Financialization of Oil Markets

Growing financial investment in the oil futures market may have magnified and influenced the scale of the oil price increases and declines of 2007 - 2008.

Figure 6

Global oil prices are determined in the futures market where crude oil futures contracts are traded. On the New York Mercantile Exchange (NYMEX), in 1990, there were 10 types of active oil futures contracts trading worldwide, with a combined daily volume equivalent to 150 Mb/d, or 130% more than oil demand at the time.²⁰ By 2009, NYMEX oil futures trading represented about 6 to 7 times the global daily volume of world oil production. This high volume of trading was facilitated by the November 1999 repeal of the U.S. Glass-Steagall Act.²¹

Traders on the NYMEX fall into two categories. Commercial traders, e.g., oil companies and refineries invest in NYMEX futures contracts to guarantee (or hedge) the future price for the commodities they are actually producing (e.g. oil and gasoline) or buying (e.g. refineries buying crude oil for which at the end of the day they take physical delivery). These companies are not necessarily seeking profit, but use the futures markets to help stabilize future revenues.

Figure 7

Non-commercial traders, sometimes referred to as speculators, invest in the futures market to profit from price fluctuations. They do not take physical deliver of oil, and are neither producers nor users of oil. They include investment banks, insurance companies, hedge funds and other market participants who have moved into oil contracts because they are trying to diversify their investment portfolio, spread geopolitical risk and maximize investment returns.

As displayed figure 6, there was a dramatic increase in non-commercial trading beginning in 2003, and accelerating through 2008. While non-commercial players had averaged about 20% of contracts in the oil futures market in the early 2000s, by July 2008 they represented more than 55% of trading activity. This peak coincided with peak oil prices at almost $150 per barrel in 2008 as depicted in figure 7. According to analysts, the growing “financialization³” of the oil market is likely to have contributed to increased oil price fluctuations by making the price spikes higher, and the price falls lower. The effect is most pronounced in the 2007-2008 period.