Crude oil has risen 77% in the last 12 months, triggering fears of global recession. But is OPEC to blame for the crisis, or have prices been driven up by the speculators?
On 2nd January Richard Arens, a lone trader on the New York Mercantile Exchange, paid significantly over the odds to snap up 1000 barrels of crude oil. When he sold them a few moments later – at a US$600 loss – the speculator was out of pocket but he had secured his place in history as the man who pushed the price of oil to a record US$100.
Today, while the Gulf’s oil-producing states can look forward to a US$1bn-a-day petrodollar surplus, oil consumers in the West are looking for someone to blame for crude oil that has topped US$145 a barrel.
And the heat is on risk-takers such as Arens, who buy a commodity like oil when they think the price is likely to rise, and they’ll be able to sell for a profit.
OPEC says that soaring demand and supply constraints are underpinning the rise; in the US and Europe, politicians are calling for the reining in of speculators blamed for flooding the oil contracts market and distorting the real cost of the commodity.
On Capitol Hill, irate Democrats have called for rules compelling traders to take delivery of crude oil, a move which would paralyse the market. In Europe, leaders have proposed a worldwide ban on oil trading by speculators, blaming the latest spike in crude prices on manipulation by hedge funds.
Oxford Business Group (OBG), a London-based research and consultancy unit, suggests that large amounts of speculative investments in oil may be having a “significant impact” on oil prices. As the global economic slump deepens, investors are increasingly looking for exposure to commodity prices rather than more traditional assets such as equities or bonds – and this shift could be the reason that 2008 consumers are facing unprecedented pain at the pumps, it said in a report.
On July 11 total trading volumes on Dubai Gold and Commodities Exchange (DGCX) touched a record new high of 14,066 contracts, registering the exchange’s highest overall daily value of above US$978m.
“There’s no doubt that we are in a commodities super-cycle, and interest in commodities is at an all-time high,” Malcolm Wall Morris, CEO of DGCX, tells Arabian Business. “Market sentiment can be that commodities are not correlated to other asset classes such as fixed-income and equities, so for risk management purposes or investment purposes they can offer an opposite to those markets.”
The exchange’s recently launched crude oil contract, the West Texas Intermediate (WTI), is its star performer – and set a new record with 3871 contracts traded equivalent to over US$562m. On the same day, Brent crude closed at US$144.49, up 32.3% since the beginning of the year. Oil futures reached a record US$147.27 a barrel on July 11, and have risen 87% in the past year.
“The high oil price has already triggered a long-term change in not only the finance world and the general economy, but the lives of every single person on this planet,” says Aalaeddine Chahbi, a hedge fund manager with Dubai-based Evolvence Capital, which manages around US$1bn
“Over the last year, between 60 and 70% of the volume traded was traded on a speculation basis, meaning it was not oil intended for consumption or for reserves. That’s a really big number, and I know that theoretically it can sometimes be even bigger than that because you can buy and sell more than what is actually consumed. One thing’s for sure – funds in general have a significant role in this price appreciation.”
And as the price of oil rises higher, it may become more difficult to explain away by pointing to rising demand – which has been increasing relatively moderately until now.Ed Morse, Lehman Brothers’ chief economist, has predicted that crude prices will average US$130 in the third quarter of the year and US$93 next year because of lower demand in industrialised countries, as a result of the increased cost and slowing economies.
The company believes, however, that oil demand worldwide will grow 1.2% next year.
According to the BP Statistical Review, oil consumption grew 1.1% last year. Lehman’s estimate for oil demand is in line with that of the International Energy Agency (IEA), which represents 27 major oil-consuming nations around the world. In its latest report, the IEA predicts demand for oil products will grow by 1.2% by mid-2009.
Defenders of the speculators have argued that there is no connection between oil price speculation and the underlying cost of real barrels of oil. They point to increased demand from emerging economies, particularly China, and argue that OPEC – which generated 44% of world crude oil in 2007 – should increase production.
Just last week, US Treasury secretary Henry Paulson refused to blame speculators for higher prices, saying “all the evidence” pointed to tight supply and robust demand.
Instability and uncertainty are other concerns, with insurgency and sabotage threatening the vast oilfields of Iraq and Nigeria, and doubts over the immediate future of Iran, the world’s fourth-largest oil producer.
“I get very angry when I find people outside OPEC blaming the speculators – this is nonsense,” says Dr Ali Hussein, an Abu Dhabi-based oil consultant. “Speculators are not stupid people, and they know it is a tight market now, and they know it will be tight in the future. They are not gambling because they have studied the market and they know there is a shortage of oil, especially light crude.”
Goldman Sachs Group Inc, the world’s biggest securities firm, last month said that supply and demand, rather than speculators, were responsible for oil’s rally.
Concerns that the gains in prices are part of a speculative bubble are “unwarranted”, said Goldman, one of the two biggest oil traders on Wall Street. Stockpiles would increase if prices were too high relative to supply and demand, bringing excess supplies to the market, analysts Jeffrey Currie and David Greely said in a report.
“It’s easy for politicians to scapegoat derivatives as the reason that people are paying high prices for gasoline, but there are a lot of other reasons,” Greg Johnson, CEO of US-based global investment management giant Franklin Resources, tells Arabian Business.
“Speculators can move things on a day or two, but they don’t form the basis of a trend,” agrees Harry Tchilinguirian, a senior oil market analyst at BNP Paribas Commodity Derivatives in London. “It’s easier to blame a nameless and faceless speculator in an office somewhere, than it is to own up to the facts of tighter supply and increased demand.
“There’s the idea that there has been some exaggerated or anomalous investment into oil since the beginning of 2008, but in fact people have been cutting back on their long positions,” he continues. “If there had been such an increase in passive long positions, then the open interest on the market today would have shot up. But it peaked in mid-2007 and since then has fallen off.”But some lay the blame firmly at the feet of speculative forces at work in the oil sector, a case argued by – among others – billionaire investor George Soros, former Federal Reserve chairman Alan Greenspan, Italian prime minister Silvio Berlusconi, French president Nicolas Sarkozy, and German chancellor Angela Merkel.
With prospects in equities, bonds and other assets looking bleak, commodity prices are increasingly being billed by financiers as a new asset class for investors,” the OBG report says.
“Institutions, hedge funds and sovereign wealth funds are all looking to profit from the rise in oil prices by pouring money into oil futures and oil-dominated commodity indices.”
As these institutions hold open positions on oil prices, they “have a profound interest in talking up prices and supply and demand pressures”, warns the report. In turn, analysts “raise forecasts attracting further investment flows, all resulting in the abnormal price rises of a classic asset bubble fit for bursting”.
Some argue that the effect of increased speculation on the oil price is more psychological than it is rooted in actual economic fundamentals.
“It’s very hard to prove a very strong mathematical link between the speculators and the rising price, but there is clearly a mentality influence,” says Samuel Ciszuk, a London-based Middle East energy analyst at forecasting company Global Insight. “It influences the feeling in the market and fuels the frenzy, especially when people see the large fluctuations and hear some of the big traders putting big numbers up there.”
“As high prices feed through the system, they will seriously undermine demand,” reads the OBG report. “It appears that the world’s financial genii may have found a way to attempt to recoup their subprime losses.”
The reality is that despite the controversy, traders will not stop speculating on the price of oil. Any scheme to ban futures trading would be extremely hard to enforce as the markets would tend to move offshore.
“You can’t live without derivatives because they’re what make the world go round as far as hedging and reducing risk,” says Johnson at Franklin Resources. “I think it’s a waste of time to speculate what the real price should be without futures, because it’s not a world that can exist.”
Last week Barack Obama called the price of oil “one of the most dangerous weapons in the world today” and said that if elected president he would form an alliance of oil-importing nations to “break the grip of OPEC on the global economy”. The speculators may be under fire today, but the US already has a far bigger target in its sights.
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