Crude Oil Prices Are Rising -- How Playing Chicken Can Get You Cooked

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By Barbara Cohen
Chief Information Officer, ShadowTraders


Republican presidential candidate Mitt Romney blamed President Obama for high gas prices, saying that "he has not pursued policies that convince the world that America is going to become energy secure, energy independent." Romney claimed that Obama refuses to build the Keystone XL pipeline from Canada to Texas as evidence that the president is sending a message to the world that: "America's not going to have the energy we need."

While it is true that oil prices have been skyrocketing, is it because of President Obama?

Even Romney later acknowledged that "no one can guarantee what the price of oil's gonna be." And he has since declined to pledge to Americans that he would make sure gas prices would come down to a certain dollar level if he is elected.

What is really behind soaring energy prices? Is it Obama's policies? Is it the pipeline from Canada to Texas that is on hold? What does a man like Romney, the founder of Bain Capital (a private equity firm that specializes in venture capital, corporate takeovers, and investor relations), really know about the price of crude?

What Romney really knows is that Keystone XL can not reduce oil prices. Keystone XL is a pipeline intended for export only. In several presentations made to their investors, Gulf Coast refineries disclosed that they intend to refine the crude oil from Canada into diesel and other oil products, and then export these products to Europe and Latin America. Why? Because proceeds from these exports are earned tax-free. This crude oil was never going to be USA domestic.

The real culprits in oil price manipulation are crude oil futures speculators. Speculators drive prices higher than what supply and demand demands. Want someone to blame? How about the Commodities Futures Trading Commission (CFTC).

With trading futures, it is a question of taking delivery. When a bread manufacturer buys wheat futures contracts, he settles in wheat, which means he takes delivery in wheat from farmers. Meat packers settle in cattle from ranchers. But oil speculators buy up crude oil contracts without taking delivery of barrels of crude. They purchase large quantities of crude futures contracts at prices higher than the current market price knowing this will cause oil producers to stock pile the oil fully expecting to be able to sell later at an even higher future price. Now add European sanctions with Iran, with oil shipments falling as much as 800,000 barrels a day, and both current and future prices skyrocket.

In October 2011, when the Dodd-Frank bill was passed after the financial meltdown in 2008, the CFTC voted to adopt rules that would limit the number of futures and swap contracts that commodity speculators may hold. But even though the rules passed, the CFTC has yet to enforce those rules.

Want to see proof of speculator influence in the Market? Take a look at this daily chart of light sweet crude oil (CL) that is traded at the Chicago Mercantile Exchange (CME) as it tracks the announcement that President Obama and Great Britain Prime Minister David Cameron struck a deal for a joint release of emergency Strategic Petroleum Reserves (SPR).

 

03/13/2012, Price hits an intra-day high of $107.35 with 146k contracts traded. No mention of any agreement.

03/14/2012, Price closes at $105.45 with 166k contracts traded. News releases hint that possibly Obama and Cameron are striking a deal to release oil reserves, mildly higher volume.

03/15/2012, Price plummets to a low of $103.78 with 235k contracts sold off. Report is released that Obama and Cameron have struck a deal to release oil reserves.
 

03/16/2012 Price rises again, with a high at $107.03 but lower volume of 97k contracts. The White House denies news reports that there will be a release of emergency crude reserves. Lower volume because speculators are not sure that the deal is on or off.

Light sweet crude trades in price movements known as ticks. 1 point in CL = 100 ticks. How could oil sell off and drop 357 ticks in the course of 3 days without speculators getting out of the market as fast as possible, closing their positions before the price takes them out altogether? And look at the number of contracts traded on the news announcement. Between 3/14 and 3/15, 400k contracts close out.

Here's the problem...Obama cried wolf instead of making good on his threat. Once speculators realized that he was not going to go through with the release of SPR, that it was just a bluff, they drove the crude oil price right back to where it started from. The answer is not to play "chicken" with speculators. The answer is to require the CFTC to enforce the rules of the Dodd/Frank bill that limits commodity speculation.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Futures , Commodities , Investing Ideas

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