My Blog

  • Energy trading markets have been undergoing radical transformation lately. These transformations are set to accelerate in 2013 because of much anticipated implementation of new rules that will govern global swaps markets. These include measures such as position limits, mandatory clearing and margin requirements, capital requirements, pre- and post- trade transparency through position reporting requirements to trade repositories, as well as trading standardised swaps on designated contract organisations or swap execution facilities where multiple traders can place bids and offers, and real time reporting of cleared and uncleared swaps to the centralised swap data repositories. These changing dynamics present new challenges not only for financial speculators, who buy or sell any asset in the anticipation of a price change, but also for traditional energy companies that use previously unregulated financial derivative instruments to hedge or mitigate commercial risk. more »

  • Allegations of price manipulation in UK wholesale natural gas prices by some major power companies and financial institutions could not have come at a worse time for price reporting agencies (PRAs). Less than a month after IOSCO’s publication of principles for oil price reporting agencies, a price reporter at energy‐ industry data provider ICIS went public with the charge that natural gas prices are regularly manipulated by physical and financial traders, and that prices assessed by price reporting agencies do not accurately reflect the underlying physical market. Furthermore, he argued that poorly trained price assessors often developed close relationships with traders, which led them to routinely engage in Libor‐style price fixing exercises. Immediately following these allegations, UK Financial Services Authority (FSA) and energy regulator Ofgem launched investigations into the claims. more »

  • US CFTC Chairman Gary Gensler declared last month that a new era for the swaps marketplace would start on 12 October 2012, the effective date of the new US swap definition rule. This marked the beginning of the process of swap dealer registration and swap data reporting. Mandatory clearing by swap dealers and major swap participants is expected to follow in February. The new rules are intended to bring transparency to the swaps markets and lower their risks. While the 12 October date may indeed be remembered as a milestone, a close look at the new rules suggests that lingering difficulties remain and that the process of regulatory swaps market reform may still be undergoing teething pains. more »

  • The debate over the impact of quantitative easing by major central banks has again intensified, especially following the announcement of another round of quantitative easing by the US Federal Reserve on 13 September 2012. Some commentators have argued that, in a world in which commodities constitute an asset class, there ought to be a positive relationship between quantitative easing and commodity prices via ‘portfolio effects’– even if quantitative easing does not affect the demand or the supply of physical oil. more »

  • Making reliable forecasts of oil prices has been of interest to a wide range of economic agents, including policymakers, oil producers and consumers as well as other market participants. However, in a rapidly changing oil market, any forecast of oil prices, especially at longer horizons, is highly uncertain, a fact illustrated by the wide confidence bands around price predictions. Research shows that forecasts based on futures prices, surveys of analyst forecasts, forecasts based on a variety of simple time series regressions and other common forecasting techniques are generally inferior to the random-walk forecast, which implies that the best forecast of crude oil spot prices is simply the current price of oil. more »

  • In recent years, the oil market has been characterised by rising, and at times, rapidly fluctuating price levels. From April 2012 to June 2012 alone, Brent crude oil prices gyrated between USD 125 and USD 89 per barrel. Higher volatility adversely affects oil exporting countries’ fiscal revenues and investment, reducing confidence in the economy, while it worsens inflation and growth prospects for oil importers. more »

  • Almost two years after the Dodd-Frank Act was enacted into law, on 10 July 2012 the US CFTC voted 4-1 to approve a 600-page final rule, jointly developed with the US Securities and Exchange Commission (SEC), to further define the statutory term “swap”. Not only does the definition provide greater clarity on which financial products can be expected to fall within regulatory oversight, and thus become subject to reporting, clearing, capital and margin requirements, but passage of the rule also sets the compliance dates for a string of other Commission rules governing the $650 trillion over-the-counter global swaps markets. Those include rules on swap dealers (SD) and major swap participants (MSP) registration, SD and MSP swap data reporting and recordkeeping, registration of swap data depositories, large trader reporting for registered SDs and MSPs, real time reporting of swap transactions and pricing data, internal and external business conduct standards and position limits. more »

  • In recent years, the oil market has been characterised by rising, and at times, rapidly fluctuating price levels. In the last three months alone, Brent crude oil prices have fluctuated in a wide range from $125/bbl to $89/bbl. Higher volatility will certainly impact both consumers and producers. Oil exporting countries can be negatively affected by the impacts of high volatility in oil prices on fiscal revenues, investment and confidence in the economy. Higher volatility can have negative impacts on inflation and growth prospects in oil importing countries as well. As a response to observed higher prevailing volatility, for example, G20 leaders called for policy options to combat excessive price volatility in commodity markets in general, and in oil markets in particular. In order to reduce volatility in oil markets, the G20 experts group emphasised the importance of improving data transparency in both financial and physical markets as well as phasing out of inefficient fossil fuel subsidies. They also urged the use of country-specific monetary and fiscal responses to support inclusive growth in order to mitigate the impacts of excessive price volatility. more »

  • On 10 May 2012, JP Morgan, the largest US bank by assets, announced that poorly designed and executed hedging strategies had caused more than $2 billion in derivatives trading losses from transactions in London. Even more worrying is the fact that some regulators, including the US Commodity Futures Trading Commission (CFTC) and the US Securities Exchange Commission (SEC), have argued that since they do not yet monitor JP Morgan as a swap dealer, they became aware of the trading losses after JP Morgan’s announcement despite earlier media reports at the beginning of April that raised red flags over the London Whale’s $100 billion notional exposure in one credit index. more »

  • Despite scant evidence of a negative impact of speculation in the oil market, in seeking to prohibit excessive speculation and its possible effect on price volatility in futures markets, the US CFTC approved final rules on federal speculative positions limits on commodity futures, options and swaps positions of speculators for 28 commodities in October 2011. As we reported in previous OMRs, position limit rules are being challenged by the International Swaps and Derivatives Association (ISDA) and the Securities Industry and Financial Markets Association (SIFMA) in court. ... more »

  • On 17 April 2012, Obama Administration proposed new initiatives to strengthen oversight of energy markets.

    The President's plan call on Congress to:... more »

  • Oil prices have experienced large fluctuations in recent years. The spike in crude oil prices in mid-2008 to more than $140/bbl, followed by a steep correction in late 2008/early 2009 and subsequent sharp rebound over the last two years have jolted the world economy and pinched consumers at the fuel pump. US dollar weakness in recent years is frequently cited as one reason for high oil prices. It is very common to see the financial press suggesting that a weak dollar has pushed oil prices higher. However, this explanation is challenged by the empirical observations that (a) a change in oil price tends to lead to a change in the exchange rate as predicted by economic theory and (b) the oil price has risen regardless of what currency unit one uses to measure the price of oil. ... more »

  • On 6 May 2010, major American stock indices and stock index futures nosedived by more than five percent before sharply recovering in less than 30 minutes. Since that infamous flash crash, high frequency traders (HFTs) have drawn the attention of regulators, exchanges and market participants, despite the fact that the crash was not triggered directly by HFTs, according to an official joint report released by the US CFTC and SEC. Nonetheless, fragmentation of trading venues and the establishment of the US Regulation National Market System and the European Union’s Markets in Financial Instruments Directive (MiFID) in 2007 requiring brokerages to find the best execution for customers, have led to the explosive growth of HFTs. ... more »

  • In a narrow 3-2 vote on 11 January 2012, CFTC Commissioners proposed their own version of the Volcker Rule, which prohibits proprietary trading activities of banks and limits their investments in private-equity and hedge funds in line with the restrictions already proposed by the Federal Deposit Insurance Corp., the Federal Reserve, the SEC and the Comptroller of the Currency in October, 2011. The intent of the Volcker Rule is to reduce risk in the US banking system by limiting the excessive risk-taking activities of banking entities, defined as any insured depository institutions and their subsidiaries. ... more »

  • Regulatory bodies on both sides of the Atlantic will be busy in 2012 finalising rules on one of the most important requirements for bringing pre- and post-trade transparency to the over-the-counter derivatives markets by ensuring prices are posted to a wide variety of market participants, not just among dealers. Initially set by the G-20 leaders at their Pittsburgh Summit in September 2009 and later adopted in reform packages in the US and Europe, transparency would be achieved through... more »

  • As part of their remit covering joint activities set out in the Cancun Ministerial declaration of March 2010, the IEA, IEF and OPEC jointly hosted their second annual workshop on linkages between physical and financial oil markets in Vienna on 29 November 2011. Over 100 participants attended from across the spectrum of research institutions, major oil producers and consumers, the financial sector, regulators and policy makers. ... more »

  • In a contentious 3-2 vote on 18 October, the US CFTC Commissioners approved final rules on federal speculative positions limits on commodity futures, options and swaps positions of speculators for 28 commodities. These include NYMEX natural gas, crude oil, gasoline and heating oil, along with a number of metals and grains contracts. In seeking to prohibit excessive speculation and its possible effect on price volatility in futures markets, the Commission adopted a two-stage approach for hard position limits as preventive medicine for excessive speculation. The main features of the... more »

  • Investors, seeking to diversify their portfolio and hedge against rising inflation, have increased their exposure to commodities by directly purchasing commodities, by taking outright positions in commodity futures, or by acquiring stakes in exchange-traded commodity funds (ETFs) and in commodity index funds. This pattern has accelerated in recent years. According to index investment data collected by Barclays Capital for US and non-US assets under management, commodity index investment has increased from $55 billion in late 2004 to $431 billion in July 2011. The initial surge in ... more »

  • Bahattin Buyuksahin’s research on the ‘fair price’ pronouncements and the market price of crude oil, with Michel Robe of the American University, Celso Brunetti of the Johns Hopkins University and Kirsten Soneson of the CFTC, was the focus of an article on energy.aol.com. The article discusses Buyuksahin and others' research, summarizing their conclusion: “Fair price pronouncements by OPEC officials are ineffective at influencing crude oil market movements.” ... more »

  • On August 24, 2011, I discussed Prof. Ken Singleton's new research paper, entitled "Investor Flows and the 2008 Boom/Bust in Oil Prices" at the U.S. Energy Information Administration's* *"Financial and Physical Oil Market Linkages Workshop"* * in Washington, DC. You can find my discussions ...more »

  • An August CFTC conference in Washington DC was modity markets. The conference came at a time of intense debate surrounding recent CFTC rulemaking. Several conference panelists argued that speculators in general, and commodity index traders (CITs) in particular, have affected the functioning of commodity markets and caused oil price swings that cannot be explained by energy market fundamentals – especially during the 2008 financial crisis. However, in the presentations of that set of papers, we ... more »

  • I will be presenting our new research paper (joint work with Celso Brunetti and Jeffrey Harris), entitled "Do Institutional Traders Predict Bull and Bear Markets?", at the American University, Washington DC, on October 13, at the International Monetary Fund in Washington DC, on October 14, 2011 and at the European Central Bank in Frankfurt, Germany on November 10, 2011. *Abstract: * We analyze the role of hedge fund, swap dealer and arbitrageur activity in a Markov regime-switching model between high volatility bear markets and low volatility bull markets for crude oil,... more »

  • Market participants still await final rules which will govern global OTC derivatives markets. Meanwhile, according to the latest Bank of International Settlements (BIS) survey, total notional value of all OTC derivatives reached $601 trillion at the end of December 2010, of which $2.92 trillion (0.5%) was commodity–related derivatives. However, at their peak at end‐June 2008, the total notional value of commodity derivatives had reached a far higher $13 trillion, or 2.5% of the total market. Although the size of commodity‐related over the counter derivatives contracts is relatively... more »

  • Prices for crude oil benchmarks WTI and Brent have historically been related. In general WTI light sweet crude oil sold at a 5% premium to Brent crude oil between 1994 and 2010. However, this relationship between WTI and Brent crude oil totally collapsed in 2011. Brent crude oil sold at an average premium of $13/bbl in 1H11, or 13%, reaching $23/bbl in mid-June. That Brent might sell at a premium over WTI is not a new phenomenon. However, the magnitude as well as the duration of the current episode raises questions about the causes of this new ‘reality’ and whether the weakening ... more »

  • Prices for oil, like those for many other commodities, are inherently volatile and volatility itself varies over time. In recent years, the oil market has been characterised by rising, and at times, rapidly fluctuating, price levels. In the last nine months alone, crude oil prices have fluctuated in a wide range from $75/bbl to $125/bbl. However, careful examination of historical patterns shows that the volatility observed during 2008-2009 is actually lower than the peak observed in 1990‑1991. The concept of volatility is often confused simply with rising prices; however, volatility... more »

  • US dollar weakness in recent years is frequently cited as one reason for high oil prices. It is very common to see the financial press suggesting that a weak dollar has pushed oil prices higher. Empirically, there is clearly an inverse correlation between oil prices and exchange rates – that is, other things being equal, oil prices rise if the dollar falls. An assessment of the dynamic conditional correlation (DCC) and of the one-year rolling average correlation between the daily change in the oil price and the daily change in the nominal effective exchange rate shows that this ... more »

  • Increased volatility, higher crude oil prices and the arrival of new financial participants in the crude oil market during the last decade have raised the question of whether financial players have an impact on commodity prices and price volatility. Unfortunately, limited publicly available data in both physical and financial markets makes it very hard to provide a definitive answer. Understanding the linkages between physical and financial markets on price formation requires more complete information on both than is currently available. Traders in derivatives markets rely on signal... more »

  • My coauthor Michel Robe and I presented our new research paper, entitled "*Does 'Paper Oil' Matter? Energy Markets’ Financialization and Equity-Commodity Co-Movements*", at Universidad Carlos III in Madrid on May 25 and at the ISTCE Business School's Annual Conference on Commodities and Energy Marketsin Lisbon on May 27, 2011. *Abstract:* We construct a uniquely detailed, comprehensive dataset of trader positions in U.S. energy futures markets. We identify considerable changes in the make-up of the open interest between 2000 and 2010 and show that these changes impact asset pricing... more »

  • On May 6 2011, I presented at the symposium of the Scientific Council, organised by AMF and CRE. My presentation was entitled "The role of financial players on financialisation of commodities." It was based on my two related articles:... more »

  • This supplement to the April 2011 OMR is designed as a reference document for member governments and subscribers. It forms part of an ongoing work programme examining the mechanics of oil price formation and the interactions between the physical and paper markets. Further research will be forthcoming in the OMR, the MTOGM and in the form of stand‐alone papers in months to come. The work programme is being supported by contributions from member governments, most notably those from Japan and Germany. We are grateful for that support. Further impetus for this work comes from the joint ... more »

  • Prices for oil, like those of many other commodities, are inherently volatile. In recent years, the oil market has been characterised by rising, and at times, rapidly fluctuating, price levels. In the last six months alone, oil prices have fluctuated in a wide range from $75/bbl to $125/bbl. The concept of volatility may itself at times be confused simply with rising prices; however, volatility can equally result in prices that are significantly lower than historical average levels. Volatility is the term used in finance for the day-to-day, week-to-week, month-to-month or year-to-year... more »

  • Fluctuations in commodity prices, particularly in crude oil prices, have been hotly debated in recent years. Some argue that underlying market fundamentals, especially the unexpectedly strong demand shock attributed to continued strong economic growth in Asia and other emerging economies, is the main reason for the resurgence of commodity prices and for the fluctuations in prices since 2004. Others argue that speculative activity in commodity derivatives markets is the main force behind surging commodity prices. They further claim that commodities have become a new asset class in ... more »

  • Speculators have never been popular, and they may never have been as unpopular as they are today. Increasingly they are blamed for fluctuations in commodity prices, particularly in energy prices, even though a market lacking speculators to take the other side of price hedging transactions for physical market players would arguably be one that would be much more volatile. Two of the most important functions of futures markets are the transfer of risk and price discovery. In a market, hedgers, who are trying to reduce their exposure to price risk, will trade ... more »

  • Investor interest in commodities, including oil, has risen dramatically over the last decade and commodities have become a new asset class in institutional investors’ portfolio. Partly, this development is due to diversification benefits. In addition, the development of new investment vehicles, such as exchange traded funds, has allowed individual investors to get exposure to movements in commodity prices. Due to the storage and trading costs associated with direct physical investment in commodities, the main vehicle used by investors to gain exposure is via commodity indices ... more »