So Where Are They Storing All the Oil?

I find the current political demagoguery that oil speculators are now the ones responsible for higher oil prices to be absolutely laughable.  I am willing to believe that oil supply and demand are perfectly inelastic over very short time periods, meaning that we might expect little change in supply or demand over a couple of days or weeks after a price change, allowing for a fairly free range of speculative excesses.  However, there is every evidence that oil is by no means perfectly price inelastic, and supply and consumption do change with price.  Already in the past few months we have seen, for example, substantial reductions in passenger car miles in this country. 

For any period of time longer than hours or days (or perhaps weeks), any cabal that is somehow manipulating oil prices well above the natural market clearing price is going to have to deal with a problem:  Extra oil.  Lots of it.  Even if the supply side is sticky due to shortages currently in drilling equipment, demand is not.  People are going to use less, and at the same time, every supplier is going to be trying to send every barrel to market as quick as they can  (oil producers know that prices that rise will eventually fall again -- that is the history of oil.  They are all programmed to move as much product as possible when prices are at all time highs).

A lot of dynamics, such as a short squeeze, can create a speculative bulge, but if speculators are somehow purposefully keeping oil prices high for long periods of time, they must be doing one of three things:

  1. Storing a lot of oil somewhere
  2. Creating an extensive system of production controls that keeps oil supply off the market.
  3. Have someone with deep pockets subsidize consumer demand for oil by selling excess oil off at below market prices.

One is just not possible, not in the quantities that would be required.  Two sort of happens in a haphazard and not very consistent way with OPEC, though it is hard to convince me that futures traders in Chicago have an active partnership with large state-run oil companies.  Three is actually happening, with the Chinese government continuing to sell gasoline and other petroleum products at below market prices, but there is evidence that there are limits to how much further they will take this.  Again, I think this is being done for reasons other than cooperation with mercantile exchange traders in the US.

To a large extent, this theory, if it is anything more than just populist capitalism-bashing, is a result of extreme ignorance.  There are an incredible number of people involved in the oil markets every day in numerous countries with numerous different incentives, such a large number that it is impossible to imagine a conspiracy.  There have been a couple of cases of proven petroleum commodity price manipulation in these trading markets - most of these have involved manipulation of prices at the end of the day on certain futures expiration and/or Platt's pricing windows.  The time frame for these manipulations have been on the order of 1-2 minutes.

But here is the best argument against this manipulation for higher prices, and it is amazing to me that no one ever thinks of it.  Sure, there are a bunch of really savvy people in the commodity trading business who are long on oil and want the price to be higher.  But for every seller, there is a buyer on the other side, someone who is at least as savvy and is desireous of lower prices.  Yes, I know it is a complicated concept, but for every trader selling there is one buying.  If there is an extended conspiracy to push up oil prices by speculators, do you really think the buyers are just going to sit on their hands and take it?  And do you really think the exchanges are going to be happy with this behavior, threatening the integrity of their trading system (really their only asset)?  Just ask the Hunt family, which attempted to corner the market and drive prices up in silver, only to have major buyers and the exchanges stop them cold, driving the Hunts in the process into bankrupcy. 

I wrote about this same topic previously here.


  1. Gene Hoffman:

    Off Kharg Island apparently -

    Add that to tulip style "long" bets on short maturity crude oil deliveries that pull future production forward to a higher prices and it looks a bit like a bubble to me. Net capital inflow in Q1 into the oil futures market was higher than all capital inflows for year 2007.


  2. morganovich:

    another way speculation could drive up prices is through over-sale of futures contracts.

    consider: if there are 100 units of oil available for june delivery, theoretically, only 100 futures contracts can be met.

    so what happens if 110 are sold?

    this will create a massive price spike as many of the folks who bought these contracts really do want delivery.

    but if a theoretically savvy speculator can keep buying contracts that he knows cannot be delivered and (possibly with a wink and a nod from a broker or trader/exchange) there si no need to store oil. he knows the demand he creates CANNOT be met, so the fear of a tanker of oil showing up at the terminal with his name on it is low.

    but if it does happen, he just sells it at spot. this can be kept high if this same type of speculation is going on for the july contract.

    and consider the way this snowballs.

    if july contracts purchased are 110 to 100 of supply, actual oil for delivery is now 20 units in deficit.

    though obviously, i exaggerate the percentages, this is not such a far fetched scenario. far more market participants now transact in oil and particularly oil based ETF's. moving oil trading from just futures to the listed stock exchanges has brought a massive flood of new capital to that market. the big jump in futures volume is mostly due to the managers of the ETF's establishing/maintaining their positions.

    this huge overall increase in volume has made it impossible to hedge with just deliverable oil. the notional value of futures contracts cannot be covered in real oil. people are getting caught short and the factors driving the bubble are self reinforcing (right up until the day they aren't)

    but government regulation is not the answer here. it would achieve nothing apart from some short term market dislocations. regulate whatever you want in the US, the market will just move overseas to london or dubai.

    the thought of our congress trying to act as a "bubble cop" is to horrifying to contemplate.

  3. Sameer Parekh:

    You're right that futures complicates the matters, but only within time frames that are shorter than the future contracts. Coyote claims that speculation can drive up prices in the "short-term". Futures can work to make that "short-term" longer. It doesn't change the fact that speculation will not drive up prices in the long-term.
    If I only have 100 contracts of oil available to deliver in June, why would I sell 110 contracts? When June comes around I will be in default on 10 of my contracts, and the holders of those 10 contracts can sue me. It makes no sense at all.
    It's true that a speculator can roll over his futures contract and never take delivery, by selling his futures contract before expiration and rolling it over into another futures contract dating 3 months hence or whatever, but he will have to sell it to someone who will take delivery of the oil. That person will then expect his oil, and if the writer of that contract does not deliver the oil as promised, lawsuit central will result.

    HOWEVER, I do not agree that the price is oil is completely supply/demand driven. More specfically, it is not driven solely by the supply/demand of oil. It is being driven in large part by the supply of money. Coyote hints at it briefly by mentioning the Chinese subsidization of oil, which they do partly through manipulation of their currency. But here we have a situation where the US Fed created the tech bubble in the 90's, that crashed, so they injected more liquidity, creating the real estate bubble of the early 2000's, and then that crashed, so they yet again injected more liquidity (will they ever learn? I doubt it.). Now that both equities and real estate had just experienced bubbles, people didn't want to put their excess liquidity into either of those two asset classes. What is left? Commodities. Hence a commodities bubble.

  4. Sedulous:

    Admittedly, I can't come up with any other concrete examples yet, but I would find it hard to believe that speculation on commodities can't/doesn't drive prices up or down. The stock market often doesn't really move up or down on tangible reasons -- it seems more whimsical and emotion based. So, too, with commodities like oil.

    The example of silver and the Hunt brothers doesn't apply with oil. The world goes on without silver for a short time, but the world comes to a screeching halt without oil.

    Presently, every industrialized economy *has* to have oil -- either for energy and/or manufacturing. People will pay anything to have it until better/different ways of providing energy are available. At this stage, without alternatives, no one is going to say "Nope. Won't buy it. Too expensive." Honestly, can you imagine any commodities trader saying that? People will buy oil at almost any price because it is currently our only option. When people quit buying oil at any price, it will be when other options are available or when entire economies collapse because they have no energy options. And when people quit buying oil, then the price of it will drop.

    Free markets are great -- the best of all bad alternatives -- but they are not perfect and often not "fair" or "reasonable". I might be wrong, but that's how I see it.

  5. HTRN:

    It is speculation that drives up prices, just like speculation drove up prices in real estate. I would point out that the number of dollars in oil futures right now is double what it was six years ago.

    It is speculation causing this(combined with the falling dollar) but there's "no plan" by some secret cabal to drive up the price of oil.

  6. bbartlog:

    if a theoretically savvy speculator can keep buying contracts that he knows cannot be delivered

    Why would someone sell him these contracts? A crooked speculator (who had some sort of connections) might perhaps *sell* contracts that he couldn't really deliver on (this is the idea behind a naked short). Buying a contract that you know can't be delivered is shooting yourself in the foot, and it appears you are confused.

    Anyway, a simpler argument against speculation as the primary driver of high oil prices is the graph of world oil production (here is one). If the price were driven up purely by speculation, we would expect to see a vast spike in production as producers responded to high prices and fed ever more oil to the stockpiling speculators. Instead, we see a simple explanation for high prices: world production dipped slightly after 2005 and has only now (Jan 2008) reached the levels of 2005 again. In a world where all of the first world economies and China have been growing more or less rapidly, it's a no-brainer to see that this will cause prices to rise.

  7. morganovich:


    that is not necessarily true. you are assuming that all contracts are being settled as they "should" be. as someone who has decades of experience on wall st, i can tell you that this is not always the case. for example, lots of stock transactions get failed delivery. the broker has lent the stock out to a short seller and doesn't want to buy him in, so they just fail delivery and, in many cases, both sides agree to be OK with that for a while. this artificially increases de facto share count as often this "notional stock" gets passed around the street.

    the same can be dome with futures. if i administer an oil ETF and use futures to cover notional exposure, the last thing i want is delivery. i am happy to wink at the broker over "failed delivery" and make some sort of deal like, we'll get it next month and roll into some longer duration. this pinches demand, provides future price support, and keeps the price of oil soaring attracting more speculators to my ETF (which is how i make money).

    i am not well enough versed in the oil futures market at the moment to tell you to what extent this is currently going on, but it's quite possible. to the extent that this is occurring, there will be a sharp correction when the big money inflows dry up.

  8. morganovich:

    however, i agree with bbartlog that most of the current price move is due to organic demand in conjunction with reduced supply due to underinvestment.

    further, you have to consider the dollar in all this. it has utterly tanked since 2001.

    it was 85 cents to a euro in 2001. now it is 1.56. if you buy oil in euros, the price change has been much less dramatic. nearly half of the rise in oil prices has been dollar driven.

  9. bbartlog:

    I would find it hard to believe that speculation on commodities can't/doesn't drive prices up or down.

    Of course it can. But in order for speculation to match the production shortfall in terms of order of magnitude, speculators would have had to buy up about $150 billion worth of oil (more than the size of the entire US Strategic Petroleum Reserve) and store it somewhere. If you want to include national actors (governments) as speculators I suppose this is possible, but for example the size of the AMEX oil ETF is only about $1 billion - nowhere near big enough. It's simpler to assume that the primary driver is the flatlining of production from 2005-2008.
    For a laugh, look at the oil price projections that the DOE put out in 2005: slide 10 of this powerpoint. While I don't side with the Peak Oilers when it comes to prophesying the doom of civilization, they were definitely closer to the truth than the DOE on this one.

  10. Tom:

    According to this link:

    Index Speculators have effectively stored 1.1 billion gallons of oil, or about 8 times the Strategic Petroleum Reserve.

  11. bbartlog:

    Index Speculators have effectively stored 1.1 billion gallons of oil, or about 8 times the Strategic Petroleum Reserve.

    Actually your link indicates that it's 1.1 billion barrels (not gallons), and that the amount they *added* during the timeframe under consideration was eight times what the SPR added during that time. But your point still stands: this speculative stockpile is a lot bigger than I thought - it's in the same ballpark as the 2005-2008 production shortfall which I figure to be about a billion and a half barrels. Sounds like I was too dismissive of speculation. I see too that one of the things mentioned in your link is the role of sovereign wealth funds (read: governments investing their foreign currency holdings), which is consistent with my earlier sense that it would take the resources of a national government to move these markets.

  12. Franco:

    A futures contract works like this: you buy 1 contract on light sweet crude oil. Say you buy a September 2008 contract. You will, if you don't sell it before September, find yourself as the proud owner of 42,000 gallons of oil ("F.O.B. seller's facility, Cushing, Oklahoma, at any pipeline or storage facility with pipeline access to TEPPCO...") Most speculators don't want this so, before the end of the period they sell the oil. Thus, there is a buy and a sell - they are perfectly matched for a speculator. Note that a seller speculating has no oil to deliver so they have to close out as well. Net oil bought by speculators = 0 gallons. Net oil used = 0 gallons.

    Now consider the case of a refiner who buys oil to sell on the market to meet consumer demand. They buy 1 contract. They take delivery of the oil, they refine it, they sell it to you and you burn it up in your car. Net oil bought = 42,000 gallons, net oil used up by consumers = 42,000 gallons.

    Only consumer demand will drive up prices in the long run unless a speculator can corner both production and the market (ala deBeers). I know a fair number of hedge fund managers and I am not aware of any of them who've ever taken delivery of oil.

  13. Turambar:

    Presently, every industrialized economy *has* to have oil -- either for energy and/or manufacturing. People will pay anything to have it until better/different ways of providing energy are available. At this stage, without alternatives, no one is going to say "Nope. Won't buy it. Too expensive."

    This is wrong. There is some amount of oil that an economy has to have, but it also is a large amount of elastic demand. Obviously consumer demand is elastic, but so is manufacturing. If I am a manufacture who makes plastic squirt guns and the price of oil rises so high that I'd have to sell each gun for $50, then I am going to stop buying oil. Maybe I get out of the business, maybe I buy recycled plastic, maybe I redesign around another material.

    If I used oil for my power production maybe I switch to coal if the price is too high. If I use oil for lubrication, maybe I switch to bio-lubricant.

  14. Sedulous:

    Franco -- thanks for pointing that commodities speculators don't generally want the actual item, they just trade for rights to buy or sell it.

    However, anything that is traded as a commodity has factors beyond consumer demand that move the price. As was stated about the real estate and tech bubbles (in the US at least) much of that was driven not by the actual value based on demand for the product, but on the speculators perceived value and, well, greed, in wanting to make a killing on those items.

    For instance, as soon as a hurricane starts heading towards refineries -- or just develops in the Gulf of Mexico -- commodities traders push the prices up, speculating that there will be shortages. Or if tensions jump in the Middle East, even if the outputs haven't changed a bit, prices see a spike. Refineries have to buy at that higher price and the consumer sees a price jump, even if nothing has actually happened yet. At least, that's my understanding of the way it works.

  15. bbartlog:

    it also is a large amount of elastic demand

    Sort of, I guess. While demand for anything has *some* elasticity, the elasticity of demand for oil in the US market seems to be very, very low. Consumption of oil was increasing about 2% per year from 1991 until around 2004. Then the price quadrupled over a period of years and consumption went flat. If we assume that consumption would have continued to go up 2% per year if the price had remained around $30-35 per barrel, that means that a 300% price increase reduced consumption by 8%. That implies a demand elasticity of less than .03 which is ridiculously low. Obviously something has to give if the price continues to go up, since consumers don't have infinite amounts of money, but it's clear from the pattern that oil actually doesn't have ready substitutes in a lot of cases.

  16. Corky Boyd:

    If I were the Saudis or the Emirates I would be making sure that my oil didn't get bottled up behind the Straits of Hormuz. Surely they will be mined by Iran if Israel atttacks. The pro-western Gulf States know this and no doubt have made plans to minimize their damage.

    20 years ago the Saudis built pipelines to the Red Sea to protect their ability to deliver crude. But the Red Sea transhipment points remain vulnerable, with choke points at either end subject to mining. According to Debka Files (not the most reliable source), the Saudis and Emirates are now building additional pipelines to guarantee supplies. Link here:

    My guess is substantial amounts of the Saudi output is being stored on the Red Sea for an emergency. They can read the tea leaves as well as we can.

    If you think the market is discounting an Israel/Iran conflict, you are wrong. I think it is the underlying reason for rising prices, with hoarding all around, by both suppliers and consumers.

  17. Mesa Econoguy:

    Morganovich has hit on all the major points here. You need to keep in mind that futures (and options) do not have a fixed “float” – there is no fixed outstanding supply of futures contracts at any one time, so in this sense they are not at all like traditional equities instruments (which are fixed at time of issue by the issuing company). Futures & options are created at the time of trade between buyer & seller.

    It should also be noted that restricting this market will have the likely effect of 1) reducing liquidity, causing 2) potentially wilder price swings.

  18. Esox Lucius:

    How come no one is suggesting that we might be running out of oil? Its like 'Listening for the dog that didn't bark". Prices are high and rising because we are running out of oil. It seems like the only suggestion that no one takes seriously.

  19. Turambar:

    Sort of, I guess.

    I think you underestimate the effect.

    "NEW YORK (Reuters) - U.S. retail gasoline demand slipped 3.8 percent from last year's levels, as gasoline prices posted yet another record high last week, MasterCard Advisors said Tuesday.

    Year-to-date, American gasoline consumption is down 1.9 percent from last year's levels, according to MasterCard's weekly Spendingpulse report."

    At this is at a rate where even though gas is historically high its still not a big percentage of the average household income.

    The original statement was " People will pay anything to have it..." which I think is clearly wrong. How many planes would fly per day if jet fuel was $30/gal and a plane trip on the East Cost was $8,000?

  20. Sedulous:


    If your statements were directed at my comment "People will pay anything to have it" -- I'll concede that's overstated and incorrect in the absolute sense. If fuel is $30/gallon and a plane trip to the East Coast is $8000, I guess we're all in deep you-know-what, going to live in the Stone Age. I was mostly thinking that if oil got really high, like that, demand would drop significantly and the oil producing countries would be left with lots of supply on hand. I'd assume prices would drop to compensate -- but maybe I'm wrong.

    Esox Lucius -- assuming the abiotic oil concept is not correct, then of course we're running out of oil. But that doesn't mean there still isn't a lot left. One is always going to run out of something that isn't renewable. There's still lots of oil to be drilled around the coast of the US and in it's interior. Other parts of the world probably have similar opportunities. Of course, we better start putting different energy solutions in place in advance of the inevitable and final drop in supply.

  21. John Moore:

    Long ago when I was involved in silver trading, there was a time when there were more contracts out for US Silver Coin $1000 bags than there were coins in existence. Commodities markets can do strange things.

    I have read that the money in oil contracts now is vastly higher than a few years ago. This may be partly shifted bubble money (I suspect), speculation on disruptions due to war (war premium), or even manipulation (or investment, depending on how you look at it) by the Sovereign Wealth Funds of the oil producing states.

    Note also that futures markets can keep prices up for a long time, because contracts can be "straddled", effectively extending their term.

    Let's see... if I'm an oil producer with zillions of bucks... I buy a bunch of long positions, driving up the price at which I sell oil (and causing speculators to jump in and drive it up more), and when the price ultimately goes down, if I still have positions, I "take delivery" from myself and then sell the oil at market. What am I missing?

  22. John Moore:

    Or another scenario...

    I'm the Iranian president. I expect to be attacked. I even ask for it, taunting the world (and especially Israel) by constantly announcing my nuclear progress and promising to nuke Israel.

    So I drive up the price of oil by buying futures and spot oil (the Iranians are reportedly stockpiling oil in rented tankers), and due to the war premium demanded by intermediaries (speculators). When I am attacked, the war fears (and my threats, and maybe a few mines floated through the Straits of Hormuz) drive the price through the ceiling. Then I sell my stockpiled oil. Meanwhile I have been making profits on the general price premium that these actions caused before the attack.

    And, of course, if I don't get attacked, I end up with nukes, and use them to protect me from retaliation as I cause serious regional problems that, among other things, drive up the price of oil.

  23. Franco:

    Re John Moore's first example (Jun 24, 2008 11:54:14 PM)

    John, always do the math to see what's really happening. Here is the math underlying your example:

    1) Oil producer goes long 5mm barrels of oil in futures market driving up market price by say $5 per bbl over the course of his buying
    2) Oil producer then sells oil 5mm barrels of physical oil (from where is a question you didn't answer) - prices now drop $5 per bbl over the course of his selling (you assumed he was big enough to drive the price up in your example so he's big enough to drive the price back down by selling). But he still makes money because he has a lower basis in this oil since he owned it before he drove the price up in 1)
    3) Oil producer now says "Oh sh*t, I've still got all these futures contracts to unwind and they are under water"
    4) Producer unwinds futures contracts and gives back all profits made in step 2.

    The only was to artificially keep the price high is by cornering distribution and production which is what deBeers does with diamonds. There is a Harvard Business School case on this which you can get for $5 (I think) which will explain in detail what it takes to corner a market. Cornering the oil market is basically impossible. Speculation can cause short-run blips but look at demand coming from China and India - there is a massive new demand for oil and oil production is capacity constrained.

  24. f0ul:

    So to get the price down, we need the Dollar to get some strength back, we need the future's trading between US and London plugged up, and we need the Chinese and any other big player to remove their subsidies.

    The problem is - where is the next bubble? will it be in Bio-tech, or will it be in alternative fuels? Or is the gap between bubbles called a depression?

    I noticed someone mentioned peak oil being the reason for the price! I would like to suggest that they read some history and note how often someone has mentioned peak anything when it came to commodities over the past 150 years. Coal was going to run out by 1890 while oil was going to run out in 1923, 1944, 1965, 1988 and 1997 - not sure when the next deadline for oil has been set - probably 2020 or so!

  25. Mark:

    IN 2005 there was only $13 billion invested commodity index funds. In 2008 there is $260 billion. A twnty fold increase in funding over three years will drive up prices. This is the market at work.

  26. John Moore:

    Your logic would be right in the very long run, but in the short run, I think it is wrong.

    1) I'm a producer. So I'm on both ends of contracts. But by going long, I drive up prices. To me, for the amount in the contract, it is net zero when it is ultimately unwound, because actually, as a producer, I am short (with actual hedge sales) a lot more than I am long.

    2) In a speculative market, an injection of money may drive up the total value of the instrument disproportionately, so that the whole market, rather than just my contracts, goes up.

    3)As a producer, I sell into that (either at higher spot prices or I sell futures into that market), and I sell far more than the amount of the contracts I go long in.

    Over the short time, this can result in favorable price manipulation with a large net profit. I don't have to corner the market (I do understand that - I know someone who once cornered a an agricultural contract, but he has a lot more money than I do).

  27. franco:


    I understand what you're getting at but over any meaningful period of time it gets tough. The basic reason is that if buying oil makes the price go up then selling it makes the price go down. If as you say in 3) you sell more than you are long the price will and up even lower than where it was before. What you really seem to be saying in point 2) is that the speculator is somehow creating a speculative fervor which is prompting other people to pile in and he is then selling out to them and making a profit (the pump and dump strategy). This is certainly a strategy which has been used but the late arriving speculators will incur a loss equal to the profit this speculator made. The only way for a long-run permanent price increase to occur is through demand. If this is speculative in nature the prices will come down eventually.

  28. John Moore:

    I have never claimed that these tactics could cause a permanent price increase. I am just saying that they might, *might* be responsible for *some* of the oil price rise recently.

    You are correct about point #2. Without that, what I propose would be a perpetual money machine driven by a perpetual motion machine. But point #2 has a long history - pump and dump is not a new concept, and this is but a variant. Furthermore, the markets of late have shown an increased sensitivity to bubble behavior - for reasons I don't fully understand. It is possible that this behavior, which went from dot-com to telecom to housing has now moved to commodities. I hope so! But like Warren, I don't know.

    What I don't know is whether we are near "peak oil." Certainly we are not when alternative fossil fuel approaches are considered (one not mentioned for gasoline is goal gassification). At current prices, many of these approaches are feasible, but how long it would take to bring new supply online is a question. I think with a crash effort, it could be relatively quick. But that would require a political consensus that was strong enough to override NIMBY and environmental concerns, and I don't know if the current prices can cause that. Also, given the appalling ignorance and bias of the media that informs many people, we could go many years with feel good socialist "solutions" before folks realized that they were being mislead.

  29. TCO:

    The price of oil is not purely dictated by CURRENT supply/demand, but by the expected future supply/demand (like a "meta" supply/demand). Oil is easily stored (in the ground). So the current price of oil may have a heavy "speculator" component, but it is not necessarily irrational or manipulative.