Counting the cost of speculation

OPEC Bulletin Commentary August-September 2014

If there is one thing that OPEC has learned over its long and eventful history it is that one cannot afford to treat the international oil market with complacency. Do so at your peril. Of all the commodities traded on global exchanges each and every day, oil is perhaps the one that attracts the most interest and attention.

From government offices to specialist media houses the world over, all eyes are on the daily ticker bringing the latest information on the price of crude oil. Little wonder some refer to it as ‘black gold’. It might not glitter in its crude form, but oil is undeniably precious. It is in high demand every day of the year and that is something that will remain for the foreseeable future. In fact, all reliable forecasts show that oil’s importance to the global economy will only heighten in the years ahead.

That is why whenever there is any marked change in the price of crude on the various energy exchanges, the alarm bells start to ring — particularly among the producers and consumers, both of which have vested interests, albeit different, in maintaining a certain price range.

As anyone involved in commodity trading will tell you, mild movements in prices are a healthy and accepted part of proceedings: some days the bulls win, some days the bears, but usually the highs and lows eventually balance out.

But when that volatility becomes extreme, with wild and uncontrollable swings, then it takes on a whole different story. The very fabric of the trading structure comes under threat. Under this type of scenario, there are no winners — apart from the unscrupulous speculators that cause it, of course.

The fact is, OPEC has been having to deal with speculation for most of its existence. Since the summer of last year, the price of OPEC’s Reference Basket of crudes — a valuable barometer on international pricing — has averaged around a steady $105/barrel. This has been acceptable to all parties associated with the oil sector — the producers, the consumers, and the oil companies alike. But most importantly, prices have remained relatively steady, with limited volatility, meaning that the stakeholders could plan accordingly.

However, in the last few months, prices have slumped — in fact they are now some $10/b lower than in July. And according to the OPEC Secretariat, the actions of speculators are again behind much of the price decline. The Organization’s Monthly Oil Market Report (MOMR) for September observed that, interestingly, these individuals are the same ones that sent prices to new highs earlier in the summer.

The report noted that speculators operating in the two main crude oil futures contracts reduced their net long positions by nearly 50 per cent in August, exerting significant downward pressure on prices over the month. It noted that, over a two-month span, as prices plunged by over $10/b, hedge fund and other money managers trimmed their net long positions by a hefty 73 per cent and 45 per cent in ICE Brent and Nymex WTI futures, respectively.

Their actions left the respective positions at their lowest level in almost two years. This is indicative of the kind of speculation oil markets have had to suffer in recent times, action that not only destabilizes trading patterns, but creates great uncertainty. This, in turn, makes it difficult to plan, going forward.

Seemingly, lessons have been learned. Since the financial crisis in 2008, there have been moves among regulators to at least limit the extent of the speculation seen on global exchanges. This is a good development. But unfortunately, where there are quick gains to be made, speculation will always be a feature in commodity trading, especially in oil.

OPEC’s position on the oil market has always been one of responsibility, continually searching for the stability and continuity that enables economies to run smoothly and prosper. Yet, it cannot tackle all the problems alone, nor should it be expected to.

The Organization needs the help of all other stakeholders — for them to show the same level of commitment, especially in such challenging times. A multilateral world quite simply requires a multilateral approach with all parties pulling in the same direction.

Unilateral actions borne out of self-interest are not only unhelpful, but risk placing us all on a slippery slope.

OPEC Bulletin August-September 2014

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