600 billion—Michael Greenberger takes a look back and offers a history of the derivatives market at The American Prospect.
Many schemes have been tried to get people to cut back on their energy use, but a utility company California seemed to hit upon a winner when they put peer pressure to work for them and started informing people whether they were using more energy, or less, than their neighbors. After people found out how they stacked up against similar households, they cut energy consumption by an average of 2 percent. There’s only one problem, says Roy Fisman at Slate: it didn’t work on Republicans, who increased their consumption by 1 percent.
As the oil spill in the Gulf of Mexico approached shore, and the Coast Guard worked to set it on fire, Andrew Revkin at the New York Times’ Dot Earth blog explained how burning an oil spill is an effective response. For video of the burning oil, check out Tom Fowler’s NewsWatch: Energy blog for the Houston Chronicle.
By Tuesday, BP had already recovered 35,000 gallons of oil from the spill. What happens to all of that? Joshua Keating at Foreign Policy has the answer. Some can be recovered and reused, some gets tossed in a landfill, and some gets the Coast Guard treatment—it gets incinerated.
Financial Regulation Bill Advances to Senate Floor
Jimmy Stewart filibusters in Mr. Smith Goes to Washington. For now, the Republicans have ended their filibuster of financial reform. (image: bcblue.wordpress.com)
Republican senators ended a three-day filibuster on Wednesday that had kept a financial reform bill from being debated on the Senate floor, reported the New York Times. While the bill is no longer blocked from floor debate, it may still be a long way from being approved. And while the end of the filibuster may be a victory for Democrats, Republicans said they won significant concessions before moving the bill to the floor.
The legislation is sponsored by Sen. Chris Dodd (D-CT) and proposes what the Times called “the most far-reaching overhaul of the nation’s financial regulatory system since the aftermath of the Depression.” Part of that overhaul would involve the increased regulation of derivatives, the financial instruments blamed for triggering the recession. Dodd’s bill is currently separate from a bill proposed by Sen. Blanche Lincoln (D-AK), which is aimed more squarely at curbing speculation in commodity futures markets, including speculation on crude oil and heating oil, but the two bills will likely be incorporated into a single reform package.
The Republican filibuster, which began on Monday, had been against cloture, a procedural motion that would have officially started debate over the financial regulation bill. Democratic senator Jeff Merkley from Oregon told the Huffington Post that the filibuster forced financial reform to be negotiated behind closed doors:
By voting against cloture, Republicans are voting to keep Wall Street negotiations behind closed doors, demanding changes to the bill without public scrutiny. Instead of closed-door deals, they should support open floor debate.
Democrats say they made no promises to change the bill and that Republicans relented because it looked bad to discuss Wall Street regulations in secret. However, Republicans claim that they wrung real concessions from the Democrats, including an agreement to nix a provision for what had been tagged a “bailout” fund, according to the Times:
In particular, Republicans said they had won the elimination of a proposed $50 billion fund that would be paid for by big financial companies and would be used to help pay for putting failed banks out of business.
Though the filibuster of the cloture motion has ended, another filibuster could block the bill from passing. Before any final vote takes place, though, representatives from both sides of the aisle have promised a genuine debate. Sen. Bob Corker (R-TN) said, “This may be a real debate, which might shock America,” and Dodd called for “a serious, vigorous debate.”
With the price of heating oil consistently climbing based on an expectation that demand for diesel fuel is about to rise—a price increase that may make sense to commodity traders, but not heating oil consumers—a vigorous debate is the least the Senate could do for consumers.
CFTC Fines Morgan Stanley $14 Million for Unreported Crude Oil Trade
The investment bank Morgan Stanley owes $14 million for violating the NYMEX rules on block crude oil trades. (image: thisislondon.co.uk)
The CFTC hasn’t made any announcement yet regarding position limits on energy commodities, but the commission is already showing its teeth, reports Reuters. On Thursday the CFTC fined leading investment bank Morgan Stanley $14 million for its failure to report an oil trade in 2009. In a separate settlement, the CFTC fined Moore Capital $25 million for trades that attempted to manipulate palladium and platinum prices.
The fines were the result of settlements that followed CFTC investigations of the trades. Neither Morgan Stanley nor Moore Capital admitted to or denied the charges, and both released statements that pinned the blame on former employees. From Morgan Stanley:
As the CFTC indicates, this matter concerned an isolated request by a former Morgan Stanley trader.
From Moore Capital:
Neither Moore Capital’s principals nor its current management were involved in any improper trading, and none have been accused of any wrongdoing.
Morgan Stanley’s fine resulted from a block crude oil trade with UBS in February 2009. Block trades, which involve large numbers of contracts, have to be reported to the New York Mercantile Exchange (NYMEX) within five minutes of the transaction. The CFTC alleged that a trader with Morgan Stanley and a UBS broker agreed not to report the trade until after trading had closed for the day. The Wall Street Journal reported that Morgan Stanley sold 33,110 April 2009 crude oil contracts and bought 33,110 March 2009 contracts in the trade. UBS faces a $200,000 fine for its role in the deal.
In addition to the penalty, the CFTC told Morgan Stanley to improve its training for traders and tighten its monitoring of block trades at the NYMEX for three years.
The public comment period on the CFTC’s proposed position limits on energy commodities ended on Monday, and the commission has yet to say whether or not it will seek to carry out its proposal. However, between Thursday’s fines and Tuesday’s ruling to bring seven electronically traded natural gas contracts under its regulation, the CFTC has been active and shown a readiness to flex its regulatory muscle. This could be a sign that oil traders like Morgan Stanley and Goldman Sachs may soon face position limits and a stronger, more assertive CFTC that will hopefully bring lower and steadier crude and heating oil prices.
Oil Analyst Schork Is Skeptical of Latest Heating Oil Rally
As Stephen Schork makes clear, abundant distillate inventories undercut the logic behind rising heating oil prices. (image: XcBiker via flickr.com)
Heating oil futures have split from crude oil futures at times this April, rallying even as the price of crude falls. The price of heating oil doesn’t always follow a strictly seasonal pattern—price can fall dramatically in the winter, and gains can be made in the summer—but it is surprising to see the price of heating oil rise with total indifference to falling crude prices at a time when warm weather has cut into heating oil demand.
There have been competing explanations for this phenomenon. It could be arbitrage between the European and US heating oil markets. Or perhaps heating oil prices are behaving normally, and it’s the price of crude that is oddly weak. But one factor that comes up again and again is that growing demand for diesel is propping up the price of heating oil. Like heating oil, diesel is a distillate fuel, and traders use the heating oil contract as a benchmark for diesel prices.
Oil analyst Stephen Schork, who authors the influential daily newsletter The Schork Report, confirms that the price of heating oil has been affected by expectations that demand for diesel is set to increase. However, as Schork points out, that demand has yet to materialize. As he puts it, if trucking activity is supposed to use up all the supplies of ultra-low sulfur diesel, then “why aren’t we seeing it?” Instead, inventories of ultra-low sulfur diesel have followed the pattern of distillates in general—they’ve gone up, adding 1.37 million barrels last week.
Distillate inventories overall are even more oversupplied, says Schork:
Total distillate stocks rose by a large 2.9 MMbbls [million barrels] to 151.82 MMbbls. To put that in perspective, it is the highest value ever recorded for April.
Heating oil users may be able to accept that demand for diesel fuel inflates their costs to heat their home, but it is grating to find out that the growing demand for diesel is a fiction and supplies are higher than they’ve ever been for this month of the year.
So are heating oil prices headed for a fall? Will traders see that prices are out of whack? Schork isn’t sure, and quotes some bitter wisdom from the economist John Maynard Keynes: “The market can stay irrational longer than you can stay solvent.”
Perhaps the three-headed push for regulation and accountability—by the CFTC, the SEC, and Congress—can inject some rationality into the market, and bring prices to a level that, if not low, can at least be seen as fair.
Is Cheap Crude Oil Responsible for High Heating Oil Crack Spread?
A high crack spread (that is, profit margin) for heating oil is good news for refiners, but consumers might be relieved to know that the crack spread could be narrowing. (image: treehugger.com)
It’s the middle of spring and people are thinking ahead to summer vacation and air conditioning, but the price of heating oil has been unfazed by the end of winter. In fact, heating oil futures on the New York Mercantile Exchange (NYMEX) have been much stronger than crude oil futures. Reuters reported on Tuesday that it hasn’t been this profitable to refine (or “crack”) crude oil into heating oil since May 2009. The profit margin on producing a barrel of heating oil—the price difference between a barrel of crude oil and a barrel of heating oil, also called the heating oil crack spread—is $12.67, giving heating oil an unusually high premium over crude oil.
So why, even as the price of crude oil falls, has the price of heating oil stayed relatively flat or, on some days, even increased? There are two competing explanations, and both hinge on relationships between different fuels and different futures contracts that are usually only of interest to oil traders.
One school of thought says that expectations of higher fuel demand has increased the price of heating oil, even as the heating season ends. The catch? The demand is for diesel fuel, not heating oil. However, traders often use the heating oil futures contract on the NYMEX as a proxy for diesel, so the expectation that economic recovery will soon spike demand for diesel as trains and trucks will increase activity has propped up heating oil prices. According to this interpretation, heating oil users are suffering from oil traders’ practice of using heating oil as a stand-ion for diesel.
A second school of thought says the real story is not the high price of heating oil but the low price of crude. There are actually a wide variety of crude oil contracts traded on commodity exchanges, but the US benchmark for crude oil—the contract and the price that people have in mind when they say “crude oil”—is West Texas Intermediate (WTI) crude. Though WTI crude is typically more expensive than the Brent crude that functions as the European benchmark for crude oil, Brent crude has recently traded at a premium to WTI, says the FT Energy Source blog.
That’s because inventories of WTI crude, which are stored at a hub in Cushing, OK, have swelled to the point that some analysts think the storage facilities are nearly at capacity. With such high inventories, the value of WTI has fallen sharply, especially for the front-month contract. Prices for later months have not declined as much, putting WTI crude in contango. According to this interpretation, it is only an illusion that heating oil prices are high in comparison to other oil commodities; the high crack spread for heating oil has little to do with the “strength” of heating oil and a lot to do with the tumbling price of WTI crude oil.
If heating oil users have been following oil prices recently they’ve likely been frustrated to see the price of heating oil stay flat as the price of crude oil slides, but the situation could be changing. Today’s EIA inventory report showed that supplies of distillates, the category of fuel that includes heating oil and diesel, increased by 2.9 million barrels. That substantial build could reflect an effort by refiners to capitalize on the high crack spread for heating oil. However, by boosting distillate inventories refiners may have cut into their own profit. So far today, the price of heating oil has fallen by roughly 1.6 percent, while the price of WTI crude has only lost 0.5 percent, narrowing the crack spread between crude oil and heating oil. If that pattern holds throughout the day, heating oil users will receive a welcome break in prices.
Survey: Speculation Is Cause of High Oil Prices, Costs Consumers $300 Billion a Year
Speculators’ dollar involvement in the US commodity futures market has ballooned in the last decade. The majority of experts believe this trend is a direct cause of higher and more volatile oil prices. (image: dinocrat.com via Bloomberg and the CFTC)
It’s official: the view that increased speculative activity in oil markets has brought higher prices and more volatility is the majority opinion.
Reuters reported on Tuesday that a survey of professionals in all segments of the oil industry showed that nearly 75 percent of respondents believed that speculation has raised oil prices above the level determined by supply and demand alone. According to the report, the extra boost to oil prices provided by speculators costs consumers of oil products $300 billion per year.
Among those surveyed, estimates of how much speculation has inflated oil prices ranged from $10 to $30 per barrel. Using the low-end estimate of $10 per barrel, Reuters found that oil producers reap $300 billion in extra profits per year—profits that come directly out of consumers’ pockets. Although speculation in commodities markets has been growing since major deregulation in 2000, close examination of its effects on prices only began after the price of crude spiked at $147 per barrel in July 2008. Speculation has been linked to the price spike, and 73 percent of respondents in the Reuters survey said that the spike was not caused by factors related to supply and demand.
Scrutiny of speculation’s influence on oil prices has intensified in the last six months, as low demand and overflowing supplies pointed to lower oil prices but the prices of crude and other oil products steadily increased.
Reuters surveyed “40 major figures in the oil industry,” including “bank analysts, traders, hedge funds, brokers, refiners, exchanges, consumers, consultants and academics.” The results of the confidential survey pointed to a clear consensus in the industry:
73 percent thought increased speculation had boosted prices above the level dictated by supply and demand, with only 17 percent saying it has had no impact.
Analyst Eugen Weinberg of Commerzbank offered his take on the subject, which provides a good summary of the majority view:
investment inflows into the market over the last years did contribute to the price increases, and heightened speculation brought more volatility.
In public discourse, financial interests continue to deny speculation’s influence on oil prices and cast speculators as important market players that allow for hedgers and other business interests to make sound investments. Analyst Phil Flynn of PFGBest told Reuters that speculators are currently serving to ready the market for a soon-to-come upswing in demand:
With the huge growth of China in recent years, we have had some of the greatest demand growth ever for commodities. The value of speculators coming into the market is that they allow the needed investment in future supplies.
The survey results were released as many business interests and market players eagerly anticipate announcement of new energy trading regulations by the Commodity Futures Trading Commission (CFTC), which wrapped up a three-month public comment period on the regulations on Monday. The CFTC has proposed “position limits” on certain energy commodities (including crude oil and heating oil), which would cap the amount of contracts one party could hold at a time.
Most survey respondents echoed initial reactions to the CFTC’s announcement of position limits: they are too generous and will therefore be ineffective at reining in price volatility.
But while 64 percent of those surveyed favored increased regulation, only 41 percent said the current CFTC proposals would be successful. Almost a quarter said the limits did not go far enough or saw ways for traders to circumvent the rules, while 35 percent said they risked doing more harm than good.
Through a confidential survey of experts, Reuters has made clear the consensus view on speculation and its relation to oil prices:
- 1. Speculation has significantly inflated oil prices in recent months and brought more volatility to the energy markets
2. Increased regulation is needed to curb speculators’ influence
3. Regulations proposed by the CFTC are too weak to address the issue
The first and second points above fit in with the larger trend toward tighter financial regulation marked by reform bills currently under consideration in Congress, and it seems momentum is building toward reforms that could actually bring lower and more stable prices of crude, heating oil, and gasoline in the near future. Perhaps this momentum will allow for new steps to be taken that will address or supersede the CFTC position limits that many view as inadequate and bring the real change consumers so desperately need.
