In Comment 68 (June 1, 2009) we have concluded that the rapid rise of crude oil price from February to May of 2009 was not due to the buying of future contracts by speculators who do not possess the storage capacity for crude oil. On the other hand a Market Watch article has claimed that big pension funds and endowment funds that invest in commodities had accumulated crude oil future contracts equivalent to 600 million barrels of physical crude oil, and thus is the culprit behind the recent rapid rise of crude oil price. Since big pension funds and endowment funds belong to the speculator group that does not possess crude oil storage capacity, the conclusion of Comment 68 and that of the Market Watch article are in direct contradiction. The purpose of this article is to point out the existence of a logical gap in the argument of the Market Watch article that invalidates its conclusion.
The trading in future market is a zero-sum game. When there is a buyer of a future contract, there must be a matching seller of the same future contract. Thus matching the buying of big pension funds and endowment funds, some speculative parties must have sold crude oil future contracts equivalent to 600 million barrels of physical crude oil. The price of future contract moves up when buyers are more aggressive than sellers, and the price moves down when sellers become more aggressive than buyers. Since it is safe to assume that the matching sellers also do not possess crude oil storage capacity, the sellers must roll over their selling positions into future month series when the current month series expires, just like big pension funds and endowment funds must do about their buying positions. If big pension funds and endowment funds are more aggressive than the matching sellers, the price difference between future month contracts and the current month contract will expand, whereas if the matching sellers are more aggressive than big pension funds and endowment funds opposite trends in the price difference will prevail. In Comment 68 it has been pointed out that there was little movement in the price difference front during the rapid rise of crude oil price from February to May, so the big pension funds and endowment funds were equally aggressive or non-aggressive as the matching sellers. This means that speculative trades in future market is not responsible for the rapid rise of crude oil price. It should be noted that when the current month series of future contract expires, the closing price will converge to the spot market price. The future price and the spot price are like two persons handcuffed together. When one person moves, the other must follow. Once we have concluded that the future price was not playing the leading role, we must reach the claim that it was the spot price playing the leading role of rapid rise due to the aggressive buying of parties with crude oil storage capacity. The Market Watch article has looked at the buying volume only and has forgotten about the existence of the matching sellers completely. From the buying volume in future market alone no conclusion about the price movement can be derived.
In article 11 similar method as Comment 68 has been employed to analyze the sharp run up of crude oil price to $145/barrel level. It has been pointed out that until May, 2008 sellers in future trading had been more aggressive than buyers so that future trading was not responsible for the crude oil price rise up to $125/barrel level. However, from May of 2008, the sentiment in the future market had turned abruptly to wildly bullish, so future trading was responsible for pushing crude oil price from $125/barrel to $145/barrel.