The great debate on speculation and oil


Oil's rally to records well above $140 a barrel has stirred a heated debate about the role played by speculators in commodity markets.

From the outset, oil futures markets have included participants unrelated to physical crude, but a rising tide of money from investors, chiefly pension funds, has fuelled arguments the market has been distorted.

The biggest producer countries, led by Saudi Arabia, which tend to favor fixed pricing, have blamed speculation for the extent of a rally that has seen oil prices double over the course of 12 months.

Politicians from consumer countries, facing electorates unhappy with soaring fuel costs, have said the problems are fundamental and have called for more oil and investment to ease what they see as short and longer term supply problems.

At the same time, the biggest consumer country the United States is considering a raft of bills to try to limit speculative activity, including the End Oil Speculation Act of 2008 and the Federal Price Gouging Prevention Act.

Many analysts say the debate is artificial and the volume of investment class cash reflects supply and demand.

“The question misses the point. It's semantic,” said Mike Wittner of Societe Generale.

“Financial flows are based on fundamentals. The big change is that they are based on long-term fundamentals, not short-term fundamentals.”

Those who believe in markets say any speculation provides valuable liquidity and ultimately will establish the price at which supply will match demand.

“As an experienced futures trader, I have learned that price is a messenger of current and future supply and demand conditions,” said Hilary Till of Premia Capital Management.

“When there is a strong rally in price, one has a signal that there is impending scarcity and that price is searching for the level to bring on new supply or, unfortunately, ration demand. Right now, of course, this is not a popular message,” added Till, who is also a research associate at the Risk and Asset Management Research Centre.

The following sets out views from major players in the energy sector.

- Ali al-Naimi, Saudi Arabia's oil minister of OPEC: “I am convinced that the supply and demand balances and crude oil production levels are not the primary drivers of the current market situation and that markets are already well-supplied.” (At the Jeddah Energy Meeting in June.)

“Supply is enough. The price is driven by many, many causes -- most of which is speculation.” (At the World Petroleum Congress in Madrid June 30)

- Abdullah al-Badri, OPEC Secretary General, called for measures to curb market speculation, a factor the Organization for the Petroleum Exporting Countries has said is driving prices to unjustified levels.

“We are not happy with the current level of price for one reason. It has nothing to do with the fundamentals,” he told the Reuters Global Energy Summit on June 10.

- Sam Bodman, United States energy secretary: “There's no evidence we can find that speculators are driving futures prices.” (At the Jeddah talks in June)

- Nancy Pelosi, speaker of the US House of Representatives: “The American people should not be punished at the pump for the actions of oil speculators.” (Washington, June 26)

- The International Energy Agency’s Medium-Term Oil Market Report at the start of July said the real reasons for high prices were strong demand growth, coupled with shortages of supply and refining capacity.

“Blaming speculation is an easy solution which avoids taking the necessary steps to improve supply-side access and investment or to implement measures to improve energy efficiency,” said the IEA, which advises industrialized countries on energy.

It said the amount of money from investors buying into oil and other commodities as an inflation hedge and to balance asset portfolios, had risen from an estimated $15 billion in 2003 to around $260 billion now.

These investors have tended to buy into indexes, or baskets of commodities, and the increased volume of their investment reflects an increase in the value of commodity markets, as well as flows of new money.

The IEA said there was no evidence this activity had thrown the market out of kilter with supply and demand at the moment even if it had caused price distortions in the past.

- The heads of some of the world's biggest oil companies have said a dearth of new supplies not speculators are behind high oil prices.

Tony Hayward, chief executive of BP said the argument that financial investors buying oil futures were behind oil's record levels was a myth.

“Supply is not responding adequately to rising demand,” he said at the World Petroleum Congress in Madrid.

Jeroen van der Veer, Shell chief executive, said: “We don't think that the financial markets are leading the speculation, probably they follow what other people fear as long-term fundamentals,” he said in Madrid.

“I do not think that you can blame speculation for the oil price.”

Antonio Brufau, chief executive of Spain's Repsol: “The fundamentals in the industry are the significant reasons for having these prices.”

- Goldman Sachs, one of most active investment banks in the energy markets, has tried to highlight the differences between speculators and index investors in a research note: “Speculators, Index Investors and Commodity Prices,” published on June 29.

“Speculators and index investors perform different economic roles in the commodity futures markets,” the bank said.

“The role of speculators is to bring to the market informed views on the future supply and demand fundamentals...”

“The role of index investors is to hold the commodity price risk that the producers wish to hedge. Because they buy and sell mechanically and consequently do not bring information to the market, index investors do not move commodity prices in the same way as speculators.” (Reuters)

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