OPEC Conference president HE Mohammad Aliabadi recently joined a chorus of international observers to blame speculation as the source of ongoing volatility in the global oil market.
Speaking at an OPEC Conference meeting early this month Aliabadi, who is also Iran’s acting Minister for Petroleum, claimed that “excess speculation” in oil futures had led to volatility observed in the price of crude oil during the first six months of this year. But he also asserted that the fundamentals of the market were just fine.
In his opening speech he stated: “Since our last meeting, speculative activity on the New York Mercantile Exchange Nymex has reached record highs. This saw, for example, open interest for Nymex WTI exceed 1.5 million futures contracts by mid-March; this was an astonishing 18 times higher than the volume of daily traded physical crude.
“Excessive speculation in the futures markets increases volatility unrelated to fundamentals and efforts by governing and regulatory bodies in the consuming countries to minimise such speculation remain imperative.”
This statement shows a gross misunderstanding of how the futures market works and what the observed data means.
The fallacy of comparison
The open interest of 1.5 million futures contracts Aliabadi mentions are for all crude oil deliveries extending out through December 2019 – so more than nine and a half years of future oil delivery.
Open interest is the measure in futures markets of the number of contracts still available for trade at the close of a day’s trading activity.
Over the life of a contract for a specified delivery period the open interest begins at zero, rising to reflect the level of trading interest by hedgers and speculators combined, and then for crude oil falling back to near zero on the last day of trade.
Dividing 1.5 million futures contracts by a single day’s physical consumption produces a completely meaningless value.
Moreover, this value of “18 times higher” than physical contracts means nothing with respect to the potential influence on the typically observed and quoted market price, which is for deliveries in the next month.
Importantly, most of these open interest positions are held by hedgers, not speculators. Speculators hold both long (buy) and short (sell) positions – this implies both upward and downward pressure on prices coming from speculators.
The truth of the data
If instead one observes current market activity for the July, 2011 contract – that is, next month’s delivery contract – it appears to have reached a maximum open interest on about 3 June 2011.
This is typical, since the last day of trade for this contract is on 21 June 2011, and the open interest for crude oil futures contracts tends to peak two to three weeks before the last day of trade.
The open interest for the July, 2011 contract on 3 June 2011 was 338,132 contracts, and since each contract represents 1000 barrels, these contracts represented 338,132,000 barrels of crude oil for delivery throughout the entire month of July.
It is also worth noting that the open interest for all contracts on this date was 1,515,219 contracts, so it was consistent with the mid-March activity cited above.
Recently, daily oil consumption in the USA has been at around 18.5 million barrels, so throughout the entire month of July we will expect about 555 million barrels of oil to be consumed.
That means that the open interest relevant to the price for the July contract represented 61% of the physical market – a fraction, rather than a multiple.
It is worth noting that contracts open on the NYMEX are not restricted to oil consumption within the US, and many of the contracts held by traders are for the purpose of hedging price risk in markets outside the US.
This means that physical consumption well in excess of that for just the US is relevant to a complete analysis of the role of the futures markets, meaning that the open interest for July, 2011 represents something less than 61% of the relevant physical market.
Neither the market nor the regulators or policy makers should be misled by statements that reflect a lack of understanding of the observed data in the market actually represent.