IN CRAZY scenes that brought me back to some of my own mad trading days in Singapore, commodity prices underwent a dramatic collapse last Thursday.
When oil prices fell below $120 a barrel in early New York trade, institutional and major oil consumers were looking at what level they should start to buy.
Received wisdom was that there would be support at the $117 level, and so when prices fell to that level, many started to buy. They were wrong; and they were forced to watch as the price of crude oil kept falling. As one market observer noted, “it was like trying to catch a falling piano”. The piano invariably wins.
Brent crude had been trading above $120 for just over a month – as a result we’d all seen a marked increase in the price we were paying at the petrol pump.
The very liquid crude oil market is typically able to withstand large inflows or outflows of investment. Moves of the order of $10 a barrel are rare, and typically restricted to being set off by major world events – the Gulf war in 1991, or the collapse of Lehman brothers in 2008.
Last week, losses were racked up in spectacular amounts. At one point, crude oil had fallen by nearly $13 a barrel – this was its biggest ever one day movement, and saw it fall to below $110 for the first time since March of this year.
Oil doesn’t fall by 10 per cent on a regular basis – and these price movements weren’t as a result of any normal supply or demand factors.
After a five-month winning run over all other forms of investment, commodities had collapsed – and nobody knew why. No single bank or fund was identified as making large sales to liquidate a position.
Goldman Sachs and George Soros had turned bearish on commodities during the week, and whilst economic data in the US had been weak, these two factors and a lessening of the geopolitical risk were not responsible for the dramatic falls.
Quite simply what happened was that computerised trading kicked in when key price levels were reached, accelerating the fall.
This sent the dominos tumbling, one after the other.
One stop loss triggered others and pushed the market lower, activating even more stop losses. These price points are programmed into the super computers in the morning by the traders, and once they are hit, could feasibly unwind a long bullish position in oil and almost immediately build up a short bearish one instead. No emotion or thought is involved; orders are simply transmitted to the trading floor.
The effect of this, recreated many times over, is dramatic on the market.
Computers don’t care how much trading they do – within predefined limits they will simply execute orders as certain levels are breached.
High frequency and algorithmic trading now accounts for as much as half of all the volume in ail markets and as the price of crude crashed on Thursday it dragged down the price of every other commodity.
Dropping my children to school this morning and filling up the car, I’ve noticed there has been no change in price of petrol or diesel at the pumps which still read €1.54 a litre for unleaded and €1.51 for diesel.
In the space of several hours, the drop in the price of crude oil had shaved nearly $1 billion off the cost of supplying the world’s daily oil needs. You could argue, quite rightly, that this should be passed onto the end consumer. But there has been no reduction in price since Thursday, and whilst we all live in hope that the significant price reductions will be passed on, it’s unlikely.
Yet Thursday’s rout will have produced many casualties.
Many will be banks, speculators or funds that specialise in commodities trading. Weekly losses of between 10 per cent and 20 per cent have been rumoured at some commodity-laden investment funds. Oil suppliers and large scale consumers will be experiencing similar problems.
In the United States, the attorney general, who is chairing a working group on oil price manipulation, wants proof that the savings are being passed on to the consumer.
Higher prices in Ireland correspond to a higher levy being added by the exchequer. Everyone needs a break, and it is important that the 10 per cent price reduction is felt where it is really needed.
The typical Irish motorist will use 150 litres of fuel per month based on doing 12,000 miles per year at 30 miles per gallon. That means the average monthly fuel bill is now €231.
In January 2009, petrol cost 95 cent per litre, and the monthly bill was €142.50. Were it not for the extra taxes added by the outgoing government since October 2008, petrol prices could be as much as 20 cents lower than they currently are.
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