Chloe

Price of Oil: Speculation vs. Fundamentals

I would like to add a little more to this discussion. I'm borrowing extensively for this post from the article by Jerry Remmers found here: themoderatevoice.com/2.../

After reading your thoughtful article, I first had the impression that speculation in paper oil has only been mostly small guys on the street, phoning in a purchase on their cell phone as they're walking to the street corner. As you write, "In my textbook a gentleman is walking down a street in Chicago when he suddenly gets the urge to buy a million barrels of paper oil with a maturity..." But what about Morgan Stanley?

'In a five year period, Masters said the amount of money institutional investors, hedge funds, and the big Wall Street banks had placed in the commodities markets went from $13 billion to $300 billion. Last year, 27 barrels of crude were being traded every day on the New York Mercantile Exchange for every one barrel of oil that was actually being consumed in the United States.'

'...Masters’ expertise is in tracking the flow of investments into and out of financial markets and he noticed huge amounts of money leaving stocks for commodities and oil futures, most of it going into index funds, betting the price of oil was going to go up. Asked who was buying this “paper oil,” Masters told Kroft, “The California pension fund. Harvard Endowment. Lots of large institutional investors. And, by the way, other investors, hedge funds, Wall Street trading desks were following right behind them, putting money - sovereign wealth funds were putting money in the futures markets as well. So you had all these investors putting money in the futures markets. And that was driving the price up.”'

Are these the South Side Chicago people or the Las Vegas people you're referring to? '“We talked to the largest physical trader of crude oil. And they told us that compared to the size of the investment inflows - and remember, this is the largest physical crude oil trader in the United States - they said that we are basically a flea on an elephant, that that’s how big these flows were,” Masters remembered. Yet when Congress began holding hearings last summer and asked Wall Street banker Lawrence Eagles of J.P. Morgan what role excessive speculation played in rising oil prices, the answer was little to none. “We believe that high energy prices are fundamentally a result of supply and demand,” he said in his testimony.' This certainly supports the thesis above.

'As it turns out, not even J.P. Morgan’s chief global investment officer agreed with him. The same that day Eagles testified, an e-mail went out to clients saying “an enormous amount of speculation” ran up the price” and “140 dollars in July was ridiculous.” If anyone had any doubts, they were dispelled a few days after that hearing when the price of oil jumped $25 in a single day.'

To quote from the piece above, "What has happened is that ‘normal’ demand is tending to exceed ‘normal’ supply, causing a fundamental supply-demand imbalance that is independent of speculative activities. Where details are concerned, this imbalance leads to the premature production of a certain quantity of oil, although later production of the same amount might reduce the present value of intertemporal production costs by allowing a less intensive exploitation of high cost deposits. This is the main explanatory factor for recent price dynamics that featured an oil price increase from about $60/b at the beginning of 2007 to a peak of $147/b in July, 2008, before declining in the wake of the international macroeconomic and financial market deterioration for which the rising oil price rise was at least partially responsible."

'That day was Sept. 22. Michael Greenberger, a former director of trading for the U.S. Commodity Futures Trading Commission, the federal agency that oversees oil futures, says there were no supply disruptions that could have justified such a big increase. “Did China and India suddenly have gigantic needs for new oil products in a single day? No. Everybody agrees supply-demand could not drive the price up $25, which was a record increase in the price of oil. The price of oil went from somewhere in the 60s to $147 in less than a year. And we were being told, on that run-up, ‘It’s supply-demand, supply-demand, supply-demand,’” Greenberger said.'

Continuing from the Remmers article... 'A recent report out of MIT, analyzing world oil production and consumption, also concluded that the basic fundamentals of supply and demand could not have been responsible for last year’s run-up in oil prices. And Michael Masters says the U.S. Department of Energy’s own statistics show that if the markets had been working properly, the price of oil should have been going down, not up. “From quarter four of ‘07 until the second quarter of ‘08 the EIA, the Energy Information Administration, said that supply went up, worldwide supply went up. And worldwide demand went down. So you have supply going up and demand going down, which generally means the price is going down,” Masters told Kroft. “And this was the period of the spike,” Kroft noted. “This was the period of the spike,” Masters agreed. “So you had the largest price increase in history during a time when actual demand was going down and actual supply was going up during the same period. However, the only thing that makes sense that lifted the price was investor demand.”'

Price of Oil: Speculation vs. Fundamentals

Please deconstruct this article...

www.globalresearch.ca/...

excerpt:
"As a result, over the past two years crude oil inventories have been steadily growing, resulting in US crude oil inventories that are now higher than at any time in the previous eight years. The large influx of speculative investment into oil futures has led to a situation where we have both high supplies of crude oil and high crude oil prices.

Compelling evidence also suggests that the oft-cited geopolitical, economic, and natural factors do not explain the recent rise in energy prices can be seen in the actual data on crude oil supply and demand. Although demand has significantly increased over the past few years, so have supplies."

I just want to know why this is wrong. Thanks.