The oil market's response to the expected announcement of production quota cuts by the Organization of Petroleum Exporting Countries seems, at first blush, to validate what the group has been saying: that persistently high oil prices are the result of factors to a large extent outside its members' control.
While drawing up plans for another quota cut, by 1 million b/d effective Apr. 1, OPEC members—notably traditional price moderate Saudi Arabia—have cited concerns over a misread of the market that holds that overall oil inventories are more plentiful than is widely believed. The group also has pointed to the relative tightness of availability of light, sweet crudes on the market, as well as to the chaotic state of the US gasoline market. And the group has been concerned about the weakened state of the US dollar, the currency that underpins oil trade.
In the days following the Mar. 31 decision to implement the cut in OPEC quotas, oil prices fell in response to circumstances specific to the US market. Prices fell the day of the OPEC meeting, as the US Energy Information Administration reported a surge in US crude oil inventories. The next day, oil prices fell further—by almost $1.50/bbl on the New York Mercantile Exchange's next-month contract—after US Energy Sec. Spencer Abraham announced that the Bush administration is considering waiving rules for reformulated gasoline specifications in key areas of the country in a bid to ease high gasoline prices. (It also helped that, the same day, Saudi Arabia pledged not to allow any shortages in the oil market.) Conversely, oil futures improved a bit on reports of a strengthening US dollar.
Overall, oil prices dropped by about $3-4/bbl from their winter peaks of $37-38/bbl (for NYMEX crude) as the date that OPEC set for the new cuts to take effect drew near. That points to evidence of oil traders' profit-taking following a surge in speculation over not only the impending OPEC cuts but also the tenuous state of US crude and gasoline supplies. Indeed, analysts' comments in the wake of the OPEC cuts were tinged with bearishness, suggesting that the actual cuts wouldn't amount to much because of OPEC's current production being well over existing quotas—a circumstance borne out by little slackening in contract liftings in time for the Apr. 1 cuts.
Market speculation
In its Apr. 2 global oil report, London-based Centre for Global Energy Studies notes that long positions held by noncommercial traders in NYMEX crude futures are indeed at record levels. This would lend support to the claims that oil prices are being distorted by growing numbers of speculators.
But CGES argues that there is no evidence to support the idea that changes in the open-interest positions of speculators (or hedgers, for that matter) drive changes in oil prices. In fact, CGES says, the reverse appears to be true—that changes in oil prices lead to changes in the open-interest positions. In other words, hedgers and speculators are trend followers, adjusting their open-interest positions over periods of a week or more in response to shifts in the oil price.
Changing expectations
CGES contends that its analysis shows that market speculators are just logically following broad oil market price trends.
"If oil prices rise over a sustained period of time—as, indeed, they have over the past 2 years—this creates expectations of further price rises," it said. "In these circumstances, it is perfectly reasonable for a growing number of speculators to want to enter the market to buy futures contracts. However, this does not mean that they are responsible for driving prices up."
Thus it follows that speculators have a much greater influence on the market by giving it greater liquidity. In a rising market, speculators are prepared to buy futures contracts at a time when many hedgers are reluctant to do so, CGES says. But speculators will continue to buy only as long as they expect prices to go on rising. If hedgers don't share speculators' price expectations, then fewer hedgers will enter the market.
"Speculators alone cannot be blamed for a major shift in expectations that is clearly shared throughout the industry," CGES said.
Much of such raised price expectations can be attributed to OPEC's own recent success with micromanaging oil supplies to defend prices. So if OPEC is a victim in this debate, it appears to be, at least in part, a victim of its own success.
(Online Apr. 5, 2004; author's e-mail: [email protected])
