Price volatility is expected in any commodity market. In fact it's how people trading those commodities make money. But lately crude oil and related products like gasoline and heating oil have had so many wild price swings that business owners and even homeowners have had a difficult time budgeting their energy costs. Here's some background for you on why these swings may be happening.
To understand the current pattern of oil prices, one has to put those prices into some historic perspective. When I was covering petrochemical markets in the early 1990s and we were in the middle of a bull market one of my colleagues insisted that crude prices would soon (in a matter of months) top $100 per barrel.
This seemed preposterous at the time, and I told him so. Markets were strong at the time (just over $40 per barrel in October 1990 during the Gulf War), but market fundamentals couldn't support a move of that magnitude. I was right, won the bet, and enjoyed a beer courtesy of my colleague.
But roughly eighteen years later, my friend's forecast finally came true. Crude oil prices hit the $100 per barrel mark in February 2008 and by July of last year they reached as high as $145 per barrel. But the honeymoon didn't last and crude oil ended 2008 closer to $35. Now prices are around $68 per barrel. That's a huge, unprecedented amount of price movement in roughly eighteen months. So why the wild price fluctuations?
Covering Physical Needs
Crude oil and related products like heating oil, natural gas and gasoline have traded as physical commodities for many years. Sometimes brokers, who earn handsome commissions but never actually own a barrel of oil, act as intermediaries for people who need to buy the physical oil and people who need to sell the oil. Other times traders take a position of ownership of the oil and later sell it, hopefully at a profit.
Oil companies have trading arms, and much of the trading that was done in the 70s, 80s, 90s and the earlier part of the current decade was more about covering a particular company's physical needs, either to obtain a certain type of crude oil or to unload an oversupply of another type.
But recently there appears to be much more speculative trading going on. They are buying or selling oil strictly on the hope that prices will rise or fall. People have always loved betting. My Irish grandfather used to get his kicks betting on the horses, but now there's a huge industry based on betting on energy product prices. And many industry experts think all the speculative trading in oil is resulting in too many unpredictable price gyrations that have nothing to due with market fundamentals of actual supply and demand.
Last week, the New York Times reported that Gary Gensler, chairman of the Commodity Futures Trade Commission (CFTC), asserted that he would like to see greater limitations on energy trades that are mostly speculative. By reducing the volume of oil-related energy product trading among groups or individuals that don't actually need or want the physical oil and, in turn, reducing their share of total oil trade volume, the hope is that price volatility will decrease.
But, some groups with close ties to futures exchanges in New York and Chicago deny that increased oil market volatility is directly related to trading of energy products as financial instruments.
The CFTC currently is analyzing data to determine if the price volatility we've been seeing since last year has much to do with increased speculative trading. If they find that it does, and if they do decide to force new trading limitations on speculators, that could mean more price stability and fewer headaches for homeowners like us trying to budget our gasoline and heating oil expenses over time.