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Speculating on Oil

Author: Toni Johnson
Updated: June 24, 2008


Truckers in Europe staged protests demanding lower fuel taxes, airlines face bankruptcy (WSJ), some Asian countries have cut fuel subsidies (CNBC), and one U.S. auto company promised a three-year guaranteed fuel price with every car. With oil above $130 per barrel, few have escaped the pain. The price problem has become so great Saudi Arabia hosted a summit with oil companies and global leaders to address concerns. In the United States, where a tight presidential race rages, proposals to ease the shock range from a summer gas-tax holiday to tapping the Strategic Petroleum Reserve (Foreign Affairs). President Bush called for opening restricted offshore areas and federal lands (CNN) to oil exploration, but the Democratic-led Congress countered that oil companies have yet to exploit millions of acres (PDF) of land and water already leased.

Worse still, the ceiling is nowhere in sight. Russia’s state-owned energy giant, Gazprom, recently predicted that oil prices might reach $250 a barrel by 2009 (Independent). Though Saudi Arabia announced it would increase output 200,000 barrels per day—putting the country at its highest output in decades (Scotsman)—the markets shrugged. Energy experts broadly agree that oil prices have spiraled out of control, but defining the cause remains a point of contention. Some experts point to the falling dollar. CFR Fellow for Geoeconomics Brad W. Setser notes a few ways in which a falling dollar might affect oil prices, and vice versa, though he says broader geoeconomic trends like developing world growth rates are the predominant driver of rising crude prices. Other experts point to the so-called fundamentals, the tightness of supplies and higher demand, especially in China and other energy-hungry developing nations.

The search for a culprit is on, and the workings of lucrative and loosely regulated oil traders have drawn much attention. Some U.S. policymakers, among them longtime campaigners for greater scrutiny of oil-industry profits, now hope to tighten the reins (IHT) on commodities traders too. Michael Greenberger, a former official at the Commodity Futures Trading Commission during the Clinton administration, told Congress recently the rush to energy market deregulation (PDF) in the 1990s created exploitable loopholes that should be repealed. However, Jeffrey Harris, chief economist for the CFTC, asserted (PDF) that “there is little economic evidence to demonstrate that prices are being systematically driven by speculators in these markets.”

The oil market used to be dominated by people in the business of directly buying and selling of oil for consumption. However, experts say, more recently the market has attracted general investors, such as pensions and hedge funds, who have poured billions into oil futures and other derivatives on behalf of their clients. One hedge fund manager recently told Congress that over the last five years, speculator demand for oil futures (PDF) nearly equaled the rise in China’s physical oil demand. Over that same period, he noted that financial speculators stockpiled—via the future markets—the equivalent of over one billion barrels of petroleum, eight times more than the U.S. government physically stockpiled. Oil investment analyst D. Barry McKennitt says that speculation on the scale seen in recent years magnifies price volatility.

But other financial analysts defend investors that critics brand as “speculators.” Some say that global supply growth has been lower than was forecast (Reuters). BP’s latest global energy review (PDF), for example, predicts Russia’s oil output will experience multi-year drops starting in 2008, a troubling reversal from the rising output predicted in previous forecasts. Other analysts worry that using speculators as scapegoats will cause even more market volatility (Reuters). On June 23, a House Energy and Commerce subcommittee held a hearing to investigate whether market speculation is inflating the price of crude oil, and whether Congress needs to improve regulatory oversight.

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