Hedge Funds May Be Messing with Oil Prices
It wasn’t too long ago that analysts covering oil prices were riding high on a wave of optimism, with various predictions of crude hitting $200.00 per barrel during the financial crisis in 2008–2009. Back then, commentators were unabashed in placing the blame squarely on hedge funds and market speculators as being the root cause of gas prices skyrocketing.
That high period passed, as it always does, but amazingly enough, pundits are now blaming the very same speculators for driving oil prices down to their current levels. (Source: “Hedge funds up short bets on oil again,” CNBC, November 2, 2015.) Essentially, the argument is that hedge funds are putting strong negative downward pressure on the price of oil through continuous short selling. But does this argument stand up to scrutiny?
Oil Price Forecast: 2016 Looks Bearish
Because the oil price crash has translated to savings for consumers at the gasoline pumps, the discussion over increased regulatory action against hedge funds that are ostensibly keeping crude prices low has been muted. But this raises the question of whether heightened oversight on hedging against the oil price would have any real positive effect.
Of course, there is a clear connection between crude oil’s price and hedge funds’ positions, but the actual effects are far more ambiguous and open to interpretation than simply pointing fingers at speculators. There is another variety of seldom-mentioned causal factors to consider and this falls into the speculator category.
Oil prices are, at the basic level, contingent on supply and demand dynamics. The former category is made up of producers, whether they are international associations, such as OPEC, or large-scale independent producers, such as Russia or the U.S. The latter is a far more nuanced creature and a lot more complex to both define and analyze. While traditionally, this is made up of ordinary consumers and various businesses, there is also the ability of financial market players, such as hedge funds, to hold considerable sway over demand patterns for oil. It all sounds more complicated than it really is, so let me explain.
If investors, including hedge funds, forecast prices to rise at a future date and purchase vast quantities of crude oil, then the laws of supply and demand suggest that they could not only provide uplift, but could also actually raise oil prices based on an assumption. If you’re looking for this process in action, think back to 2008, when hedge funds were betting large on oil prices skyrocketing, which proved to be correct.
Are we seeing this same pattern play out today? To be honest, there is considerable evidence to suggest the process is currently underway. When oil is purchased, it will eventually need to be either sold or refined for consumption, a move that carries it into the supply portion of the equation. Investors thus serve as actors, stabilizing possible volatility by purchasing oil under the assumption that it will rise in price and selling it when they expect its price level to drop.
This equation works well in theory, as it balances the crude oil market by providing stability against what could otherwise be huge price volatility. In practice, however, it leads to companies purchasing oil and storing it away for a hypothetical future price boost, which they believe will be high, leading to market distortions. (Source: “World’s Largest Traders Use Offshore Supertankers to Store Oil,” The Wall Street Journal, January 19, 2015.)
The billion-dollar question here is whether or not hedge funds have the capacity to swing the global price of oil, a commodity that boasts the largest commodity market by far in the entire world. Hedge funds make up an estimated $2.7-trillion industry (source: “Hedge Fund Industry – Assets Under Management,” Barclays, last accessed December 2, 2015), yet only a comparatively small $330 billion of that is tied in with commodity trading advisors (source: “Assets Under Management,” Barclays, last accessed December 2, 2015).
Doing a little basic math, total daily oil traded on global markets amounts to roughly 96 million barrels, which, at an average between WTI and Brent of $45.00 per barrel, works out to be worth $4.32 billion. (Source: “Oil Market Report,” International Energy Agency, last accessed December 2, 2015.)
When put in those terms, hedge funds may not quite be the market-swaying force that some would suggest, but they certainly have the ability to cause significant short-term swings, if they so chose to. Theoretically speaking, hedge funds could represent an additional seven percent to eight percent of global demand on any given day, which represents a substantial force, but not one that stands up to accusations of market manipulations.
The Bottom Line on the Oil Price Crash
While there is evidence to suggest that market speculators and hedge funds are certainly able to swing oil prices through high-volume trades in the short-term, broad scapegoating by pundits and analysts may be a convenient excuse that simply obscures the reality of crude oil markets.
There is still far too much oil being produced, as production levels both by OPEC and outside the cartel are maintaining record levels, and not enough demand for it, as the global economic outlook remains bearish into 2016. In the medium- and especially the long-term sense, it’s unlikely that broad manipulation by hedge fund managers and other financial entities would be able to swing the crude oil price, except in short bursts.