How big specs trapped bears & caused steep oil rally

By Neil Behrmann

June, 2008:- Shaul Mofaz, a prominent Israeli cabinet minister is being blamed for the latest spike in the oil price by saying that an Israeli attack on Iranian nuclear sites is "inevitable".

Market traders, however, say that oil bears who were caught unawares, were responsible for the price surge. These speculators, including energy hedge funds and commodity trading advisors had sold oil derivatives short at prices of $122 to $127 a barrel. Traders contend that major speculators, that could include Iran, Middle Eastern sovereign wealth funds, possibly Russian energy companies and hedge funds, snared the bears by buying and pushing up prices. Panic stricken oil bears were forced to buy back their derivatives at a loss, thus causing the steep spike in prices to a record $138.5 a barrel last week.

Bear covering rallies have been part of the pattern in the six year bull market. The bulls wait on the edge of the ring as prices fall. (In this latest example, several technical services recommended short sales as oil first fell from $135 to $122.). They assess the sell positions.  They then enter and gorge bearish speculators and commercial concerns that are genuinely trying to hedge against falling prices. In this way they curb supplies, as they scare off commercial hedgers and speculative bears.

Iran could be involved in price rigging

Crude oil fell back to around $136 a barrel on Monday when Saudi Arabia stressed that oil supply demand fundamentals didn't justify current extraordinary quotes. Unfortunately, from various statements and speeches, it appears that the Iranian regime is involved in price rigging.  It is aiming at $150 a barrel or more to increase its leverage in the nefarious objective to obtain nuclear armanents and stir up trouble in the Middle East. President Mahmoud Ahmadinejad has stated that he believes that the oil price is still low and "should find its real value".


Supply demand fundamentals caused only part of price surge

Some analysts continue to maintain that there is a shortage and won't buy the argument that speculators have played a big part in boosting oil prices from their low of $19 in 2002 to around $70 in 2007 before almost doubling again in 2008. Yes, there is some justification for price increases. Total world oil demand has risen by 7.5% since 2002. China's crude oil demand is up from 6.3% of global demand in 2002 to the current 9% and Indian consumption has also risen. The Iraq war and periodic supply disruptions were other factors.

These supply demand fundamentals justified a trading range of $50 to $80 a barrel, so the rest has to be speculation, hoarding or so called "investment".

(Note, the marginal increase in demand or supply can cause big price moves and volatility. So if the speculators have the money, they can lever the price for a long time. But the higher the prices, the harder for them to keep the Ponzi scheme going. In the end, prices crash.)

A recent International Energy Agency report showed that global oil supplies of around 87.3 million barrels a day, were slightly more than physical demand. With this narrow gap it is easy for speculators to push prices up or down. But there is no shortage of oil.  Global oil inventories of Organisation For Economic Cooperation & Development (OECD) nations amount to 4.1 billion barrels of oil, equivalent to 83 days demand. This includes government strategic stockpiles of around 1.5 billion barrels.

Huge speculative trading and positions

According to the Commodity Futures Trading Commission (CFTC), open WTI crude oil bull and bear positions were 2.9 million contracts on June 3. This is equivalent to 2.9 billion barrels of long and short positions worth $400 billion. The massive position compares with around 780,000 contracts in June 2005. The nominal value of swap dealings of hedge funds and commodity index products on the over-the-counter market (OTC), according to the Bank For International Settlements was $9 trillion at the end of December 2007. This compares with $1.4 trillion in 2004. The majority of these derivatives relate to oil and other energy products.

Sales of a fraction of strategic stockpiles would hit speculators

The extent and growth of commodity derivatives trading illustrates why the CFTC, UK & other regulators, FBI, the CIA and other intelligence agencies are investigating possible manipulation in the markets. Economists and market participants fret that governments and regulators, have so far failed to act to curb extensive speculation. In terms of an IEA agreement, strategic stocks, currently 1.5 billion barrels, cannot be used to counter speculation. Traders believe that the current oil shock is an emergency and a sale of only one day’s supply i.e. around 87 million barrels plus the threat of more, would be sufficient to unsettle speculators.


Heating oil surge hurts consumers     


Impact on economies

Sky high crude oil and product prices from heating oil, gasoline to jet fuel, have raised fears of a US and European inflationary recession and worries that global stock markets could slide further. Economists and analysts are concerned that business profits are being hit by the treble whammy of the credit crunch, rising energy and raw materials costs and declining consumer demand.

The worry is that the European Central Bank, Bank of England and other central banks will raise interest rates, while businesses and consumers are struggling under the burden of a credit crunch. Rising oil prices and other raw materials raise business costs and reduce spending power of consumers. Unemployment in the US jumped to 5.5 percent from 5 percent and is expected to rise in Europe. The downturn in the US and European economies will dent Asian exports.

The failure of energy ministers from the Group of Eight industrial nations to propose concrete short term measures has increased concerns. At the meeting in Japan last weekend, they once again appealed to OPEC to increase output. But OPEC has its own agenda. The G8 ministers also committed themselves to increased investment in energy efficiency and alternative technologies, but admitted that this was a costly long term solution.

About Neil Behrmann

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