The Role of Speculation in Energy Markets
January 25, 2007
Kyle Dickard
Managing Director, Global Commodity Analysis
Overview
Quotes on Speculation
Market Manipulation Defined
Benefits of Speculation in the Energy Markets
Hedgers, Speculators and Investors
Speculation and Volatility
Potential Impacts of Speculation on Price
Other Drivers of Price Movements
Market Responses to Price and Shape of the Curve
Changes in Historical Relationships
Conclusion
2
Quotes on Speculation
“Overwhelmingly, academic research has shown that speculation actually reduces
price volatility and that speculation increases availability of market information.
Recent CFTC data supports the research by showing that physical commodity
futures markets with higher non-commercial participation have lower overall
volatility.”
“Our bill would give regulators the information needed to expose oil traders
engaging in market speculation or manipulation.”
3
Market Manipulation
“Any planned operation, transaction, or practice that causes or maintains an
artificial price. Specific types include corners and squeezes as well as unusually
large purchases or sales of a commodity or security in a short period of time in
order to distort prices and putting out false information in order to distort
prices.” CFTC
4
Benefits of Speculation in the Energy Markets

Counterparty for Hedgers

Accept Risk

Add Volume

Provide Broad Market Information

Create Liquidity

Reduce Volatility
5
Hedgers, Speculators and Investors


New Participants
•
Pension Funds
•
University Endowments
•
Hedge Fund Investors
•
Financial Institutions
Commodities as an Asset Class
6
Speculation and Volatility
Crude Oil Futures and Options
Commercial and Non Commercial Positions
1995 - Current
Contracts
Volatility
1,400,000
0.75
Commercial Long
Commercial Short
Non-Commercial Long
Non-Commercial Short
Non-Commercial Spread
Volatility
1,200,000
1,000,000
0.65
0.55
800,000
0.45
600,000
0.35
400,000
0.25
200,000
9/21/2006
3/21/2006
9/21/2005
3/21/2005
9/21/2004
3/21/2004
9/21/2003
3/21/2003
9/21/2002
3/21/2002
9/21/2001
3/21/2001
9/21/2000
3/21/2000
9/21/1999
3/21/1999
9/21/1998
3/21/1998
9/21/1997
3/21/1997
9/21/1996
3/21/1996
9/21/1995
0.15
3/21/1995
0
Sources: CFTC, NYMEX
7
Potential Impacts of Speculation on Price

Estimated $100B from investors enters markets

40% allocated to crude oil

Incremental demand of 1MM barrels per day

Strong uptrend in prices
8
Potential Impacts of Speculation on Price
NYMEX Crude Oil Prices and Total Open Interest Positions
1995 - Current
Contracts
$/Bbl
2,500,000
80
70
WTI Weekly Avg Price
2,000,000
60
50
1,500,000
40
1,000,000
30
20
500,000
10
WTI Open Interest
-
0
Mar-06
Mar-05
Mar-04
Mar-03
Mar-02
Mar-01
Mar-00
Mar-99
Mar-98
Mar-97
Mar-96
Mar-95
Sources: CFTC, NYMEX
9
Other Drivers of Price Movements

Lack of investment in energy infrastructure

Asian and North American demand

Lack of investment in exploration and production

Limited potential for OPEC swing production

Threat of disruption in producing regions

Terrorism premium

North American natural gas fundamentals
10
Market Responses to Price and Shape of the Curve

Stimulate additional production of both natural gas and crude oil

Increase in inventories

Scale back of consumption

Finance production and storage to meet future demand
Oil Rigs and NYMEX WTI Price
Natural Gas Rigs and NYMEX NatGas Price
$/Bbl
No. Rigs
500
450
Baker Hughes Oil Rig Count
$/Bbl
16
No. Rigs
80
1,600
70
1,400
14
Baker Hughes Natural Gas Rig Count
400
60
1,200
12
300
50
1,000
10
250
40
800
8
200
30
600
6
20
400
350
Nymex WTI
150
4
100
Sources: Baker Hughes, NYMEX
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
0
Jan-99
0
Jan-98
2
Jan-97
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
0
Jan-96
0
200
Jan-96
10
50
Nymex Natural Gas
Sources: Baker Hughes, NYMEX
11
Changes in Historical Relationships

Traditionally, there was an inverse relationship between crude oil price and inventory

High inventories meant low prices and vice versa

Recently, we have seen high inventories AND high prices
Thousands of
Barrels
410000
$/Barrel
80
70
WTI NYMEX Monthly Avg Price
390000
60
US Crude Oil Inventories
370000
Feb-06
Feb-05
Feb-04
Feb-03
Feb-02
Feb-01
250000
Feb-00
0
Feb-99
270000
Feb-98
10
Feb-97
290000
Feb-96
20
Feb-95
310000
Feb-94
30
Feb-93
330000
Feb-92
40
Feb-91
350000
Feb-90
50
Sources: NYMEX, DOE
12
Changes in Historical Relationships

Relationship between crude oil inventory and price appears to have changed in 2004

Gulf War points illustrate price increase on PERCEPTION of future supply disruption
$/Bbl
Monthly
80
70
CL1 before 2004
CL1 2004+
60
Gulf War
50
40
30
20
10
0
250000
270000
Sources: DOE, NYMEX
290000
310000
330000
350000
370000
390000
410000
Thousands of Barrels
13
Changes in Historical Relationships

Relationship between crude oil inventory and shape of the curve remains relatively
unchanged

Strongest incentive to store when inventories are the highest and vice versa
Thousands
of Barrels
$/Bbl
410000
2.5
390000
US Crude Oil Inventories
2
Month 2 - Month 1
1.5
370000
1
350000
0.5
330000
0
310000
-0.5
-1
290000
-1.5
Feb-06
Feb-05
Feb-04
Feb-03
Feb-02
Feb-01
Feb-00
Feb-99
Feb-98
Feb-97
Feb-96
Feb-95
Feb-94
Feb-93
-2.5
Feb-92
250000
Feb-91
-2
Feb-90
270000
Sources: NYMEX, DOE
14
Market Responses to Price and Shape of the Curve

Global demand outpaces supply

Spare refining capacity declines over time
Global Spare Refining Capacity
(Capacity – Refinery Runs)
Thousands of Bbls
13000
12000
11000
10000
9000
8000
7000
pr
-0
2
Ju
l-0
O 2
ct
-0
Ja 2
n03
A
pr
-0
3
Ju
l-0
O 3
ct
-0
Ja 3
n04
A
pr
-0
4
Ju
l-0
O 4
ct
-0
Ja 4
n05
A
pr
-0
5
Ju
l-0
O 5
ct
-0
Ja 5
n06
A
pr
-0
6
Ju
l-0
O 6
ct
-0
6
A
Ja
n-
02
6000
Source: MLCI Proprietary
15
Market Responses to Price and Shape of the Curve

Contango shape of the forward curve

Adequate supplies in the near term

Supply concerns in the future
$/Bbl
WTI Curve as of 01/19/07
62
60
58
56
54
52
Fe
b0
A 7
pr
-0
Ju 7
nA 07
ug
-0
O 7
ct
-0
D 7
ec
-0
Fe 7
b0
A 8
pr
-0
Ju 8
nA 08
ug
-0
O 8
ct
-0
D 8
ec
-0
Fe 8
b0
A 9
pr
-0
Ju 9
nA 09
ug
-0
O 9
ct
-0
D 9
ec
-0
9
50
Source: NYMEX
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Conclusion
Speculators are Necessary
 Meet the needs of hedgers
 Provide liquidity
 Reduce volatility
Potential Causes of Price Movements
 Investors enter energy markets
 Lack of investment in energy
infrastructure
Crude Oil Futures and Options
Commercial and Non Commercial Positions
1995 - Current
Contracts
1,400,000
Volatility
0.75
Commercial Long
Commercial Short
Non-Commercial Long
Non-Commercial Short
Non-Commercial Spread
Volatility
1,200,000
1,000,000
0.65
0.55
800,000
0.45
600,000
0.35
400,000
0.25
200,000
9/21/2006
3/21/2006
9/21/2005
3/21/2005
9/21/2004
3/21/2004
9/21/2003
3/21/2003
9/21/2002
3/21/2002
9/21/2001
3/21/2001
9/21/2000
3/21/2000
9/21/1999
3/21/1999
9/21/1998
3/21/1998
9/21/1997
3/21/1997
9/21/1996
3/21/1996
9/21/1995
0.15
3/21/1995
0
Sources: CFTC, NYMEX
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