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Saudi Arabia Takes Aim at Oil Bears: What Traders Should Know

Published 06/04/2023, 10:02
Updated 09/07/2023, 11:31
  • Saudi Arabia's surprise production cut was targeted at short sellers.
  • While Saudi energy ministers dislike futures trading's role in the oil market, it helps increase liquidity.
  • Meanwhile, water has entered the futures market, and economists argue that it will help increase efficiency.

Oil prices rose this week after OPEC+ announced a surprise voluntary production cut on Sunday. Several reasons were given for the change, but according to Saudi energy minister Abdulaziz bin Salman, one of them was to make “the guys in the trading floors to be as jumpy as possible.” Apparently, short sellers prompted by the recent banking crisis were betting that oil prices would fall, and Saudi Arabia wanted “whoever gambles on this market [to] be ouching like hell.”

Bin Salman’s anti-speculator sentiment is not new amongst Saudi energy ministers. Ali Naimi was never shy about calling out speculators when he thought financial trading was distorting oil markets. In 2008, he told reporters that speculators were to blame for triple-digit oil prices, which was why there was nothing OPEC could do from a supply perspective to bring down prices. “Speculation in the futures market is determining prices,” he said then. “Today, there is no link between oil (market) fundamentals and prices.”

Saudi oil ministers may dislike the role that futures traders play in the oil market because it makes it more difficult for OPEC to influence the price of oil by adjusting supply. Still, futures trading plays an important part in the oil industry today. Speculation on oil futures helps increase liquidity in the oil market, allows those in the industry to efficiently hedge their positions so they can be protected from future volatility, and helps distribute risk.

In recent years, oil producers like BP (NYSE:BP), ExxonMobil (NYSE:XOM), and even Aramco (TADAWUL:2222) have started their own trading units and have profited significantly from trading oil futures. There are definite drawbacks for the industry and for consumers, but overall, futures trading has helped the global oil market run more efficiently.

In 2021, a new commodity—water—entered the futures market. Investors, farmers, municipalities, and speculators can now buy and trade futures contracts for water. The primary beneficiary of futures contracts for water are farmers in drought-prone areas. They can use futures contracts to protect themselves from spikes in the price of water by buying water for future delivery at lower prices today. But can futures trading help promote water security, affordability, and environmental goals? Is it a market that traders should consider entering, and do the potential benefits outweigh the problems?

Economists argue that trading water futures will help move water to where it can be put to the best economic use and increase efficiency in the market. It could also help make water more affordable for farmers and promote water security for those in drought-prone areas. Just as the oil futures market can help oil producers plan for the future by better understanding the future price of their commodity, water futures trading could help municipalities, farmers, and other consumers of water plan more effectively for the future. Better insight into the market and greater price certainty would encourage utilities and others in the water purification and supply industry to make investments in water storage, recycling, efficiency, and environmentally sound sourcing for the future.

For example, a municipality could analyze the futures market and determine that in order to ensure future water security for its consumers, it should invest in building a desalination plant that will provide a consistent stream of water at affordable prices instead of having to buy water from other areas at variable prices. Greater certainty about the future price of water could help localities justify investments in new, energy-efficient water purification and transportation technology for the future, particularly in areas like California that regularly experience water shortages.

Right now, the market for futures trading in water contracts is very small, so the water industry isn’t benefitting from increased liquidity or risk distribution as other commodified industries do. There is very little incentive for traders to trade water futures contracts because the volume of trading is so low that profits are negligible for speculators.

However, water will be an important topic of discussion at the upcoming World Utilities Congress, to be held May 8-10 in Abu Dhabi. Expanding the futures market for water must be discussed when considering how to ensure a sustainable future for vital commodities like water. Those in water-insecure areas could derive significant benefits from a robust futures market even though it opens the water market to some degree of financial distortion.

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Disclosure: The author currently does not own any of the securities mentioned in this article.

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