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$100 oil and the 'S' word | Oil Watchdog

$100 oil and the 'S' word

Tue, Nov 27, 2007 at 10:03 am

    $100 oil and the 'S' word

    November 27, 2007

    by Steve Hargreaves, CNNMoney.com staff writer

    $100 oil and the ‘S’ word: Is it growing demand and tight supply, or merely rampant speculation that has pushed crude to record highs?


    Greed is driving oil prices to $100 a barrel.

    That’s a common feeling among the general public, which sees
    record profits for investment banks that bet on oil prices — making
    wealthy oil companies even wealthier — while drivers shell out $3 and
    more for a gallon of gas.

    It’s also a common refrain from OPEC states. Having to defend
    themselves against charges their production quotas are responsible for
    the high prices, they point to near-average crude oil supplies and say
    speculation is what’s behind the frenzy.

    But industry experts offer mixed opinions on speculative
    investment’s impact on oil prices. Some say it’s marginal, that strong
    demand and limited supply are the real reasons oil prices have risen
    five-fold since 2002, and say additional investors actually benefit the
    market by adding more liquidity.

    Others say the tight supply and demand situation has been known
    for a while, and nothing but speculation is behind the doubling of oil
    prices over the last year. They say there is a cost to the sheer number
    of oil contracts now traded on the oil exchanges, and this trading has
    just enriched Wall Streeters at the expense of average Americans.

    The Energy Information Administration, the Energy Department’s
    independent statistical and analysis arm, thinks strong demand and
    limited supply — otherwise knows as "the fundamentals" — is why oil
    is so pricey.

    "Our view is that the market is tighter [than last year]," said
    Doug MacIntyre, senior oil market analyst at EIA. "We don’t have the
    inventories now."

    MacIntyre said inventories in developed countries — crude oil
    stored at refineries, or in tanks at ports, pipeline terminals and
    other locations — went from 150 million barrels above their five-year
    average at the start of the year to 10 million barrels below the
    five-year average now.

    "That’s a big difference," he said. "There’s less slack in the system than there was a year ago."

    EIA attributed the decline to OPEC production cuts of about 1.5
    million barrels a day beginning at the start of 2007, when inventories
    were so high and oil prices briefly dipped below $50 a barrel.

    The cuts came despite continued strong worldwide economic
    growth, which EIA said caused oil demand to rise by 1.3 million barrels
    a day over the last year. The agency projects an increase in demand of
    1.5 million barrels a day in 2008.

    "High oil prices are not rationing demand," Addison Armstrong,
    director of market research at the brokerage Tradition Energy Futures,
    said, adding that speculative money might be tacking on just $5 or $10
    to the price of a barrel. "The fundamentals are much tighter than they
    were a year ago."

    EIA said other factors contributing to a doubling in oil prices
    over the last year include moderate growth in new supplies from
    non-OPEC countries, the inability to immediately produce much more oil
    in OPEC countries, a lack of refining capacity and ongoing geopolitical

    But longtime Oppenheimer oil analyst Fadel Gheit doesn’t buy it.

    Gheit said inventories are declining because high oil prices
    give people an incentive to sell crude now and wait until later to
    restock supplies, when hopefully oil is cheaper.

    Other than the decline in supplies, Gheit says all the other
    factors EIA lists have been with us since last year, when oil traded at
    under $50 a barrel.

    "It’s pure speculation," he said. "What’s changed that we didn’t know in January? Not a single thing."

    It’s hard to gauge the amount of money investment interests —
    as opposed to refiners or airlines or people who actually use oil —
    have in the oil markets. The government tracks contracts held by what
    it calls "commercial’ and "non-commercial" users, but it lumps
    investment banks in with the commercial side.

    Either way, the amount of investment money in oil is certainly large.

    It’s been rumored Goldman Sachs has over $80 billion in the
    market, although the investment bank declined comment for this story.

    Its influence is so big, traders refer to the day of the month
    when the bank sells the current month contract and buys the future
    month as the "Goldman roll" due to its effect on price. When Goldman
    last month told its clients to sell oil when it approached the
    mid-90’s, crude lost over $3 in one day.

    Goldman is of course not the only one. Morgan Stanley, which
    also declined comment, has reportedly bought facilities to store oil.
    Hedge funds, pension funds, commodity-centered mutual funds, insurance
    companies — all have gotten in on the act.

    "Just the multiple [contract] turnovers in the futures markets
    has a cost of its own," said Judy Dugan, research director at the
    Center of Taxpayer and Consumer Rights.

    Dugan, echoing recent sentiments by oil company executives
    themselves, said there’s no fundamental reason why oil prices should be
    anywhere near $100 a barrel.

    "There’s no inability to buy oil, this is not 1981," she said.

    "It’s a crime," said Gheit. "A family of four is going to have
    to cut corners to benefit a Wall Street trader who makes $20 million a

    The high prices and talk of speculation has attracted the
    attention of Congress, which is holding hearings on the matter
    beginning next month.

    Among things lawmakers could do is increase the margin
    requirements – or require oil traders to put down a greater percentage
    of a contract’s worth in-order to buy or sell it. Currently, traders
    can buy or sell oil with just 4 percent down, compared to 50 percent
    for stocks.

    Another option could be to require traders to hold oil contracts for a certain amount of time before they sell them.

    But one source familiar with the oil markets said that while the
    physical number of oil barrels available is limited, there is no limit
    on the number of contracts that can be written. So just because there’s
    more money chasing oil contracts, that in and of itself doesn’t
    necessarily guarantee higher prices.

    He said speculators provide liquidity in the oil markets, and noted that they can lose money just as fast as they make it.

    And he cautioned about lawmakers attempting to write rules for a market they know little about.

    "Their intent may be good, but sometimes they do more harm than good," he said.

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