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Friday, July 03, 2009

Bike Messengers And Oil

The impact of unregulated futures exchanges can be intuitively seen in this story:
The startling spike in oil prices to their highest level this year on Tuesday was caused by a rogue broker who placed a massive bet in the Brent oil market, triggering almost $10m (€7m) of losses for his company.
Oil traders in London and New York said the “unauthorised trading” explained the exceptional spike in business activity and prices in the early hours of Tuesday that some initially thought must have been caused by a geopolitical event.
Traders said the broker implicated had allegedly accounted for at least half of the unusual activity, with the rest the result of others chasing the rally.
No matter how stupid a big trading move, you can usually get a decent number of people to follow. If there are a couple of stories out there about oil going to $200 a barrel, the atmosphere is favorable. This time it wasn't, since a bunch of reports had just been issued suggesting otherwise (i.e. summer price peak of gasoline already here, high supplies, world demand not to reach previous peak for years).

If everyone knows who is doing what, murky movements on the exchanges can be rebutted (for a profit) by more knowledgeable traders. Commodities exchanges overall reduce the price of commodities because they tend to forecast supply/demand changes and signal producers to adjust earlier. That is to the good. But really murky thin trading can cause rampant speculation. See this June 08 article discussing some of the problems with ICE.

In our current situation, in which returns on bonds are very low and currency risks are very high, commodity speculation is likely to be used as a hedge. That is okay only to the point at which has not yet divorced from the fundamentals of physical contracts.

I have no doubt that ICE and other means are currently being used by oil producers to prop up oil prices. While fundamentally evil and despicable I still hope for the proper outcome; their getting a taste of Mr. Market reasserting.

The above ground oversupply is getting so serious I am beginning to worry about the reset effects resulting in outright disruptions. If House of Saud goes the way of the Shah it will be decades before they are reliable partners again.
There's a very good post on the distortion of the commodity markets by speculators at (in)efficient frontiers: Why Crude Oil Traders Should Also Worry About Wheat
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