Tuesday, September 23, 2008

Crude oil squeeze one more speculation problem

As Daniel Drew was once supposed to have said,"He who sells what isn't his'n, must buy
it back, or go to prison." The crude oil market saw a significant increase in price before the October expiration contract. The price went from $105 in the overnight market to a high of $130 only to settle back down at $120 at the end of the day. This is unusual but not extraordinary in markets that have physical delivery. There have been squeezes in many markets often when hedgers get caught with a position that cannot be unwound quickly enough before expiration. This hurts price discovery but most of the speculative positions and index positions had been rolled out out the curve.

The positions of hedgers going into expiration are monitored by exchanges and the CFTC and there are position limits that decrease as you move to the expiration period. While this is something that should be reviewed, physical settlement at delivery points causes the potential for congestion. If the physical oil cannot be made in delivery positions have to be covered before expiration. If this occurs more frequently, then there has to be a review of the contract term and the exchange upon review with market participants has to adjust the contract expiration process.

Politically, this is not something that is needed for the futures markets right now and sends up a red flag for further regulation. Nevertheless, a thorough review of the facts are necessary before there is a rush to judgment.

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