Oil prices: what if it is caused by speculation?

[Quartz]

Various sources say that the rise in oil prices is due to speculation (sample cite). What if this is true? What does this bode for the next year?

[dalej42]

The oil bubble pops and the price goes down. See dot.com bust and housing market bust.

[John_Mace]

If the people speculating are right, they will make a ton of money. If they are wrong, they will lose a ton of money. That’s the nature of speculation.

[Quartz]

But will there be effects on the wider economy?

[smiling_bandit]

If the speculation is wrong, they’ve driven the price up temporarily. But if the speculation is right, they’ve ensured that stocks will be available even if supplies are low.

[RTFirefly]

By what mechanism would speculation be driving up the price of oil? It’s easy to cry “speculation,” but it’s equally easy to say, “the price of oil is going up because there are Martians in my toilet.”

See, I just said it. It wasn’t hard at all.

[ultrafilter]

The major factor driving up oil prices is the increase in demand from the developing world, including India and China.

[LonghornDave]

I posted some of this same information in a General Questions post last week. Here is what Goldman Sachs had to say about speculation in a 5/5/08 report.

@Goldman Sachs

Commodity speculators play a critical role in balancing oil supply/demand

We believe there is a fundamental misperception among many in the oil industry, Wall Street, the media, politicians, and the general public that so-called “speculators” are driving up the oil price to supposedly unjustified levels. Unfortunately, we do not think the energy crisis will be solved by finding and punishing the big, bad speculator. In fact to the contrary, we believe commodity investors are helping to solve the energy crisis by speeding up the process of incentivizing higher capital spending on a wide range of energy projects while at the same time encouraging lower levels of demand by energy users.

Without question increased fund flow into commodities has boosted prices. The issue is whether the resulting oil price is “real” or represents speculative excess; we strongly believe the former. We note that if it is an excessive oil price, where is the excess supply? Inventory levels look normal and just about all of industry—both non-OPEC and OPEC—are badly missing production forecasts. The minimal supply growth despite what is now nine years of favorable energy market conditions is remarkable and in our view the most substantive indication that current oil prices are fundamentally justified.

The fact that tight oil supply/demand fundamentals are attracting large amounts of capital is a good thing. Higher oil prices signal to oil companies the need for greater investment. Higher oil prices also signal to consumers the need to demand less. This is basically the point of capitalism, which over the past hundred years has proven to be the superior economic and geopolitical philosophy.

The so-called commodity speculator should be applauded for speeding up the message to both oil companies and consumers that energy markets are tight. Commodity speculators also encourage venture capital and private equity firms to invest in alternative energy and other new forms of supply. During the 1990s, very little investment went into clean energy. Today, alternative energy investment is rising rapidly thanks in large part to the role of commodity investors in bidding up energy prices.

In our view, supporters of a cleaner environment should be supportive of commodity investors, as the combination of lower demand and new alternative energy investments take hold. In our view, commodity investors are helping to accelerate the speed by which the world will naturally want to burn less crude oil.

[smiling_bandit]

@RTFirefly

By what mechanism would speculation be driving up the price of oil? It’s easy to cry “speculation,” but it’s equally easy to say, “the price of oil is going up because there are Martians in my toilet.”

In short, there are more people buying rights to future oil stocks and more people taking oil out of current stocks in a sort of “layaway” plan. Thus, we currently have very high oil stocks (possibly a record amount, I don’t know) but prices are still high now because people are betting they’ll be higher later. Oil companies are making sure they can afford to buy oil in the future and speculators are trying to make money off the expected rise.

I personally think this will collapse come September.

[BrainGlutton]

According to George Soros, it portends a bursting of the oil “bubble.”

He does not say this portends lower prices at the pump.

[LonghornDave]

@smiling bandit

I personally think this will collapse come September.

What would constitute a collapse in your mind? For a reference point, the front month futures for crude are trading around $126/bbl right now.

Also, certainly prices will be significantly affected by the storm season, which we will be right in the middle of in September. Here is the current forecast by the NOAA.

[Kevbo]

The Euro is currently worth around US$1.65 If the dollar hadn’t dropped to this extent, we’d be looking at ~ $80/bbl Oil, and $2.50 /gallon gas even with speculation etc. To a large extent the current price at the pump is due to taking on debt to fund the fiasco in Iraq.

[BrainGlutton]

@Kevbo

The Euro is currently worth around US$1.65 If the dollar hadn’t dropped to this extent, we’d be looking at ~ $80/bbl Oil, and $2.50 /gallon gas even with speculation etc. To a large extent the current price at the pump is due to taking on debt to fund the fiasco in Iraq.

For the economically half-educated, could you explain the connection between a nation’s level of public debt and the international-market value of its currency?

[LonghornDave]

@BrainGlutton

According to George Soros, it portends a bursting of the oil “bubble.”

Directly from the article you posted:

Mr Soros will say a crash in the oil market “is not imminent”.

[ultrafilter]

@BrainGlutton

For the economically half-educated, could you explain the connection between a nation’s level of public debt and the international-market value of its currency?

Everything I’ve seen points to our recent monetary policy as the reason for the dollar’s decline. Furthermore, if the public debt were really a significant factor in the value of currency, the dollar would not be falling relative to the yen. The US debt is 36.8% of our GDP, whereas Japan’s debt is 182.4% (cite).

[John_Mace]

@ultrafilter

Everything I’ve seen points to our recent monetary policy as the reason for the dollar’s decline.

If US interest rates are low relative to what investors see in other countries, then the demand for dollars is going to be lower, driving the price down relative to other currencies. Also, some countries are putting more of their reserves into Euros rather than dollars, driving demand down even further.

[ralph124c]

Back in the 1970’s when the Hunt brothers tried to corner the silver market, their activities drove up the price. The price of silver collapsed, and the Hunts lost a fortune. Could the same thing happen with oil?

[mazinger_z]

@ralph124c

Back in the 1970’s when the Hunt brothers tried to corner the silver market, their activities drove up the price. The price of silver collapsed, and the Hunts lost a fortune. Could the same thing happen with oil?

If you mean: could oil producers, seeing such a high price of oil, flood the market with more oil, causing speculators to run out of money available to buy this extra oil, and eventually end their demand, causing the price of oil to drop dramatically (because of the excess supply), then yes, I agree.

[RTFirefly]

@smiling bandit

In short, there are more people buying rights to future oil stocks and more people taking oil out of current stocks in a sort of “layaway” plan. Thus, we currently have very high oil stocks (possibly a record amount, I don’t know) but prices are still high now because people are betting they’ll be higher later. Oil companies are making sure they can afford to buy oil in the future and speculators are trying to make money off the expected rise.

I personally think this will collapse come September.

Can you produce a cite about the very high oil stocks? Everything I’ve read in the past few months says they’re not out of the ordinary.

And to me, that would be the tipoff: if oil is overpriced, then oil would be piling up somewhere because the price is too high to sell all the oil being pumped out of the ground.

[smiling_bandit]

@RTFirefly

Can you produce a cite about the very high oil stocks? Everything I’ve read in the past few months says they’re not out of the ordinary.

I’m having trouble finding the bloody figures. From my last check, production was up a bit (though not as much as we’d like, because Iran and Venezuela are complete disasters) but usage was falling, even despite India and China. Will keep looking.

In response to anopther question, yes, I think the collapse (price dropping by, oh, a third) will come around September despite sotrm season. It doesn’t mean the future for that period will change right now.