The Effect of Financial Speculators on Crude Oil Prices

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Presentation transcript:

The Effect of Financial Speculators on Crude Oil Prices

Price Volatility The possible impact of financial investors on futures and spot prices would depend on their investment and trading strategies. Passive index investors, who are investing money in commodity markets and holding that investment for long-term gain, typically hold funds in the most liquid short-term futures months. active investors tend not to take large one- way directional bets. Trading tends to occur in spreads, either between months or other related commodities, meaning that such participants are rarely exposed to any flat price risk.

Do Financial Speculators drive or stabilise the crude Oil market? Theory 1: speculative drivers of volatility Theory 2: The stabilising role of speculation

Theory 1: speculative drivers of volatility In this scenario described the logical response of passive long-only investors would be, to a degree, driven by the relative price structure of the futures price curve. For example, if strong contango markets persisted for a long time, passive long-only money would be likely to exit. Equally, the price structure of the futures curve may limit how far a higher futures price affects the spot price.

Theory 1: speculative drivers of volatility For instance, in a steeply backwardated market, even if futures prices increased, it may well be the case that the backwardation persists. The net effect would be that the increase in the futures price would not prove to be enough of an incentive for producers to divert oil for immediate spot delivery (where prices are higher) to future sales (where prices are lower). Thus in backwardated markets, it is not clear whether a temporary boost to future prices would necessarily affect inventory storage levels.

Theory 1: speculative drivers of volatility Complex links between the futures markets, physical markets and products market may also tend to limit the scale of price divergence from true fundamentals. A market which is focused on complex relativities and spreads may be less likely to be subject to self-reinforcing divergence from equilibrium than one focused primarily on overall price levels.

Theory 1: speculative drivers of volatility Despite the complexities, however, it seems clear that if a major new category of investor enters the market with the intent of building and holding long-only positions it is unavoidable that there will be a temporary boost to futures prices and possibly, to spot prices.

Theory 2: The stabilising role of speculation oil price volatility that are present even if financial speculators are absent.  passive long-only investors who have already achieved their desired allocation and who now follow a strategy of keeping a balanced or fixed proportion portfolio of various asset classes, then these investors will now tend to be systematic sellers of the market when prices rise and to be buyers when prices fall, playing a stabilising anti-momentum role.

Theory 2: The stabilising role of speculation If there are thoughtful active investors who truly do analyse the fundamentals of supply and demand carefully, and do so more effectively than the commercial participants then their activity can help make the market more efficient. The existence of active traders – taking both long and short positions – can also help increase the day-by-day liquidity of markets, increasing the ability of producers and consumers to match future commercial needs in large quantity and at better bid-offer spreads.

Theory 2: The stabilising role of speculation … we recognise that it is possible to construct theoretical arguments that suggest financial investor involvement can play an important role in equalizing price deviations.