Several experts who spoke at GasMart in New Orleans last week agreed with the conclusion of a recent study by the New York Mercantile Exchange (Nymex) that found that hedge funds have been unfairly blamed for being the cause of recent gas price spikes.
The run-up in natural gas prices and high futures market volatility over the last few years conincided with rising hedge fund participation in the gas market, leading many to speculate that the funds have been largely responsible. But Nymex said in a report released two weeks ago that hedge fund participation in the market actually appeared to lead to a decrease in market volatility.
The exchange said hedge funds have been “unfairly maligned by certain quarters who are seeking simple answers to the problem of substantial price volatility in energy markets, simple answers that are not supported by the available evidence.”
The U.S. Energy Information Administration made similar comments last Wednesday in response to a record crude oil price spike to more than $56/bbl. “EIA does not believe that hedge funds and speculator trading in energy are the main reasons why oil prices are higher now than they were a year or two ago,” the Administration said in its weekly petroleum report.
Some panelists at GasMart attributed misperceptions about hedge funds to a lack of available information and to a clear correlation between recent price spikes and increases in noncommercial market participation.
While gas prices were extremely volatile from November 2003 to February 2005, gross noncommercial long and short positions moved sharply higher in concert, reaching highs of more than 300,000 contracts at the end of last year and more than 35% of the market on both the long and short sides, said David Kass, senior economist at the Commodity Futures Trading Commission’s Division of Market Oversight.
Noncommercial futures traders represented about 10% of the “spread market” (usually offsetting short and long positions over periods of time) in 2001, but in 2004 their percentage of that market jumped to more than 30%, said another panelist, Tom Lord, president of Volatility Managers.
Meanwhile, market volatility was high, jumping to an average of more than 50% in 2004. Volatility during this winter ranked fifth out of the last 13 winters, Lord said. “I’m not saying here that the hedge funds are intentionally causing high volatility,” said Lord. “But [as the saying goes] if you are sharing a jungle path with an elephant, whether you stumble or the elephant does you are the one that gets squashed. The reality is that if the hedge funds are trying to trade $50-100 million stakes in the same 10-minute period that you are trying to trade 10 lots, you are the one that is going to get [squashed].”
Lord said part of the problem when it comes to looking at the impact of hedge funds on the market is that there is a lack of sufficient information to determine their role in the market. This leads others in the market, such as commercial traders — most of whom are facing increasing costs and much higher market risk today compared to five years ago — to draw their own conclusions.
“The perceptions that hedge funds and other noncommercials [are adversely affecting the market] impacts the willingness of commercials to utilize transparent markets,” Lord said.
Are hedge funds taking the blame for other issues affecting prices and volatility? Lord asked. The perception of inequality in the marketplace often is as big an issue as an actual inequality, he said.
However, a misperception should not be the reason for regulatory action, said Dan McElduff, director of natural gas research at Nymex. He noted that Nymex’s report on hedge fund trading last week found that the funds’ share of futures market volume was only about 11.13% for all of last year and their share of open interest from January through August 2004 was about 20.4%.
McElduff said rather than hedge funds, market fundamentals, particularly the tight supply-demand balance, as well as disruptions such as Hurricane Ivan last year, were mainly to blame for the rise in market volatility. Fundamentals have been the driving force in the market, he said.
He also noted that there has been “suboptimal” utilization of existing storage capacity by gas utility companies, who use storage purely to ensure there is adequate winter supply but not to dampen price volatility.
McElduff said any legislative action or measures taken by regulators or the exchange to reduce price volatility in natural gas futures likely would end up having the opposite effect. Imposing tighter position limits on noncommercial traders or placing tighter limits on price movements would reduce market participation, cut liquidity and in the end increase gas price volatility.
Some end-users, particularly Huntsman Chemical, have been active on Capitol Hill trying to drum up support for legislation that would impose trading limits and gas futures price limits that would shut down trading during periods of high volatility. However, McElduff said those cries for intervention largely have fallen on deaf ears. He also said they are based on misconceptions about the market and would lead to adverse consequences that would damage the marketplace for all involved.
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