january 25, 2007 the role of speculation in energy markets kyle dickard managing director, global...

January 25, 2007

The Role of Speculation in Energy Markets

Kyle DickardManaging Director, Global Commodity Analysis

2

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

Overview

3

“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.”

Quotes on Speculation

4

“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

Market Manipulation

5

Benefits of Speculation in the Energy Markets

Counterparty for Hedgers

Accept Risk

Add Volume

Provide Broad Market Information

Create Liquidity

Reduce Volatility

6

Hedgers, Speculators and Investors

New Participants

• Pension Funds

• University Endowments

• Hedge Fund Investors

• Financial Institutions

Commodities as an Asset Class

7

Speculation and Volatility

Crude Oil Futures and OptionsCommercial and Non Commercial Positions

1995 - Current

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

3/21

/199

5

9/21

/199

5

3/21

/199

6

9/21

/199

6

3/21

/199

7

9/21

/199

7

3/21

/199

8

9/21

/199

8

3/21

/199

9

9/21

/199

9

3/21

/200

0

9/21

/200

0

3/21

/200

1

9/21

/200

1

3/21

/200

2

9/21

/200

2

3/21

/200

3

9/21

/200

3

3/21

/200

4

9/21

/200

4

3/21

/200

5

9/21

/200

5

3/21

/200

6

9/21

/200

6

0.15

0.25

0.35

0.45

0.55

0.65

0.75

Commercial LongCommercial ShortNon-Commercial Long

Non-Commercial ShortNon-Commercial SpreadVolatility

Sources: CFTC, NYMEX

Contracts Volatility

8


Estimated $100B from investors enters markets

40% allocated to crude oil

Incremental demand of 1MM barrels per day

Strong uptrend in prices

9

NYMEX Crude Oil Prices and Total Open Interest Positions1995 - Current


-

500,000

1,000,000

1,500,000

2,000,000

2,500,000

Mar-95

Mar-96

Mar-97

Mar-98

Mar-99

Mar-00

Mar-01

Mar-02

Mar-03

Mar-04

Mar-05

Mar-06

0

10

20

30

40

50

60

70

80

WTI Open Interest

WTI Weekly Avg Price

$/BblContracts


10

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

11


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

0

50

100

150

200

250

300

350

400

450

500

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

0

10

20

30

40

50

60

70

80

Baker Hughes Oil Rig Count

Nymex WTI

Sources: Baker Hughes, NYMEX

No. Rigs $/Bbl

0

200

400

600

800

1,000

1,200

1,400

1,600

Ja

n-9

6

Ja

n-9

7

Ja

n-9

8

Ja

n-9

9

Ja

n-0

0

Ja

n-0

1

Ja

n-0

2

Ja

n-0

3

Ja

n-0

4

Ja

n-0

5

Ja

n-0

6

Ja

n-0

7

0

2

4

6

8

10

12

14

16

Baker Hughes Natural Gas Rig Count

Nymex Natural Gas

Sources: Baker Hughes, NYMEX

No. Rigs $/Bbl

12


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

0

10

20

30

40

50

60

70

80

Fe

b-9

0

Fe

b-9

1

Fe

b-9

2

Fe

b-9

3

Fe

b-9

4

Fe

b-9

5

Fe

b-9

6

Fe

b-9

7

Fe

b-9

8

Fe

b-9

9

Fe

b-0

0

Fe

b-0

1

Fe

b-0

2

Fe

b-0

3

Fe

b-0

4

Fe

b-0

5

Fe

b-0

6

250000

270000

290000

310000

330000

350000

370000

390000

410000

WTI NYMEX Monthly Avg Price

US Crude Oil Inventories

Thousands of Barrels

$/Barrel

Sources: NYMEX, DOE

13


Monthly

0

10

20

30

40

50

60

70

80

250000 270000 290000 310000 330000 350000 370000 390000 410000

CL1 before 2004

CL1 2004+

Gulf War

$/Bbl

Thousands of BarrelsSources: DOE, NYMEX

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

14


250000

270000

290000

310000

330000

350000

370000

390000

410000

Fe

b-9

0

Fe

b-9

1

Fe

b-9

2

Fe

b-9

3

Fe

b-9

4

Fe

b-9

5

Fe

b-9

6

Fe

b-9

7

Fe

b-9

8

Fe

b-9

9

Fe

b-0

0

Fe

b-0

1

Fe

b-0

2

Fe

b-0

3

Fe

b-0

4

Fe

b-0

5

Fe

b-0

6

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

US Crude Oil Inventories

Month 2 - Month 1

Thousands of Barrels $/Bbl

Sources: NYMEX, DOE

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

15


Global demand outpaces supply

Spare refining capacity declines over time

6000

7000

8000

9000

10000

11000

12000

13000

Jan-0

2

Apr-0

2

Jul-0

2

Oct-0

2

Jan-0

3

Apr-0

3

Jul-0

3

Oct-0

3

Jan-0

4

Apr-0

4

Jul-0

4

Oct-0

4

Jan-0

5

Apr-0

5

Jul-0

5

Oct-0

5

Jan-0

6

Apr-0

6

Jul-0

6

Oct-0

6

Source: MLCI Proprietary

Thousands of Bbls

Global Spare Refining Capacity(Capacity – Refinery Runs)

16

Contango shape of the forward curve

Adequate supplies in the near term

Supply concerns in the future

WTI Curve as of 01/19/07

50

52

54

56

58

60

62

Feb-0

7

Apr-07

Jun-0

7

Aug-07

Oct-0

7

Dec-0

7

Feb-0

8

Apr-08

Jun-0

8

Aug-08

Oct-0

8

Dec-0

8

Feb-0

9

Apr-09

Jun-0

9

Aug-09

Oct-0

9

Dec-0

9

$/Bbl

Source: NYMEX


17

Conclusion

Speculators are Necessary Meet the needs of hedgers Provide liquidity Reduce volatilityPotential Causes of Price

Movements Investors enter energy

markets Lack of investment in

energy infrastructure

Crude Oil Futures and OptionsCommercial and Non Commercial Positions

1995 - Current

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

3/21

/199

5

9/21

/199

5

3/21

/199

6

9/21

/199

6

3/21

/199

7

9/21

/199

7

3/21

/199

8

9/21

/199

8

3/21

/199

9

9/21

/199

9

3/21

/200

0

9/21

/200

0

3/21

/200

1

9/21

/200

1

3/21

/200

2

9/21

/200

2

3/21

/200

3

9/21

/200

3

3/21

/200

4

9/21

/200

4

3/21

/200

5

9/21

/200

5

3/21

/200

6

9/21

/200

6

0.15

0.25

0.35

0.45

0.55

0.65

0.75

Commercial LongCommercial ShortNon-Commercial Long

Non-Commercial ShortNon-Commercial SpreadVolatility


Contracts Volatility

18

Disclaimer

Merrill Lynch prohibits (a) employees from, directly or indirectly, offering a favorable research rating or specific price target, or offering to change such rating or price target, as consideration or inducement for the receipt of business or for compensation, and (b) Research Analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to benefit investor clients.

This proposal is confidential, for your private use only, and may not be shared with others (other than your advisors) without Merrill Lynch's written permission, except that you (and each of your employees, representatives or other agents) may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the proposal and all materials of any kind (including opinions or other tax analyses) that are provided to you relating to such tax treatment and tax structure. For purposes of the preceding sentence, tax refers to U.S. federal and state tax. This proposal is for discussion purposes only. Merrill Lynch is not an expert on, and does not render opinions regarding, legal, accounting, regulatory or tax matters. You should consult with your advisors concerning these matters before undertaking the proposed transaction.

january 25, 2007 the role of speculation in energy markets kyle dickard managing director, global...

Documents