Investment firms that can influence the oil futures market stand to make a lot; oil companies that both produce the commodity and drive prices up of their product up through oil futures derivatives stand to make even more. Investigations into the unregulated oil futures exchanges turned up major financial institutions like Goldman Sachs and Citigroup. But it also revealed energy producers like Vitol, a Swiss company that owned 11 percent of the oil futures contracts on the New York Mercantile Exchange alone [source: Washington Post ].
And despite having an agency created to prevent just such speculative price inflation, by the time oil prices skyrocketed, the government had made a paper tiger out of it. In the United States, oil futures come in three major forms: contracts on crude oil, gasoline and heating oil. All three of these commodities are essential for the nation to operate and thrive.
Unfortunately, the Commodity Futures Trading Commission CFTC was unable to do anything to stop manipulation of the market for the energy on which we're painfully dependent. The CFTC was established by Congress in specifically to prevent speculation from artificially inflating the price of commodities.
Over time, its powers were slowly stripped. Traders on this exchange must file daily reports on exchanges so the commission can keep an eye on speculation. But speculators were able to make an end run around the CFTC's regulatory power, thanks to help from oil giant Enron.
The year was a bad one for consumers as far as oil goes. Enron had created specialized software that allowed futures to be traded OTC -- exchanges outside of the formal exchange markets. The software and what came to be known as the Enron loophole for OTC trading allowed futures exchanges without government oversight.
Also in , a consortium of oil companies and financial institutions created the Intercontinental Exchange ICE in London to trade European oil futures, although the group was headquartered in Atlanta.
But once the commission allowed U. The convergence of the Enron loophole and the establishment of ICE meant the CFTC could no longer accurately police speculators who sought to drive up energy prices through futures speculation.
Whether it was speculators that drove up the cost of gas and oil is still debated. But a report issued the following September contradicted the IEA report, pointing to correlations between the influx of money in oil futures markets and the rising cost of oil. Senate ]. In response to calls for better regulation of oil futures, Congress introduced the Consumer-First Energy Act in May The bill would have extended CFTC oversight to foreign markets, but the act died on the Senate floor the following June.
After the bill was defeated, the argument over oil speculation changed focus. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification.
I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. What is a Speculator A speculator utilizes strategies and typically a shorter time frame in an attempt to outperform traditional longer-term investors.
Key Takeaways Speculators are sophisticated investors or traders who purchase assets for short periods of time and employ strategies in order to profit from changes in its price. Speculators are important to markets because they bring liquidity and assume market risk. Conversely, they can also have a negative impact on markets, when their trading actions result in a speculative bubble that drives up an asset's price to unsustainable levels. Compare Accounts.
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Terms Punter Definition A punter is a trader or gambler who hopes to make quick profits in the financial or betting markets.
Stag Stag is a slang term for a short-term speculator who attempts to profit from short-term market movements by quickly moving in and out of positions. Short Selling Short selling occurs when an investor borrows a security, sells it on the open market, and expects to buy it back later for less money. What Is Flip in Investing? A flip generally refers to a dramatic directional change in the positioning of investments. But despite some weaknesses the agreement represents huge progress, meaning that for the first time the EU has rules to tackle food speculation.
Following work by the Stop gambling on hunger campaign in the US, regulation of food speculation was included in the Dodd-Frank Act in which was brought in following the financial crisis. This shows what a successful campaign can achieve. However, Wall Street is now lobbying hard to hinder the implementation of the new regulations and the US campaign has another fight on its hands. Strong regulation in Europe would help our US allies overcome this final hurdle.
WDM is not alone in identifying excessive speculation as a key factor in driving up global food prices. Lots of world leaders, civil social organisations, financial and business experts, academics and media commentators all support regulation of commodity futures markets. Close Pharma. Take action online Support our work Act locally. Email Signup. Close Sign-up. Close Support us with a donation or a membership subscription today and help us fight social and economic injustice around the globe.
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The short's decision to exit does not affect the long, who may prefer to ride the trend. This is because all contracts are assumed by the exchange's clearing house, which becomes the opposite party on each trade, and guarantees payment.
The ability to enter and exit the market by offset, without having to make or take delivery of the physical commodity, permits trading strategies based on short-term price expectations.
While some traders may keep a long or short position open for weeks or months, others buy and sell in fractions of seconds. The exchange clearing house, which guarantees all trades, also controls traders' funds. All contracts are priced, or "marked-to-market," each day. When traders exit the market, any funds remaining in their margin accounts are returned. Other transaction costs, such as brokerage commissions and clearing fees, are not returnable. Options on futures are also available for many futures contracts.
The holder of an option has the right but not the obligation to enter into a long or short futures contract over the life of the option. The option will only be exercised if price movements are favorable to the option buyer, that is, if the underlying futures contract would be profitable.
The seller of the option receives a payment called a premium for granting this right. The seller profits if the option is not exercised by the buyer. Swap contracts are traded in the over-the-counter market, rather than on organized exchanges although the Dodd-Frank Act Reform and Consumer Protection Act, P.
The terms of swap contracts are not uniform, as futures contracts are, but can be negotiated between the counterparties. Economically, however, swaps are equivalent to futures: one counterparty will gain if the price rises, the other if prices fall. Derivatives traders can be classed as either hedgers, who use the market to avoid price risk, or speculators, who assume risk in search of profits. In futures markets the distinction is formal, and is important because hedgers pay lower margin rates and are not subject to limits on the size of their positions.
Hedgers and speculators may be further broken down into subcategories, as follows. Commercial hedgers are those involved in production, processing, transportation, or use of oil and petroleum products. In their physical trading, they buy and sell oil up and down the supply chain. For example, an upstream producer sells crude oil to a refinery, which sells jet fuel to an airline or gasoline to a retail station, which then sells it to motorists.
Commercial participants can sign long-term sales agreements or may buy short-term contracts for near-term physical delivery of oil.
Derivatives allow commercial participants to manage their risks related to the oil business, or hedge against oil price risk.
This is a form of insurance against market fluctuations. For instance, an airline's profits may suffer when jet fuel prices increase. To address this risk, the airline can purchase long derivatives contracts whose value rises when oil or jet fuel prices increase.
If prices then do increase, the cost of higher-priced fuel is offset by the money gained on derivative contracts. Alternatively, an upstream oil company can obtain a short derivative to insure against lower future oil prices. Swap dealers are entities that deal primarily in swaps for a commodity and use the futures markets to hedge risk associated with those swap transactions.
For example, a pension fund wishing to include commodities in its investment portfolio might enter into a swap linked to a published commodity price index. If the index goes up, the dealer will owe the pension fund money.
To hedge that risk, the swap dealer may take an equivalent but opposite position in the futures market. Then any payment due to the swap counterparty will be offset by earnings on the futures position. A swap dealer's counterparties may be speculative traders, like pension funds or hedge funds, or producers and commercial users that are hedging risks of dealings in the physical commodity. Many hedgers prefer swaps to futures because swaps can be customized to fit the exact quantities and time frames relevant to the hedger's business, whereas futures have uniform contract sizes and expiration dates.
Thus, swap dealer positions represent both hedging and speculation. Money managers, a group of purely speculative traders, are professionally managed funds trading on behalf of clients. The money manager class includes hedge funds, which invest on behalf of institutional investors such as pension funds and wealthy individuals. Other kinds of speculators include floor traders, or exchange members who trade for their own accounts, as well as a variety of firms and wealthy individuals.
Small, public investors are able to trade futures, 6 but the retail presence in futures is likely much lower than in the stock market. The industry uses different terms for speculators with different time horizons. High-frequency trading, where the relevant time unit is the microsecond, is making inroads into derivatives trading, just as it has in the stock market. As a global commodity, oil trades around the clock.
There are no public data on how much oil futures trading is speculative, although the assumption is that speculators account for most short-term trading, which in turn accounts for most market turnover. COT data, usually published late afternoon each Friday, reflect the open interest, or the number of contracts outstanding, as of close of trading on the previous Tuesday.
Thus, comparing week-to-week COT figures shows whether classes of traders have increased or decreased the size of their long, short, or spread positions. Another significant limitation of COT data is that they do not cover swap contracts—another form of oil derivative contract not traded on exchanges. Thus, COT figures arguably cover only a subset of oil derivatives, all of which play a role in setting prices.
The Dodd-Frank Act P. In the future, COT reports may reflect swap positions, but the data currently available cover only exchange-traded futures and options on futures. Table 1 breaks down open interest in crude oil futures and options on futures as of July 19, Notes: Figures are based on large, "reportable" positions of over contracts, which must be reported daily to the CFTC.
Smaller positions are combined in the "Non-Reportable" category, which includes all types of market participants. The data in Table 1 prompt several observations about the market:. The figures show the amount by which long traders increased their long positions net buys and the amount by which short positions were increased net sells. Thus, for each week and for class of trader, the data show whether on average long positions buys exceeded short position increases sells , or the reverse.
Figure 2 presents 1 the net figure of buys and sells for managed money trading, which includes trades of hedge funds, commodity pool operators, and others; and 2 changes in the price of oil during the same period.
Each point in the graph represents a single week's change in these two figures: the net average sales or purchases by money managers and the price change over the same week. The horizontal and vertical axes divide Figure 2 into quadrants. Data points located in the upper right indicate weeks when money managers were net buyers and the price of oil rose. Points in the lower left indicate weeks when the price dropped and money mangers were net sellers.
The other two quadrants indicate weeks when prices rose and money managers sold or when prices fell and they were net buyers: in other words, when their transactions and the price moved in opposite directions.
Figure 2 suggests that there is a correlation between money manger transactions and price movements. The more prices fell, the more they tended to sell. Very few data points fell into the upper left quadrant, that is, money managers were rarely net buyers when prices were falling. Indeed, the results of regression analysis, given in Appendix A , show that a strong and statistically significant correlation does exist between money manger transactions and price movements.
Please see Appendix A for details of the regression. Here, there appears to be no correlation, or trend-line. Neither is there any apparent correlation between the trades of 1 swap dealers or 2 other speculators and price movements, as shown in Figure 4 and Figure 5.
Figure 2 suggests that crude oil futures are not a textbook case of an efficient market, where prices incorporating all known information about the commodity move in a random walk.
The group of speculators classified as money managers appears able either to anticipate price movements or to cause those price movements through their trades. This observation raises some interesting questions. Why should money managers be better forecasters of oil price movements than other speculators or commercial hedgers?
Given that their long and short positions constitute a small share of the total market, why should money manager trades have a unique price impact?
Most fundamentally, are money managers' trades determining prices or are they simply more adept than others in following trends or identifying information and news that will drive prices up or down? Assuming that money managers have a unique impact on price, what is the mechanism by which their transactions—relatively small in terms of the total market—move prices?
A possibility is that they affect intraday trading, which the available open interest data fail to capture. Short-term traders might observe and seek to copy the strategies of certain money managers who are regarded as especially capable of identifying new information that might be expected to move prices, or who simply have achieved superior returns in the past.
If significant numbers of short-term speculators copy money manager trades, the impact of those trades on prices would be magnified. In effect, under this scenario, money managers may have market power beyond what the size of their positions would suggest. Such "herding behavior" among speculators, if it exists, would support arguments that the oil price at times includes a "speculative premium" above and beyond the price justified by the fundamentals.
On the other hand, it may be that money managers do trade on fundamental information and that they are especially skilled at identifying news that is going to move prices.
If money managers are consistent in their ability to identify new and relevant information that will affect prices and trade on that information before others do , one result would be the observed correlation. A potential objection to this explanation is that it implies that some financial speculators are better analysts of the oil market than actual producers and end-users of oil, who also trade in the futures market.
Money managers might also profit by following price trends. Rather than cause price changes, they may buy when they see prices are rising and sell when prices begin to fall. But why would money managers' trading patterns, and not those of other market participants, be correlated with price changes in this way?
Other market participants may have longer investment time horizons or be less sensitive to price changes. Hedgers, for example, are generally less affected by price changes, because whatever they may lose on their futures positions, they make back in the spot market because, for example, the physical commodity they produce will have gone up in price.
Similarly, swap dealer positions may reflect long-term commodity index investments by pension funds and other institutional investors who are seeking to allocate part of their portfolio to an asset class that is not correlated to other assets they hold, such as stocks and bonds.
Because the object of such investment is portfolio diversification, such investors are less likely to buy or sell in reaction to short-term price movements. Hedge funds, by contrast, are known for taking aggressive positions in search of high yields and for seeking to extract the maximum return from any price trend. A CFTC study referred to speculators "who take positions based on price expectations over a period of days, weeks, or months" as "trend followers.
If money manager trades can be said to cause price movements that is, if we assume that such trades cause price changes, rather than follow them , are they responsible for long-term price changes such as the run-up of prices in the first half of ?
The data released by the CFTC do not support that conclusion. When weekly position changes are plotted against changes in price in the following week instead of the same week, as in Figures 2 though 5 , the correlation essentially disappears. In other words, managed money trades may cause prices to rise or fall in the week they are made, but they do not appear to trigger longer price trends. The same is true over other time horizons. For example, Figure 6 shows changes in money manager positions and price changes four weeks later.
The data suggest that there is no correlation between whether hedge funds and other money managers buy or sell this week and what happens to prices over the next month. Figure 6. If derivatives speculators have mispriced oil during recent years, there are two ways this could have happened. The first is through deliberate manipulation of the price by a group of market participants. Knowing action to create artificial prices is a violation of the Commodity Exchange Act, and the regulators and exchanges have market surveillance programs to detect attempted manipulation.
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