Fundamentals, Speculation, and the Pricing of Crude Oil Futures

Master's Thesis, 2011

82 Pages, Grade: 8,0


Table of Contents

List of Abbreviations

Index of Tables

Index of Figures

1 Introduction

2 The Market for Crude Oil
2.1 Fundamentals of Physical Crude Oil Demand and Supply
2.2 Financial Markets for Crude Oil
2.2.1 Ways of Gaining Exposure
2.2.2 Participants in Financial Commodity Markets

3 Regulation and Commodity Derivatives Speculation
3.1 Current Commodity Futures and Derivatives Markets Regulatory Regime
3.2 Debate about Commodity Speculation and Proposed Regulatory Measures

4 Literature Review
4.1 Related Studies
4.2 Contributions of this Study

5 Data
5.1 CFTC Position Data
5.2 United States Oil Fund Position Data
5.3 Financial Markets Data
5.4 Physical Storage Data
5.5 Time Series Derived from the Raw Data

6 Methodology
6.1 Correlation
6.2 OLS Regression Model
6.3 Granger Causality

7 Results and Interpretation
7.1 Correlation Analysis
7.2 OLS Regression Analysis
7.2.1 Weekly Regression Analysis
7.2.2 Daily Regression Analysis
7.3 Granger Causality Analysis

8 Conclusion



This study finds that while a large part of the variation in crude oil futures prices is driven by fundamental factors, financial investment and speculation has the potential to aggravate reactions to changing fundamental variables and furthermore move prices on its own. The evidence is gathered by performing linear regressions and Granger Causality tests on futures returns, position data of different categories of futures traders on the New York Mercantile Exchange and proxies for relevant fundamental factors such as equity and exchange rate returns gathered from August 2006 to December 2010. While higher prices for crude oil naturally come along with increasing physical demand and finite world supply, future regulation might temper market volatility and guarantee that prices reflect a sustainable physical market equilibrium.

List of Abbreviations

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Index of Tables

Table 1: Time Series Employed in the Statistical Analysis

Table 2: Suggested AR Lengths by BIC

Table 3: Correlation between Weekly Time Series

Table 4: Correlation between Daily Time Series

Table 5: Weekly Full Sample Regression Results

Table 6: Weekly First Subsample Regression Results

Table 7: Weekly Second Subsample Regression Results

Table 8: Reactions of Trader Categories to Fundamental Information

Table 9: Daily Regression Results

Table 10: Weekly Granger Causality Test Results

Table 11: Daily Granger Causality Test Results

Index of Figures

Figure 1: WTI Spot Prices, Volatility and U.S. Recessions

Figure 2: World and U.S. shares of Energy Supply Resources

Figure 3: Global Petroleum Consumption

Figure 4: Global Petroleum Production

Figure 5: U.S. Field Production of Crude Oil

Figure 6: U.S. Well Count and Average Well Depth

Figure 7: U.S. Average Cost per Well

Figure 8: Access Routes to Commodity Futures and Options Exchanges

Figure 9: Shares of Long Open Interest in WTI Futures and Options

Figure 10: Shares of Short Open Interest in WTI Futures and Options

Figure 11: Money Flows into U.S. Commodity Funds

Figure 12: AUM replicating the DJUBSCI

Figure 13: Net Positions of Trader Categories in the WTI Futures and Options Market

Figure 14: Changes in Managed Money Relative Positions and Crude Oil Futures Returns

Figure 15: Moving Correlations

1 Introduction

Over the recent years, commodity prices exhibited high volatility and reached levels never seen before. For instance, prices of crude oil exploded in 2008 reaching 147 U.S. dollars per barrel in June after they had been trending higher for quite some time. The boom was followed by a quick bust with prices falling to as low as 31 dollars at year-end. Since then, prices have been trending higher again, reaching 100 dollars in March 2011 (see Figure 1).

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Figure 1: WTI Spot Prices, Volatility and U.S. Recessions

The Figure illustrates the development of West Texas Intermediate Light Sweet Crude Oil spot prices in U.S. dollars (left scale) and their annualized 10-day volatility (right scale) over the time period 1983-2011. Red areas mark U.S. recessions. Data Source: Thomson Reuters Datastream (2011).

This behavior in prices coincided with large fund inflows from financial investors into commodity futures markets and the breakthrough of financial innovations such as Exchange Traded Funds (ETFs) and financial swap agreements as easy ways to gain exposure to commodity prices. Commodities have developed into a mainstream financial asset class with allegedly appealing characteristics for portfolio diversification. On the other hand, at least regarding crude oil, there are fundamental dynamics at play such as fast growing demand from emerging economies, limited supply, low demand elasticities and the risk of supply shortages because of geopolitical tensions or natural disasters.

This study tries to shed more light on the drivers behind commodity futures prices by regressing crude oil futures returns on position changes of different classes of futures traders and economic proxies such as equity returns and by performing Granger Causality tests. Crude oil is chosen among other commodities for its high futures market liquidity and the existing research and information available on the relationships between its price and fundamental factors.

Since futures markets for many other commodities work in the same way, the essence of the results of this study is transferable to other commodities. Examples are industrial metals such as copper and aluminum as well as agricultural commodities such as wheat and soybeans. In third world countries which are dependent on food imports, higher agricultural commodity prices can quickly translate into severe famines, as happened in 2008. This illustrates the importance of scrutinizing today’s commodity market dynamics. The remainder of the paper, however, focuses on crude oil.

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Figure 2: World and U.S. shares of Energy Supply Resources

The calculation excludes electricity trade. ‘Other’ includes geothermal, wind, heat and solar. Data Source: IEA (2008)

The investigation of the factors behind crude oil price movements is specifically important in the context of crude oil’s crucial role for industrialized and emerging economies alike. Oil is the world’s most important energy source (see Figure 2) and recessions in the U.S. have historically been linked to oil price spikes (marked areas in Figure 1). Masters and White (2009) estimate the damage done to the American economy by the run-up in oil prices in 2008 as lying above 110 billion dollars. Asset price bubbles are usually sources of economic hardship and instability as is vividly illustrated by the stock market and housing crashes of 1929, 2001 and 2008. Bubbles in commodity markets, their purpose being, among others, to improve supply stability and planning ability, can have the same if not stronger detrimental effects on economic agents relying on the physical supply of the commodities. Should financial investment and speculation in commodity markets be a driver behind powerful price movements beyond fundamentally reasonable values, the paradigm that speculators involve increased market efficiency and price discovery in line with fundamentals is highly questionable. The associated economic instability and hardship would be unnecessary and legislators should consider reforms of commodity market regulation to reestablish stability.

A central but difficult point of the debate is defining a fundamentally sound price. In fact, the concept of fundamental value for commodities is not as straightforward as for example for cash-flow bearing securities such as bonds or stocks, which are principally driven by speculation about future realizations of said cash-flows. A possible concept of a fundamentally sound price could be a price that is in line with stable long-term physical supply and demand equilibrium. Assuming that prices would be driven up to exorbitant levels by financial investors and speculators, physical consumers would still be willing to pay nearly any price in the short and intermediate term given the high dependence of nearly any economic activity on petroleum products and very constricted substitutability. However, over the long term, higher prices are likely to suppress economic output: demand destruction occurs with a lag. The International Energy Agency (IEA) estimates the threshold where prices start damaging the world economy to be 100 dollars per barrel (source: IEA Oil Market Report, April 12, 2011). The price finally adjusts to a level where it reflects the curbed demand and likely beyond if speculators start to unwind their positions. The unstable price pattern over 2004 to 2011 fits our scenario (see Figure 1).

The investigation adds to the discussion in the literature in regard to the following main points:

- Employment of disaggregated CFTC position data in a multiple regression context
- Disentanglement of the effects of fundamental factors and position changes
- Examination of the interrelationships between different trader categories
- Investigation of how market actors process fundamental information
- Check for a structural break and revelation of the fact that market dynamics changed over time and were actually different in the build-up phase of oil prices and thereafter
- Employment of holding data of the United States Oil Fund ETF, which no other study known to me has done before
- Setting into context financial innovation and the emergence of commodities as an asset class with proposed future regulation intended to curb negative effects of excessive speculation

For a more detailed description of the contributions please consult section 4.2.

The key result of this study is that financial investors as well as fundamentals drive crude oil prices and that the former (latter) have played a more (less) prominent role during the 2008 run-up in oil prices.

The remainder of this paper is structured as follows:

Section 2 gives an introduction to the global physical and financial crude oil markets and briefly discusses the characteristics of speculative investment in commodity futures markets. Section 3 discusses possible regulatory consequences to put the study into perspective with the environment in which responses to changing market dynamics can be formulated. Section 4 provides an overview of the discussion in the academic literature. Section 5 explains the data used and how it was collected. Section 6 introduces the econometric methodology. Section 7 displays and interprets the results of the econometric analysis. Section 8 concludes the study.

2 The Market for Crude Oil

2.1 Fundamentals of Physical Crude Oil Demand and Supply

The Physical Market for Crude Oil is global and complex. There exist different grades and types of crude oil, of which West Texas Intermediate (WTI) and Brent are the most prominent ones. Physical delivery takes place through oil tankers and ports or through pipelines and delivery hubs such as the Cushing facility in Oklahoma for WTI crude. An extensive network of crude oil pipelines spans across North America connecting the major delivery hubs. Global total production and consumption of petroleum products has hovered around 85 million barrel per day since 2004(source: EIA).

The biggest oil producer as of 2010 is Saudi Arabia with 12.1% of total supply while the biggest consumer is the U.S. with 22.5% of total oil consumption (source: EIA). While OECD consumption has flattened out over the past years and is now at 1996 levels, consumption in emerging economies has climbed by more than ten million barrels per day since 2000 (see Figure 3).

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Figure 3: Global Petroleum Consumption

The figure depicts global petroleum consumption on an all liquids basis in million barrels per day from 1980 to 2010. Data Source: EIA (2011).

Sluggish growth in world oil production (see Figure 4) has been matched with real world economic growth of 6.6% on average and a growth of the world’s population of 690 million people from 2000 to 2009, mostly driven by emerging markets, (source: World Bank). These facts are aligned with the regression model specification of this study, which, except for crude oil storage volume changes, focuses on demand-side oriented economic proxies. The figures convey that global competition for an all but constant supply of liquid fossil fuels is increasing. Whether stalling production follows from a deliberate choice of the large oil producers, primarily represented by OPEC, or is an indication of physical production limits is unknown at this date. The latter scenario is in line with the prospects of Peak Oil Theory.

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Figure 4: Global Petroleum Production

The figure depicts global petroleum production on an all liquids basis in million barrels per day from 1980 t0 2010. Data Source: EIA (2011).

Peak Oil Theory argues that global crude oil production has already or will eventually reach its maximum in the not too distant future. It is generally based on the assumption that oil production of regular oil fields follows a bell shaped curve and that the production of several (or all) oil fields together then follows a similar pattern. Production has to decline eventually if new discoveries or new technologies cannot compensate for the depletion. The theory’s pioneer M. K. Hubbert, a geologist who worked for Royal Dutch Shell, correctly predicted the 1971 peak in U.S. oil production in 1956 (Hubbert, 1956). Figure 5 illustrates the case of peak oil for the U.S while figures 6 and 7 convey that once the easy-to-produce oil has been gradually depleted, even a sharp rise in the number of producing wells and more sophisticated drilling techniques can hardly stall a decline in overall production.

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Figure 5: U.S. Field Production of Crude Oil

Data Source: EIA (2011).

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Figure 6: U.S. Well Count and Average Well Depth

The figure illustrates the number of crude oil and natural gas rotary rigs in operation in the U.S. (left scale) and the average depth of such wells in feet per well (right scale) from 1949 to 2009. Data Source: EIA (2011).

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Figure 7: U.S. Average Cost per Well

The figure illustrates the average real cost per crude oil, natural gas, and dry well drilled in million dollars per well in the U.S. from 1960 to 2007. Data Source: EIA (2011).

Whether the proponents of global peak oil are right remains to be seen. Nevertheless, world production and consumption seem to be in tight equilibrium, especially when the world economy is in phases of growth as pre-2008 and mid-2009 to 2011. Moreover, crude oil supply is subject to shocks, stemming from “random” events such as political unrest, geopolitical tensions in oil-rich regions as well as extreme weather events such as hurricanes. Demand elasticities for crude oil and petroleum products are estimated to be fairly low – see Hamilton (2008) for a synopsis. Factors behind this are among others constrained substitutability and fuel subsidies in large net-importing economies such as China and India. Furthermore, the reaction of oil supply to price increases is naturally delayed by long lead times to bring new projects online. When taking into consideration all these points, the conclusion that increasing crude oil prices and price volatility could reasonably be in line with global fundamentals, seems not so far off.

2.2 Financial Markets for Crude Oil

Crude oil is traded directly on spot markets or through financial derivatives, both Over the Counter (OTC) and through exchanges. Among the financial derivatives traded on crude oil, futures are the most closely watched as they provide a liquid, standardized and timely benchmark for global oil spot-prices and are assumed to give a picture of the present and anticipated future supply-demand situation. Crude oil futures are traded on a variety of oil grades on different exchanges worldwide. For the timeframe investigated by this study the contract of West Texas Intermediate Light Sweet Crude Oil (WTI) on the New York Mercantile Exchange (NYMEX) constitutes the most relevant global benchmark. It is followed by the European benchmark Brent light sweet crude oil contract on the Intercontinental Exchange (ICE). One futures contract on both exchanges is on 1000 barrels of crude oil. WTI futures contracts volume on the NYMEX was 15,675,148 in March 2011, which is equivalent to over 1,6 trillion dollars at an average price of 103 $/bbl (source: CME Group). Brent futures volume on the ICE was 11,120,576 contracts for the same timeframe (source: ICE). This study focuses on WTI-NYMEX price data since the trader positions investigated are held in these contracts.

2.2.1 Ways of Gaining Exposure

Access to commodity futures markets is possible either directly, by entering swap agreements or by investing in Exchange Traded Products (ETPs). Ultimately, every engagement is usually mapped in futures or options but market participants use different access routes.

The category of ETPs comprises securities such as ETFs and Exchange Traded Commodities (ETCs). While ETFs are separate assets, ETCs entail the credit risk of the emitter. These securities track single commodities or diversified commodity baskets, such as the Standard & Poor’s Goldman Sachs Commodity Index (S&P GSCI) or the Dow Jones-UBS Commodity Index (DJUBSCI) which are the two most replicated indexes. They realize their exposure through direct investments in futures contracts or - largely - through OTC derivatives such as swaps or structured debt instruments. I will use the term “ETF” for the remainder of the paper for these kinds of products.

OTC swap agreements are useful to put on large exposures, while not acting at the commodity futures markets directly. Swaps can be highly standardized and can act as substitutes to futures contracts but can also be customized to the specific needs of the counterparty. One party pays fixed cash-flows and the counterparty pays floating cash-flows based on the price of the underlying commodity. Analogous to swap agreements, indirect exposure to commodity prices can also be achieved through commodity-linked notes. These are structured debt instruments whose cash flows are linked to commodity prices.

Banks and investment banks act as commodity swap counterparties or offer structured notes to many different players simultaneously. However, unless the dealer wants to gain exposure to commodity prices itself, it has to hedge its net position, commonly in the futures markets. Notwithstanding, dealers firms commonly also take directional bets on commodity prices in the course of their proprietary trading activities. The different access options to commodity futures markets are summarized in Figure 8.

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Figure 8: Access Routes to Commodity Futures and Options Exchanges

The figure illustrates possible access routes for commercial and non-commercial agents to commodity futures and options exchanges. Dealer firms can also act as brokerage firms (e.g. banks). Dashed lines stand for (OTC) derivative transactions such as swaps or the issuance of commodity-linked structured notes.

2.2.2 Participants in Financial Commodity Markets

Usually, a wide range of participants with different intentions and scopes act on commodity futures markets. I segregate them by their ultimate intentions into Commercial Hedgers, Speculators and Investors.

Commercial Hedgers

Hedgers in this sense use the futures markets to set-off the risk related to physical exposure to future cash-delivery prices of the commodity or correlated products. Their interest in the commodity is related to their commercial activity. Typical long-side engagements in the market for crude oil and crude oil related products are entered by airlines, shipping companies and chemical companies. Characteristic commercial short-side participants are oil companies wanting to lock-in future revenues, for example to secure the profitability of new exploration projects.

Traditional Speculators

Speculators in a traditional sense are traders who seek long- or short-side exposure, trying to exploit market movements. Some speculators engage in spread-trading (speculating on changing spreads between markets or contracts) or statistical arbitrage and algorithmic trading involving both long and short investments. Since futures contracts are usually traded on margin, speculators are able to transact with high leverage. Players in this category include hedge funds, individuals and proprietary trading desks at banks and other financial firms. High leverage, paired with large amounts of funds at hand may allow particularly hedge funds to exert market-moving transactions.

While traditional speculators might also take on large and concentrated directional bets, they are not as focused on long side engagement as “investors”. Speculators have always been present on exchanges and their engagement is generally not considered to be harmful, quite the opposite. In classical economic theory speculation is generally viewed as a positive phenomenon which increases liquidity, stabilizes prices and brings information to the market. Essentially, this is due to the supposed better information or superior foresight of speculators, which enables them to identify under- or overpricing.

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Figure 9: Shares of Long Open Interest in WTI Futures and Options

The Figure illustrates the percentage shares of long open interest (reportable positions) of commercial, non-commercial and swap traders in NYMEX WTI Light Sweet Crude Oil futures and option contracts on a futures equivalent basis from August 2006 until the end of 2010. Data Source: CFTC (2011).

However, according to Kaldor (1939) this mechanism can only work if speculators make up just a minor part of a market, for if they do not, it is sufficient for them to forecast the psychology of other speculators, making long-term price deviations from fundamental value – or “bubbles” – possible. In such a scenario speculators can “live” on each other or “hijack” the market and price trends can reinforce themselves. Working (1960) argues that speculation can facilitate hedging in certain futures markets and that an “adequate” rate of speculation is desirable to efficiently meet short and long hedging demand. Figure 9 and 10 depict the percentage of (long and short) open interest of commercial hedgers, swap dealers and non-commercial traders in NYMEX WTI futures and option contracts since 2006. The relative presence of commercial hedgers has declined since 2006 and was especially low in mid-2008.

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Figure 10: Shares of Short Open Interest in WTI Futures and Options

The Figure illustrates the percentage shares of short open interest (reportable positions) of commercial, non-commercial and swap traders in NYMEX WTI Light Sweet Crude Oil futures and option contracts on a futures equivalent basis from August 2006 until the end of 2010. Data Source: CFTC (2011).

In the end the question boils down to a market efficiency debate. If markets were efficient (Fama, 1970) speculation should not be able to drive prices above or below fundamental value for longer time periods. Rather, bubbles can be viewed as temporal anomalies in the adjustment process to fair value (Fama, 1998). However, if markets could be assumed to be highly efficient, analyses such as the one at hand would be needless. The observable behavior of commodity prices over the past years does not suggest this conclusion, either.


Investors in this narrow sense are market actors or the clients of market actors whose motive is to gain exposure to commodity markets in a portfolio-optimization context. The participants in this category have considerably scaled up their engagement in futures markets only in recent years (see Figures 9 and 10) and hold a large fraction of the open interest. Their engagement is one central focus point in the academic literature since investors control large amounts of money and the scale-up of their engagement over the past years has coincided with wild swings in commodity prices. Players in this group include institutional entities such as pension funds, hedge funds, mutual funds, university endowments and private asset management firms. Figure 11 depicts monthly and weekly fund flows and AUM of commodity investment funds and ETFs from 1997 to 2011.

The positions of commodity ETFs also arguably fall under this category as ETFs are a popular instrument for portfolio diversification among retail and institutional investors alike and successful ETFs have large amounts of assets under management (AUM). ETFs can offer straightforward direct exposure to commodity prices and are traded like stocks. Retail investors commonly do not have futures trading accounts. Before the introduction of ETFs, the only widespread way for them to load up on commodity exposure was trough commodity related equity or physical holdings of the commodity in case of precious metals. Thus financial innovation has paved the way for large fund flows from a new investor base to commodity futures markets.

The biggest ETF investing in crude oil futures is the United States Oil Fund (USO). The USO attempts to track the spot price of WTI Light Sweet Crude Oil. It does this by investing in futures contracts traded on the NYMEX and the ICE. Futures contracts are not held until expiration but are rolled over into later expiry months instead. This makes the returns of the fund susceptible to the shape of the futures curve. Enduring contango diminishes returns. As of February 2011, the USO is the biggest Oil ETF by market capitalization (1.88 Billion) and average volume (12.05 Million shares per day, source: NYSE). Because of its size, the funds’ operations were said to be affecting futures prices, especially on roll dates. An article in The Wall Street Journal (WSJ) on February 9, 2009 reported that the fund was holding 22% of front-months contracts and that rolling over that position to longer-term contracts affected both contracts’ prices. Another article in WSJ from March 6, 2009 quotes a trader saying “It's like taking candy from a baby”, when talking about front-running the fund’s trades, which are announced beforehand. However, in an efficient and liquid market environment such an opportunity should theoretically be arbitraged away very quickly or not emerge at all in the first place.

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Figure 11: Money Flows into U.S. Commodity Funds

The figure illustrates money flows into U.S. commodity funds (e.g. commodity mutual funds, index funds, commodity ETFs) in billion U.S. dollars (right scale), total assets and cumulative money flows (both left scale) from April 1997 to April 2011 as covered by the Lipper U.S. Fund Flows Database. Data Source: Thomson Reuters Lipper U.S. Fund Flows Database (2011).

Many commodity ETFs replicate commodity indexes of which the Dow Jones-UBS Commodity Index (DJUBSCI) and the Standard & Poor’s Goldman Sachs Commodity Index (S&P GSCI) are the two most common ones. Large institutional investors such as mutual and pension funds also seek exposure to or are even fully specialized on commodity indexes. Figure 12 portrays the aggregate of funds dedicated to the replication of the DJUBSCI from 2006 to 2010. Index investment can be seen as a special sub-category of the investment category. As index replicators, ETFs and other institutional investors alike, often employ OTC swap agreements to gain exposure, it is appealing to investigate the positions of swap dealers in commodity markets as a proxy for net index investment. The terms “index investment”, “index speculation” and “index replication” are used interchangeably in the remainder of the paper.

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Figure 12: AUM replicating the DJUBSCI

The figure illustrates the assets under management replicating the Dow Jones-UBS Commodity Index in billion U.S. dollars from the second quarter of 2006 to the third quarter of 2010. Data Source: Dow Jones Indexes (2011).

Commodities are imperfectly correlated with other asset classes such as equities or debt securities and their addition to an investment portfolio can improve its risk-return characteristics. The average time horizon of investors is longer than that of traditional speculators and their engagement is usually concentrated on the long side. From a theoretical point of view investors could also be deemed speculators but I put them in a separate category as they behave differently and their isolated impact is of special relevance. Generally, traders in this category, especially index replicators, are primarily interested in gaining mere exposure to an asset class than in trading on fundamental, oil price relevant information. In times of economic uncertainty or high price inflation, commodities are also historically viewed as a safe heaven or “value” investments; however, this is more applicable to the precious metals universe than to energy commodities, whose physical demand depends largely on economic conditions.

Commodities, unlike stocks or bonds, do not generate any cash flows from just holding them. Rationally, consistent long-term positive real abnormal returns could only be achieved if the market is “constantly surprised” by fundamental factors or actors constantly revise their future fundamental or risk estimates upwards. Why should, for example, strong expected growth in emerging economies not be factored in futures prices instantly, but over time? The alternative is that investors themselves bet on net positive flows of investment money to flood the markets over longer periods of time; compare Kaldor (1939).

Settlement and Market Impact

Ultimately, every physically settled futures contract will likely be between agents who require the physical commodity for their business activities. Hardly any financial investor or speculator will have an interest in being supplied with thousands of barrels of crude oil at a specific pipeline-hub in Oklahoma or elsewhere. Between 2003 and 2008, roughly two percent of all entered into NYMEX crude oil futures contracts resulted in physical delivery. Speculative futures contracts are set-off by contrarian transactions before expiry; “extra demand” from financial investors will become “extra supply” at some point in time, preconditioned that net-positions of financial investors are not growing indefinitely. This logic is often brought forward as a reason why the involvement of financial investors could not possibly drive up commodity futures prices systematically from fundamental value. However, this argument does not distinguish between traditional speculators and investors, nor does it reflect what might happen during the time between the build-up and squaring of the positions.

If anything, the rationale suggests that speculation and price behavior should exhibit swings. Financial investors often hold large positions longer term, behaving differently from “traditional speculators” such as statistical arbitrageurs or algorithmic market makers. When, as can be observed for example in Figure 11, overall net positions rise week over week, this effectively constitutes extra demand over that time period. Investors as a group take a slack of the supply. Even if contracts expire, the investment is commonly just rolled over into later expiry months. Nonetheless, position build-ups are unlikely to continue indefinitely, even more, since commodities, unlike equity or debt securities, do not deliver cash-flows over the holding period and therefore only expected price returns, aside from diversification benefits, offer a strong holding argument.

At some point, possibly induced by a macroeconomic event such as a recession and a flight to safety, investors will start net-selling again, generating extra supply. This scheme also fits what can be observed: commodity prices exhibited an uptrend from 2005 to 2008, which was followed by a quick bust in the aftermath of the financial crisis (see Figure 1). Finally, they started trending higher again in line with equities in early 2009. These observations also question the power of the portfolio diversification argument, at least for base metals and energy commodities.

3 Regulation and Commodity Derivatives Speculation

This section gives an overview of the regulation in place and describes new regulatory proposals in connection with the Dodd Frank Wall Street reform act and their implications for the commodity investment industry.

3.1 Current Commodity Futures and Derivatives Markets Regulatory Regime


The current basis for commodity market and derivatives regulation in the U.S. is provided by the 1936 Commodity Exchange Act (CEA), which specifies, among other things, rules on how commodities can be traded and who is allowed to trade them. It also defines reporting and record keeping requirements. The act was preceded by the Futures Trading Act of 1921 and the Grain Futures Act of 1922. In 1974 the United States Congress established the Commodity Futures Trading Commission (CFTC) on the foundation of the CEA.

The CFTC is an independent federal agency with the responsibility to overlook and regulate the commodity derivatives markets in the United States. Its main goals are to protect the integrity, efficiency and competitiveness of these markets.

Exchanges, clearing members, futures commission merchants and foreign brokers have to report all positions in trader accounts above certain reporting levels to the CFTC. The Commission then assesses individual large trader’s activities and potential market power. The CEA enables the CFTC to establish its own regulations in line with its mandate upon commodity futures markets under Title 17, Chapter I of the Code of Federal Regulations. Specifically, it enables the commission to implement and enforce futures and option contracts position limits, which may not be exceeded by any particular market participant. The stated aim is to “diminish, eliminate or prevent excessive speculation causing sudden or unreasonable fluctuations in the price of a commodity”, thereby protecting the integrity of the market from “excessive speculation”. The commission has the authority to investigate and prosecute possible violations of the CEA or its own regulations.

Current Position Limits

Part 150 of Title 17 of the Code of Federal Regulations specifies position limits for commodity derivatives. At present, CFTC-set position limits are in place for seven exclusively agricultural commodities (corn, cotton, soybeans, oats, soybean meal, soybean oil and wheat). The limits constrict the netted long or short position on a futures equivalent basis any trader may hold in a single expiry month and over all expiry months in aggregation. The single-month limits depend on the average open interest over the last calendar year: A position may not exceed 10% of open interest of the first 25,000 contracts and 2.5% for the remaining open interest thereafter. Spot month positions may not exceed 25% of physically available supply in the expiry month. Futures exchanges are free to set their own speculative position limits, provided that they are approved and can be enforced by the CFTC. Exchanges are also required to protect market participants from manipulation and price distortion. However, the exchanges probably do not have a vivid interest in constricting their customers, even less in the face of inter-exchange competition.


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Fundamentals, Speculation, and the Pricing of Crude Oil Futures
Maastricht University  (School of Business and Economics)
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Crude Oil, Futures, Speculation, Oil, Oil Price, Oil Speculation, Dodd-Frank, NYMEX, WTI, Peak Oil, Index Speculation, Commodity Swaps, CFTC, Commodity Derivatives, USO, Commodity ETF, Oil ETF, Futures Position Data, CFTC Position Data, CIT Report, COT Reports, Commodity Funds, Position Limits, Ölpreisspekulation, Ölpreis, Rohöl, Index Replication, Rohstoffspekulation, Rohstoff Spekulation, Commodity Exchange Act, GSCI, ETC, CFTC Data, CIT Reports, Commitment of Traders
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Thomas Hoehl (Author), 2011, Fundamentals, Speculation, and the Pricing of Crude Oil Futures, Munich, GRIN Verlag,


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