Crude Oil Prices Could Be Easily Manipulated; Helped By Ridiculously Low 7% Margin Requirement for Oil Futures. We Don't Know That Oil Prices Are Being Manipulated, But They Could.
The ridiculously low 7% margin requirement for crude oil futures contracts means that oil producers, big or small, could easily be manipulating the price of oil for their own benefit. That's not to say that pension funds and other hedge players aren't also going steadily long crude oil and other commodity futures. But it is in the obvious self interest of oil producers to have an ever rising price of crude.
For example, suppose the "players" who run Russia (or Iran, or Venezuela or any major or minor producer) decided a year ago to invest $200 million per month as margin to go long oil futures. Margin of $200 million could control as many as 25,000 contracts at $8,000 per contract, which would be equal to 1.3% of notional open interest.Wouldn't adding 1.3% each month to the 1.9 million contracts of notional open interest be enough to produce the crazy oil market that exists now?
Publicly available sources indicate that Russia produces 9.4 million barrels of oil per day, Iran 4.0 million bpd and Venezuela 3.0 million bpd. The increase in oil prices from $60 per barrel to $130 per barrel in the past year for Russia alone has translated into an additional $20 billion per month (9.4 million barrels per day * 30 days per month * $70 increase per barrel = $20 billion). Not only would higher prices mean more cash now but also higher values for what's left. Let's not forget that someone who bought $2.8 billion worth of oil last year at $60 per barrel using $200 million in margin is sitting on a profit of over $3 billion per $200 million investment.
We have no evidence of any kind that oil producers are pumping up oil prices, but they could. If we were producing millions of barrels per day of oil, we would consider going long oil futures, putting up $1 to control $14 dollars of crude, to ensure that prices keep rising.
Our Modest Solution to Oil Price Spike: U.S. Should Divert Money Saved from Ending Strategic Petroleum Reserve Purchases to Go Short Oil Futures.
One obvious way to burst the oil bubble would be to boost the margin requirement for oil futures. Since exchanges and brokers earn big bucks from trading lots of contracts, we therefore doubt margin requirements will be boosted any time soon.
But there is another way to bring the oil mania under control. If it is logical for oil producers to go long oil futures to enhance the future value of their remaining oil, why is it not logical for oil consumers to go short oil futures? Japan, are you listening?
The U.S. recently suspended its daily purchases of 70,000 barrels of oil for the Strategic Petroleum Reserve. Why not use the savings of roughly $275 million per month to short oil futures (70,000 barrels per day * 30 days per month * $131 per barrel = $275 million)? That $275 million would be enough to short 34,400 contracts per month. The U.S. has more than 700 million barrels of oil in the Strategic Petroleum Reserve, which is about 1/3 the notional open interest of oil futures. In essence the U.S. would be offering to sell at a high price the crude it bought at much lower prices. For the future, would the U.S. be better off with lower oil prices or more high-priced oil in salt caverns?
The TrimTabs-BarclayHedge Hedge Fund Flow Report indicates that $1 billion per month flowed into commodity hedge funds in the first three months of 2008. If half of that $1 billion, or $500 million, is invested in oil futures, it is enough to go long 62,500 contracts, which would be equal to 3.3% of notional open interest. But what if oil users shorted enough contracts to counteract that $500 million?
The world consumes 85 million barrels of oil per day. At $131 per barrel, the world is paying $11 billion per day, or $334 billion per month, to oil producers. If oil prices fell back to $80 to $90 per barrel--prices at which almost all alternative energy schemes are profitable--the world would save $105 billion to $129 billion per month on its oil bill. Is that savings not worth shorting $500 million in oil futures per month?
Alison Simard President, West Coast bureau Stern & Co.
