Are speculators driving up the price of oil?

What all of the pundits have missed is that Bush's foreign policy and the Iraq war have destablized the Mid East including the oil exporting countries.---BBB

Posted on Thu, Apr. 27, 2006
Are speculators driving up the price of oil?
By Kevin G. Hall
Knight Ridder Newspapers

WASHINGTON - Are you angry about rising gasoline prices? British Petroleum's chief executive officer, Lord John Browne, suggests that you blame financial speculators for running up the price of oil futures, the contracts for future delivery of crude oil.

BP, one of the world's largest oil companies, reported first-quarter profits Tuesday of $5.3 billion. In the earnings report, Browne noted that oil companies are benefiting from, but aren't to blame for, the recent run-up in prices.

"Ample inventories and increased OPEC production capacity have failed to stem the increase. Oil prices are expected to remain strong," Browne wrote, later saying that financial speculators in the futures market - particularly lightly regulated hedge funds - are behind the high prices. They're buying oil contracts purely as a bet that they'll be worth more in the future, not because they ever intend to take delivery of oil.

Whether such speculators are driving up the price is open to debate.

"I believe that the speculators' role has been the introduction of more buyers ... it has actually added a degree to the overall price," said Kyle Cooper, an energy analyst for IAF Advisors in Houston. "I personally think it's in the order of $5 to $10 a barrel. Is there any way to prove it? Absolutely not."

Cooper points to rapid growth in commodities funds, those that cater to big institutional investors and to average Joes alike. Money from these funds flows not only into oil but also into commodities broadly, including gold, coffee and wheat. London-based Barclay's Capital recently estimated that investors pumped $80 billion into commodities markets last year, and the figure could grow to $100 billion this year.

Is that speculation or investment?

"For anyone to say that speculators are to blame for the run-up is really ignoring all the other participants in the market," said Michael Haigh, associate chief economist for the Commodities Futures Trading Commission, the federal entity that regulates trade in oil and other commodities.

Investors who don't plan to take delivery of oil play an important role in the futures market, he said. They serve as a balance between sellers who prefer high prices and buyers who want them as low as possible. Real-world uncertainties such as tension over Iran and production problems in Nigeria, he added, are behind the swing in oil prices, which climbed from $57 per barrel in November to more than $75 last week.

"Differences of opinion about future refining capacity, geopolitical uncertainty, weather expectations, those differences of opinion create the market," Haigh said.

Red Cavaney, the president of the American Petroleum Institute, the trade association for Big Oil in Washington, seconded that view.

"You can call it speculation, but in the commodities business if you don't have the product to deliver, you're out of business," said Cavaney, who thinks that tight supply and political risks are the real culprits in high oil prices.

The rush of money from investors into the booming commodities market has "carried values above what supply and demand" would dictate, said Peter Biebel, vice president and manager of the futures department at investment broker A.G. Edwards & Sons in St. Louis.

He's careful not to call that speculation; rather, he sees it as a diversification of investment portfolios amid so-so stock returns in recent years.

"I think a lot of money that's coming into futures is really investment," Biebel said, cautioning that at least for oil, the volatile prices reflect threatened supplies.

Others see clear speculation.

"I think there's more at work here than the simple fundamentals of supply and demand. I think speculation has been driving some of these markets higher," said Dan O'Neil, partner in Xpresstrade.com, an online trading firm in Chicago that caters to individuals who are investing in commodities.

O'Neil thinks the speculation is coming from hedge funds, which pool money from private, often wealthy, investors. Hedge funds tend to take bigger risks, but offer investors greater financial rewards.

It's unclear how much money hedge funds have in oil contracts, which are weighted at 1,000 barrels of oil each, or about $72,000 per contract at today's prices. The Commodities Futures Trading Commission provides little detail about who invests in oil contracts; it discloses only the broad categories of commercial and noncommercial positions.

Commercial positions are traders who have stakes in the delivery of oil, either as sellers or buyers. These include oil producers and refiners, who use the futures market to hedge against falling prices in oil, diesel and gasoline. They also include users of petroleum products such as manufacturers and airlines, who hedge against prices going higher in the future.

Noncommercial positions represent traders who never intend to take delivery but are investing in price fluctuations on the futures market. These investors include hedge funds, managers of retirement funds and endowments, and some large individual investors.

Amid allegations that hedge funds were profiteering, the New York Mercantile Exchange, where oil futures are traded, issued a report in March 2005 disclosing that hedge funds held only modest stakes. Nymex said hedge-fund trading constituted only 2.69 percent of the trading volume in crude oil in 2004 and 13.4 percent of the open interest in crude oil futures, a term for the money flowing into the oil futures market.

Those figures suggest that hedge funds aren't big enough to dominate the oil market and have only a modest ability to affect prices. But the numbers also represent a period before the world oil market tightened and before the run-up of prices in 2005 and this year.

So the degree to which speculators are driving today's oil prices is anyone's guess.

"I think it's safe to say they play an important role, but given ... that this is such a global market, to imply that speculators have absolute control is a little too radical," cautioned A.G. Malliaris, a senior economics and finance professor at Chicago's Loyola Graduate School of Business.

And since futures markets mitigate risk, he said, "if there are deviations (from market fundamentals) they are very temporary."

For now, Rodney Boyce, a crude-oil broker for BNP Paribas Commodity Futures Inc., warns to brace for higher prices.

"We're moving to the high side. Demand isn't going to drop off," he said, envisioning prices soaring past $80 per barrel after a pause this week for profit taking. "I can't see a reason why we have a pullback."