Thursday, July 24, 2008

Crude Oil Prices: Crude Oil Baloney

In an earlier post I suggested that the decline in crude oil prices from $147 a barrel to $127 a barrel couldn't be completely explained by a sudden drop-off in demand. An article in the Financial Times discusses the bankruptcy of SemGroup which in the process of covering its hedging activities could have caused $10 increases in the prices of crude oil.

Traders sold oil futures as news emerged that tropical storm Dolly was set to miss oil and natural gas installations in the US Gulf of Mexico.

Oil traders said SemGroup could have exacerbated the spike in oil prices this month, when the market experienced unprecedented swings of more than $10 a barrel, as the company was buying back some previous bets on lower prices.

The bankruptcy of SemGroup, which describes itself as the fourteenth largest US private held company, affects approximately $3.1bn of debt, according to court filings. Oil company BP is the largest creditor, with almost $160m.

SemGroup bet in the futures market that oil prices would fall as a way to hedge its positions in the physical market. But as prices jumped this month to a record of $147.27 a barrel from less than $100 a barrel at the beginning of the year, the mounting losses triggered large margin calls from banks – a request to put up more collateral – draining the company’s cash reserves.”

While this particular instance does not in another itself account for significant crude oil price increases, it does provide evidence that the trading in crude oil futures is very volatile and can be influenced by traders. Crude oil prices dropped to $125 a barrel on Wednesday and there is some in the industry who are talking about the possibility that crude oil prices could eventually drop as low as $100 a barrel. A 30% plus decrease in crude oil prices in the absence of a significant drop-off in demand suggests the heavy hand of speculation. Those who continued to deny the influence of speculation need to be reminded of the line from Macbeth, "Methinks the lady doth protest too much."

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