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Large amounts of speculative investments in oil may be having a significant impact on world oil prices, according to the latest economic briefing entitled “Speculative Oil” from Oxford Business Group (OBG) the global publishing and research firm.
 
It questions the common explanation for the hike in prices that supply, demand and other structural market factors are forcing prices upwards, noting that the higher prices go, the less plausible it becomes that unremarkable supply and demand pressures could account for such dramatic price increases.
 
Prices are now almost seven times higher than the average price of $20 for the last 15 years of the 20th century and have already increased by over 30% in 2008.Evidence suggests that there are other, more speculative forces at work in the oil sector which are driving up prices.
 
The briefing, which comes as the G8 finance ministers have called for an investigation, involving the IMF, into the recent energy price volatility, and pressure is mounting on political leaders to produce a solution to the price spike, asserts that, with prospects in equities, bonds and other assets looking bleak, commodity prices are increasingly being billed by financiers as a new class for investment.
 
Accordingly, institutions, hedge funds and sovereign wealth funds are looking to profit from the rise in oil prices by pouring money into oil futures and oil dominated commodity indices.
 
It notes that defenders of the speculators, principally politicians and media from economies with advance financial sectors, have argued that there is no connection between oil price speculation and the underlying cost of real barrels of oil. Settlement of futures contracts takes place in cash, with no physical delivery of oil taking place, thereby avoiding any pressure on the underlying market.
 
However, future contracts are the most direct way speculators, or fund managers acting on their behalf, can gain exposure to oil prices, and there are good reasons to believe that speculators are having a larger impact on oil prices than their defenders suggest. By purchasing futures contracts, speculators are driving up the forward price of oil, which encourages consumers of crude to buy oil today, in turn driving up spot prices of crude. A US Senate sub committee has reported that 40-50% of the price of a barrel of oil was the result of speculative investment.
 
Most analysts are estimating that over $200bn is currently invested in commodity indices, up from $13bn five years ago. A recent Lehman Brothers report, entitled “Is it a Bubble?” estimated that between January 2006 and April 2008 every $100m of new inflows causes an increase in the price of WTI (Western Texas Intermediate, the American benchmark in crude oil prices) of 1.6%.    An estimate that commodity index funds saw investment flows of $2bn in the first quarter of 2008 would, according to Lehmans, cause oil prices to increase by 32%.
 
This does not account for speculative investment directly into oil futures. The size of these investments is unclear due to the lack of transparency on the principal global oil exchanges.
 
As hedge funds, banks, institutions and other investors hold open positions on oil prices they have a profound interest in talking up prices and supply and demand pressures.Adding to the hype, analysts raise forecasts attracting further investment flows, all resulting in the abnormal prices rises of a classic asset bubble fit for bursting.
 
As high prices feed through the system they will seriously undermine demand, providing a possible trigger for prices to take a sharp about turn back to more normal levels.   It appears that the world’s financial genii may have found a way to recoup their subprime losses.   There is very little end-users can do but suffer the high prices at the pump until they ease off again.

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