342. MATT SIMMONS: SPECULATORS SET OIL PRICES
Big hat tip to juan for finding today's tasty nugget: a January 27, 1998 paper by Matthew R. Simmons* entitled Is Another "MG" at Work? (Or, What is Driving Down the Price of Oil?) (paper archived here: Simmons & Co). In this paper, Simmons proves that oil prices are set by speculators, with little reference to the underlying fundamentals.
Some choice quotes from this explosive document (bold in original):
Effectively, the changing perceptions of a small handful of speculators now appear to set the price for West Texas Intermediate crude oil, which in turn sets the general price for almost all other crude grades throughout the world.
If this is true, the world's most important commodity is being priced by a handful of hedge funds or individual speculators who, as a group, invest less than $100 to $150 million at any period of time.
For all those that fervently believe price movement always reflects fundamental changes in the physical markets, the discussion in this paper bears careful reading. Our work strongly suggest that large swings in the funds' net position in oil contracts on the NYMEX have driven virtually every significant movement of crude oil since the MG position was unwound in 1994.
Why Should the Funds Have Such Heavy Influence on Crude?
It seems hard to believe that the buying behavior of a small group of hedge funds could actually move the price of a commodity as important as crude oil. After all, it is the world's largest single traded commodity both in terms of dollars changing hands and in daily volume.
Throughout this period, the commercial buyers generally held three to four times as many contracts. So why would they not be the big drivers of crude prices?
The answer is that few, if any, of the significant commercial traders are charged with betting on the future direction of crude. While the commercial traders do watch the technical charts and attempt to minimize daily losses or make reasonable trading profits, few have the mandate (or the temperament) to make a heavy bet on the direction of crude prices. In fact, a number of the large industry traders have company policies which preclude being able to "bet on the future of oil".
But the funds are clearly a horse of a different color. Their huge shifts between holding big short and big long positions clearly indicate this. Both the velocity and magnitude of their swings, often occurring in a handful of weeks, have become the proverbial tail wagging the dog or Archimedes' famous lever, which moves perhaps not the entire world, but certainly the world of crude.
Thus, if funds are driving the NYMEX price, the NYMEX price drives the WTI cash price and the WTI drives world crude prices, it leads us to the conclusion that a small number of speculators are driving the world price of oil.
In our opinion, this indicates that prices over the short-term tell us nothing about the supply and demand fundamentals for oil. Rather than being a perfect indicator for the fundamentals, price is a perfect indicator for the psychology of a small number of funds.
*) Chairman of Simmons and Co., Intl., the world's leading investment bank in the energy industry.