Monthly Report - Focus
Financial derivative trading in crude oil: victim or executioner?Financial derivative trading in crude oil: victim or executioner?Financial derivative trading in crude oil: victim or executioner?

The financial community will remember 2014 as the year in which, against all expectations, oil prices underwent one of the biggest slumps since the financial crisis erupted in 2008. After plummeting by 46% in 2014, the price of crude has fallen by a further 15% since the start of the year. Although there is broad consensus regarding the factors that lie behind this situation (oversupply, a fall in the demand forecast, OPEC's strategy), there are other, more controversial aspects. One area of debate in financial and academic circles is the effect of financial transactions in derivative markets on crude oil prices and their volatility, a discussion that has revived given the oil market's current situation.

In order to shed some light on the influence exercised by this phenomenon, namely the financialisation of crude oil, two important points need to be made. The first concerns the trends in speculative positions and in the price of crude, which very often run in parallel. During the last six months of 2014, net speculative positions in WTI oil fell by 35% to 312,000 contracts due to the closure of long positions and an increase in short. Over the same period, the drop in the price of a barrel of crude reached 50%, down to 53 dollars. Is there any causal relation between these two variables? Empirical evidence suggests there is not, arguing that many different common factors underlie the behaviour of both: expectations regarding the supply and demand for crude futures, world growth and the accumulation of oil reserves. This last point is reflected in the first graph: while the price of crude plummeted during the second half of 2014, net speculative positions remained stable. Secondly, it is useful to determine which flows are due purely to speculative strategies, which is very often a complex task. In this respect, although it is useful to assume that all non-commercial activity is speculative, this is actually not very accurate.

Although financial transactions may not have influenced the price of crude oil, they have certainly had an effect
on its degree of volatility. This is because there have been more derivative transactions than usual, in turn
due to the great uncertainty affecting the underlying fundamentals of oil. This can be seen in the third graph, which shows how the current number of put options with very low strike prices has shot up. Nonetheless, this volatility will probably calm down as the strategies of derivative operators increasingly take into account the new scenario of oil prices.