The recent sharp recovery in oil prices was accompanied by a massive surge in buying by non-commercial traders on the Nymex crude oil futures exchange, prompting some market commentators to reiterate their one-sided view that speculators drive the oil price. Hedgers, however, play an equally important role in the futures market, since prices are set by the interaction between willing buyers and willing sellers, and neither side is able to trade without the willing participation of the other.
This new study by the CGES both updates and extends our previous work on hedging and speculation in oil futures markets. The study re-affirms our earlier view that hedgers take a net short position in a rising market because the supply and demand curves for futures contracts of hedgers are more stable than those of speculators. This is the case because hedgers have an ongoing need for hedging, which is determined by their underlying exposure in the physical market. Speculators, on the other hand, buy and sell futures contracts purely on the basis of expectations. As a result, speculators take a net long position in a rising marketbecause their supply and demand curves adjust rapidly to changes in market conditions.
New analysis of changes in the numbers of hedgers and speculators in the market and their average open interest positions also supports the CGES view. In the case of hedgers, changes in prices only affect the number of traders in the market and not the average size of position, indicating movement along the supply and demand curves as hedgers enter or leave the market in response to price changes, rather than shifts in the position of the demand and supply curves. In the case of speculators, changes in prices affect both the number of traders and the average trading position, indicating both movements along and shifts in the positions of the demand and supply curves.
The study goes on to examine the question of causality, using statistical tests to investigate whether changes in WTI prices follow changes in the open-interest positions of hedgers or speculators or lead them. The results show clearly that there is no evidence to support the idea that changes in the open-interest positions of speculators (or hedgers) drive changes in oil prices. In fact, the reverse appears to be true — changes in oil prices lead to changes in the open-interest positions — suggesting that hedgers and speculators are trend followers, adjusting their open-interest positions over periods of a week or more in response to shifts in the oil price.