Shocked oil futures face another week of excessive volatility

China (Platts) -- September 22 - 26, 2008

By reporters at Platts, the energy information division of the McGraw-Hill Companies. For more information about Platts' information products in China, contact Platts at china@platts.com, or call its representative office in Guangzhou at (+86) 20 2881 6588.

Excessively volatile and thinly traded would both be understatements to describe the state of the world's energy futures markets.

Deep shock has started to set in from months of economic turmoil, financial chaos and unpredictable oil demand trends.

Much of the week ahead will likely be spent picking over the fall out from September 22 on the New York Mercantile Exchange, when the expiring October crude oil futures contract rallied an inexplicable 25% in value before closing the day at $120.92/barrel, up $16.37/barrel in one day and a record single-day movement in price.

That surge and the volatility on the day "do not reflect fundamentals," the US Energy Information Administration's acting chief told a Senate panel the next day, giving new ammunition to Senate Democrats looking to rein in commodity speculators.

The EIA's Howard Gruenspecht told the Senate Energy and Natural Resources Committee that the record gain was not related to supply and demand fundamentals and may have reflected "short-term trading activity" and a "short squeeze" as speculators who bet on oil falling were forced to buy oil in order to cover their positions as the October contract expired.

Gruenspecht's comment could fuel anti-speculation legislators like Dorgan to bring up legislation in the Senate when Congress returns in November.

Meanwhile, US Energy Secretary Samuel Bodman said the spike was not the work of speculation. "I think it was an anomaly," he told reporters at a Washington event.

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Bodman said, however, that he was encouraged that the US Commodity Futures Trading Commission will investigate possible speculative manipulation of the market.

The same day, the New York Times reported that the CFTC had issued subpoenas to obtain trading records for that day.

An NYMEX spokeswoman declined comment on the report, while the CFTC would only refer to its September 22 statement.

Even with the talk and evidence of an historic squeeze, analysts and traders pointed to some technical and fundamental factors behind the apparent squeeze.

A 158 point drop in the US dollar -- as the US' planned bailout of mortgage securities was met with skepticism -- helped oil prices soar, for instance.

"Oil was being bought against the falling dollar and against systemic risk," said Phil Flynn of Alaron Trading in his daily Energy Report. Still, he said oil also soared as investors were caught in a "classic short squeeze" along with supply concerns over hurricanes Gustav and Ike. Others saw a buying opportunity for oil as well.

"While a $700 billion government buyout of 'toxic' mortgages does not guarantee the end of economic woes, it did abruptly calm concerns that global markets were moments away from seizing up like a leaky engine on a hot highway," said Kevin Book, chief energy analyst with Friedman, Billings, Ramsey in a report.

"Given that economic growth drives oil demand, it stands to reason that preventing financial Armageddon probably put the squeeze on short positions predicated on an 'end of days' economic collapse."

Also, supply risks remain in the market, Book continued, "like Venezuelan nationalizations, Russian power grabs in the Caucasus and Nigerian militants declaring war on oil infrastructure, just to name a few."

Further, Gulf of Mexico production shut-ins from Gustav and Ike have totaled 26.38 million barrels.

"Our hunch is that commercial traders probably saw low prices as a buying opportunity and (some) speculators bounced back in behind them, hoping for long positions at bargain prices in the wake of the Lehman collapse and the Merrill Lynch fire-sale," he said.

Notices for the crude contract started to be issued on September 24, with a strong 556 contracts, or 556,000 barrels, to be delivered into Cushing, Oklahoma, the contract's delivery point, exchange documents showed.

In contrast, delivery notices for the full 30 days of the NYMEX September crude contract were 196 contracts, or 196,000 barrels, and the August contract totaled 183 lots, or 183,000 barrels.

The largest delivery against the contract was 4 million barrels in the late 1990s, according to the exchange.

NewEdge, a joint venture between Fimat and Calyon Financial, will deliver all 556,000 barrels, while Morgan Stanley will accept delivery of 25,000 barrels and JP Morgan will take delivery of 531,000 barrels, the documents said.

Updated: September 29, 2008

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