October 16, 2006


Why gas prices dropped: Trust us. It wasn't OPEC or Republicans trying to influence midterm elections (Nelson D. Schwartz, 10/16/06, Fortune)

By late summer, hedge funds and other investors had poured billions into long positions in oil, gasoline, natural gas and the rest of what traders call the "energy complex," all betting on a replay of the severe 2005 hurricane season that sent prices soaring in the wake of Katrina and Rita. But one day after oil reached a monthly high of $76.98 a barrel on Aug. 7, government meteorologists downgraded their hurricane forecast and cautioned that a repeat of 2005 was "unlikely."

That announcement, combined with the end of the summer driving season and a recalibration of the Goldman Sachs (Charts) commodity index that reduced the weighting of gasoline, prompted speculators to head for the exits even faster than they'd piled in.

The switch in Goldman's basket of commodities had been previously announced by the firm, but that didn't stop the conspiracy theorists. "Hmm, what a coincidence, luring Goldman's top dog to take a HUGE pay cut by becoming Treasury's top dog, and then Goldman Sachs makes this unexpected decision, serving to dramatically drive down gas prices," said the Grey Matter, a liberal blog. But the grassy-knoll crowd didn't bother to crunch the numbers.

According to Joel Fingerman of Chicago-based OilAnalytics.net, between the peak of $77 a barrel in August and the October low of just under $58, traders dumped nearly 40 million barrels (a 20 percent drop) from their long positions. The volatile gasoline market showed an even sharper decline - with traders cutting long positions from 32 million barrels in midsummer to just 1.7 million in October.

"Whatever you want to call it - speculators, fast money, hot money - a big part of the drop in crude that we've seen this year is because of selling by hedge funds," says Merrill Lynch technical analyst Mary Ann Bartels.

Indeed, while we needn't see them as conspirators, a relatively small group of speculators was the only thing keeping prices so artificially high.

Shell USA says oil prices still high; fall doesn't change plans (MarketWatch, 10/16/06)

Oil prices at $58 a barrel are still high, Shell U.S. President John Hofmeister said on the sidelines of an oil industry conference.

"Fifty-eight dollars is not a low price to me, it's still a high," Hofmeister said.

Posted by Orrin Judd at October 16, 2006 12:14 PM

From my own experience (as a natural short in the market as an electricity/natural gas buyer), I can't tell you how frustrating the past year or so has been.

All the market fundamentals (i.e., storage, production, reserves, etc.) are telling you that there's no reason for the prices to be so high, but yet you have everyone banking on Godzilla heading for the powerlines and oil rigs.

The funny thing is how quick the hedge funds were to trumpet their profits last October, but how quiet they are about their losses this one. And believe me, there are some funds who are losing hundreds of millions right now. Ditto about everyone screaming for windfall profit taxes.

Natural gas storage is virtually full right now, and if the winter is anything short of disastrous, there's very little to prop this market up as the funds try to unwind their positions.

Posted by: Dreadnought at October 16, 2006 1:30 PM