The Highest Oil Price Spike in History

NEW YORK CITY -- What did it mean when oil prices today spiked by their largest amount in history, $16 in one day? It means something is seriously wrong with the oil price market. Analysts had no obvious explanation for the rise other than to say that it may have had something to do with the October contract expiring. But a price spike of this magnitude -- oil prices have now traveled from lows in the $90s last week to $130 today -- is alarming. And oil price volatility of this magnitude in the absence of any magic changes in supply or demand is frankly unacceptable over the long term for a commodity on which so much of our economy depends.

A hint into the source of this volatility was provided at the U.S. Senate's recent summit on energy. The fireworks commenced when Senators Bill Nelson of Florida and Maria Cantwell of Washington asked Goldman Sachs' COO, Gary Cohn, about the need to reign in speculation in the oil markets. The Senators cited a recent study by Michael Masters, manager of a hedge fund and a trader himself, blaming volatility on speculation on indices.

Northwestern CEO Doug Steeland echoed his belief that speculation was responsible for the bulk of volatility in the price of oil. Cohn answered that Goldman's position was that market prices were set by supply and demand and, in support, he cited a recent CFTC, trade by trade analysis, that showed no outright market manipulation.

However, Cohn also noted that in setting up the index market, Goldman and others' goal was to create a buy side among pension funds and other long term investors for oil futures to balance the supply side of oil producers seeking money for exploration. And, indeed, pension and others have become large players in the index market as energy futures have become another investment "class."

Today's volatility showed signs of institutions or traders shifting large blocks of money into an asset class to balance chaos in other markets. This is not outright market manipulation. But the emergence of oil futures indices as an asset play for huge non-energy investors, chasing yield, may be responsible for the unacceptable volatility in these markets.

Congress and the CFTC should be examining whether this is the case and, if so, devise measures to reduce the the exposure of this nation-critical market to large shifts in money and what hedge fund traders like to call, cross market correlation.

This was cross-posted at the NDN blog.

Comments

[miroslodki]

Michael,
When market prices lose their ability to track with the fundamental nature of supply and demand, laws that reflect society's ability to identify and distribute resources based on individual value judgments and requirements then we face a critical failing that demands immediate attention.

The 2007/2008 run up of oil prices was a explained away by local supply or demand anomalies - which in the context of a tightly constrained production network meant immediate market price jumps that naturally were passed on the end users all the while Big Oil, somehow in the midst of this turmoil, deftly manage to secure record level profit (Mobil securing almost $1B per week profit) .

But as we later learned, the oil market was transformed by outsiders effectively pushed out the industry users (some reports stating only 20% of trades actually being performed by market participants that will be taking possession of the oil). So it begs the question whether the liquidity benefits of speculators merit the increased price the world is paying for fuel. If not, then I would like to understand what, when and how steps can be taken to bring the fundamentals back into line.

The Sept 28 one day spike is only further evidence that the system needs to be cleaned up. There is simply no room (or need) for speculators in such a fundamentally critical economic input.

Look forward to the opinions of others
Miro

[KillTheMessenger]

My only opinion is that you sound like someone who is just rambling. I can't identify a logical thread in your post. Maybe you want to clarify and then we can discuss?

[miroslodki]

KTM
I'll keep it simple

the role of speculators in the oil sector has become counter productive

[cylindar]

Yes, but it will not happen fast enough. In the meantime the prices will go where they go and no one will be able to do anything about it. Congress has been called on in the past to look at this very problem, but to date has refused to budge on this issue.

[KillTheMessenger]

The "time to do something about it" in politics was thirty years ago. Today one can only watch a train wreck unfold in front of the world's eyes. Which is not a bad thing. It might just lead to the insight that we need to put engineers on our trains.

[KillTheMessenger]

Please provide a link to an economics textbook that proves mathematically that there has to be an upper limit to the price of a commodity or the rate of change of the price of a commodity.

If you do not have such a link, please provide your own theoretical explanation why such limits have to exist.

If you can not provide either, please explain why you are so surprised that these fluctuations exist.

Looking forward to everyone's responses.

[LeftRight]

I guess the speculators didn't get booosh's memo about ensuring the gas prices are lower until after November....