Speculators in 'hibernation'

US House Minority Leader Nancy Pelosi (D-Calif.) called for Congressional action against speculators in the futures market, blaming them for the run-up in oil prices and cost of gasoline at the pump. But the Centre for Global Energy Studies (CGES), London, recently reported, “Speculators in the oil market seem to be in hibernation, for our index of speculation intensity has been declining since the beginning of October and is now at its lowest point since early June.”

Speculators must have long futures positions “at least to the extent required to cover the hedgers’ net short positions” in the market, CGES analysts explained. “Therefore, when the speculators are increasing their short positions it must indicate that they are engaging in pure speculation, requiring in turn other speculators or hedgers to go long, for the futures market must always balance.”

But that’s not happening. Instead, large-scale, noncommercial speculators have been reducing their short positions since late October regardless of whether the price of West Texas Intermediate was rising or falling, as have small-scale speculators. “Little wonder that our index of speculation intensity is at low ebb,” CGES analysts said.

Consumer-hedgers typically take long positions in crude futures and “tend to benefit when spot prices settle on a rising trend, especially if these consumers are engaged in a rolling hedge.” Their gains likely will be lower in this quarter “because the lagged third-month futures prices have been rising faster than the expected increases in spot WTI. Nonetheless, their returns are likely to remain positive, “which should keep hedger demand for futures contracts healthy,” CGES reported. “In contrast, the producer-hedgers will have been making corresponding losses on their rolling hedges, which should reduce their desire to sell these contracts,” said CGES analysts.

Although the level of “pure speculation” is low, most participants in the New York Mercantile Exchange futures market expect oil prices to rise. “The only group expecting WTI prices to decline are the commercial shorts, the oil producer-hedgers, who increased substantially their short positions between the weeks ending Jan. 3 and Feb. 7, taking advantage of what they presumably perceived as strong enough prices along the forward curve,” said CGES analysts.

“Strong expectations that the price of oil will indeed rise into the foreseeable future would seem to be justified by the fundamentals of the oil market right now,” they said. “There have been seven consecutive quarters of global stock draws since the second quarter of 2010, which have taken global forward stock cover down from 70 days’ worth at the start of 2010 to below 63 days at the beginning of this year.” Moreover, data indicate production from countries outside the Organization for Economic Cooperation and Development are likely to decrease by 330,000 b/d in this quarter, “at a time when question marks are being raised about Nigerian supplies and the Iranian crisis keeps rumbling on.”

Market fundamentals

Meanwhile, analysts at Barclays Capital Commodities Research observed, “A seriously warm winter and a series of extremely weak OECD demand indications paved the way for further downgrades to demand and demand expectations. This should have then allowed for the almost barren inventories to fill and provide somewhat of a cushion to tightening fundamentals in the second half of the year.”

That hasn’t happened either. Despite late winter weather in Europe, rising Asian demand helped absorb extra OPEC production. Barclays Capital analysts report Asian and former Soviet Union oil demand is growing faster than markets can price in. Global oil demand may be disappointing but “it is not declining, contrary to market expectations,” they said.

In the interim, non-OPEC production declines have intensified, so what was once an OPEC surplus “has now become a necessity to simply maintain the status quo,” said Barclays Capital analysts. “Not surprisingly, inventories have failed to build and are once again more than 50 million bbl below the seasonal averages.” They estimate sustainable spare capacity in the market has dropped below 2 million b/d. “With European policymakers now on a clearer path to protect global markets from potential spillover from a disorderly Greek default, downside risks from a complete macroeconomic economic meltdown are receding fast, too. However, geopolitical risks are on the rise, with the escalating tensions about Iran manifesting itself in a series of proxy wars, while a messy end-game is becoming increasingly likely.” With limited safeguards against potential geopolitical mishaps, Barclays Capital analysts said, “The backdrop of the oil market is getting uneasy, and maintaining a deep short position would not be wise, in our view.”

(Online Feb. 27, 2012; author's e-mail: samf@ogjonline.com)

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