Commentary: Speculative trading and algorithms drive up oil prices and create shortages

Normally, this doesn’t get much mainstream attention because derivatives trading is so obscure. But currently, this corner of finance is producing even more startling numbers than US$90 a barrel. And that could push spot prices well above the US$100 mark in the coming months – and trigger an equally dramatic crash down the road.

Futures prices are in a state of what analysts call a “super pullback”, meaning there is a near-record high gap between short-term (high) oil futures and long-term oil futures. term (lower). However, another sign of dislocation is the volume of bets placed on future oil prices via the options market.

As veteran oil analyst Philip Verleger points out in a recent report, the number of buy contracts with strike prices above $100 per barrel (i.e. bets that profit if the price goes above this level) recently exploded.

It calculates that the volume of call options with strike prices above US$100 for June and December 2022, for example, is now around 714,000, according to data from the Commodity Futures Trading Commission. This is many times the “normal” level, creating an “unprecedented” level of “open interest” (i.e. bets).


The initial trigger for this can be traced to economic fundamentals — the kind of supply shortage, relative to growing demand, that prompted Biden’s call on Salman.

However, Verleger believes the imbalance has been greatly increased by another less discussed issue: a sharp rise in automated trading by investors using algorithmic strategies, often based on artificial intelligence tools.

That’s almost certainly correct. The last time the CFTC studied this question, in 2019, it found that roughly 80% of energy trades were executed through automated entries — not manual trades — up from 65% six years earlier (and significantly lower in during previous decades). I would bet it is much higher now.

Since these automated strategies typically use artificial intelligence programs to analyze and react to market dynamics, rather than economic fundamentals per se, this tends to exacerbate a herd effect, not only in commodity markets, but across all asset classes.

And since the institutions that sell these derivatives bets must hedge their own risk with other instruments, extreme robo-herding creates distortions in market niches that can suddenly fall apart, causing wild volatility.

Sharon D. Cole