What a coincidence

 Last week, oil prices rose on the short-term futures market when traders cleared their positions, reported the Wall Street Journal.   A word of explanation: To profit from a falling price, a trader can borrow an asset and sell it at today’s high price, then purchase it at next month’s low price and return it to the lender.  Her profit is the price difference, minus transaction costs.  If, for example, the asset price falls from $100 to $60, then she clears $40.  If many traders clear their positions at the same time, then demand for the asset will rise, increasing its price.  So is this adjustment somehow mechanical, with no implications for the asset’s perceived value?

No.  Traders will choose to close their deals precisely when they expect the price to rise.  If I think that the price will be $60 on Wednesday and $65 on Thursday, then I will buy back the asset on Wednesday, profiting by $40 rather than $35.  Last week’s increase in price was not some mysterious happenstance; it reflected the belief of traders that oil prices are going north.  The prophecy fulfilled itself.

So, are oil prices finally rising for good?  Not necessarily.  The daily futures price is volatile, prone to temporary changes in what traders expect the market to do.  A more stable measure is the annual spot price.  (The “spot” market is where oil is bought and sold; the “futures” market is where traders speculate on future spot prices).  But this measure is backward-looking, since it is dominated by prices that occurred several months ago.  A reasonable compromise may be the quarterly spot price, which is a fifth lower now than it was at this time last year.  For September through November of this year, the European Brent spot price for a barrel was $88; for the same period in 2013, the price was $109, according to data from the United States Energy Information Administration.  In contrast, the annual spot price for Brent has fallen 12.4% -- $103 for December 2013 through November 2014, and $118 for the same period in 2012-3. 

In short, oil prices are still falling.  But the completion of short sales last week reminds us that the prices need not continue to decline for, say, two years.  Expectations may change and indeed may be changing.  –Leon Taylor tayloralmaty@gmail.com

Notes

I calculated the quarterly and annual prices as averages of monthly FOB prices.

References

Nicole Friedman.  U.S. oil prices bounce off multiyear lows.  Wall Street Journal.  December 17, 2014.

United States Energy Information Administration.  Data on prices and quantities of energy fuels.  www.eia.gov.