Behind Skyrocketing Oil Prices

Last month came the news that the Commodity Futures Trading Commission (CFTC) is investigating potential manipulation of the oil trading market.

That’s a good thing, though the CFTC is not exactly the most aggressive regulator around. (Says Judy Dugan of Consumer Watchdog: “On its face, the investigation smacks of the fox investigating a hen shortage in the chicken coop.”)

Market manipulation may be contributing to the recent oil price spike — though even in the worst case, it is only part of the story. The most important factor is supply and demand: supply is having trouble keeping up with unabated demand growth.

Are Wall Street firms and hedge funds in fact manipulating the oil market? Perhaps. There are certainly enough conflicts of interest, and unregulation, to make such activity plausible. These aren’t exactly guys with an honorable track record.

Whether speculation is driving price up is a separate issue from manipulation. Investment dollars are pouring into oil futures, pretty clearly driving up price. This reflects supply and demand for oil futures as an investment tool, more than available supply and demand for actual crude oil. Some nontrivial portion of the recent run-up in price is almost certainly due to this speculative activity, which is fueled by leveraged buying (use of borrowed money).

At the end of 2007, with oil prices around $100 a barrel (a shocking height, just half a year ago), Jennifer Wedekind, my colleague at Multinational Monitor, interviewed roughly a dozen oil analysts about the price of oil. They were divided on the reasons for high oil prices of $100, with some agreeing that speculation — but not manipulation — played a role and others fiercely denying it.

Among those attributing some role to speculation was Linda Rafield, a senior oil analyst, with Platts: “We have seen money market funds and asset managers and portfolio managers definitely putting money to work in the commodities sector, and that certainly has bolstered prices, since most of those people notoriously will trade from the long side.” Against speculation as a factor was Jeff Rubin, chief economist and chief strategist, CIBC World Markets. Asked what factors were driving the price spike, he said, “Certainly not Middle Eastern instability or speculation or so-called geopolitical factors.”

Six months later, it seems like speculation has become increasingly important. It’s just very hard to identify what has happened in the last half year to jump prices by a third.

A second key factor in rising prices is the decline in the value of the dollar. A barrel of oil today is worth a barrel of oil tomorrow. If the dollar is worth less tomorrow than today, then the dollar value of a barrel of oil will be higher tomorrow. Against a basket of currencies, the dollar has fallen by 25 percent since 2003, and considerably more since its peak in 2001.

But, whatever the allocation of blame for today’s price, the most important factor in the big picture is supply and demand.

Global demand is growing at a steady clip, thanks to very rapidly rising oil use in China, India and the Middle East.

Global supply is stretched thin. Some argue this is because the world is at or near “peak oil production,” a tipping point when half the world’s oil has been extracted, and yields begin to decline, with very major price effects.

A different view is uncomfortable with the apocalyptic element of peak oil theory. From this vantage point, more oil — or close substitutes, like tar sands or shale — is available, but it is harder and more expensive to get. This is the preferred view of the oil industry analysts (many of whom note that much oil that is easily attained from a technological standpoint — for example, in Iraq — is hard to reach for political reasons).

Either way, the supply challenges combined with rapidly growing demand means the world is going to see steadily higher prices. Additionally, very tight supplies will inevitably lead to price spikes that appear irrational from a close-up view.

Says Charles Maxwell, senior energy analyst at Weeden & Co: “So long as capacity utilization in the world crude oil producing system is running at 98 percent, which it is today, and so long as perhaps one-and-a-half, 2 percent, that’s excess, is in the form of Saudi heavy, sour crudes, which the typical American refinery can’t use any more of — they use some, but they can’t use any more of because it has very serious effects in pitting the insides of these pipes and then requiring the refinery to shut down for a long time and the redoing of all the pipes — we’re going to have these periodic price rises of this sort.”

Explains Maxwell: “Any system needs to have a little cushion between adversity that strikes — weather factors or cut-offs for political purposes or political struggles from civil wars. We don’t have in this system enough of a cushion. Normally, capacity utilization is considered ideal around 94 to 95 percent. So our 98 percent capacity utilization is well above that and we can’t get it down, because it takes 5 to 7 years to create it and we aren’t spending the money today that would create it 5 to 7 years out.”

So, by all means, forward with a robust investigation of market manipulation, and yes to re-regulating oil markets that are now too financialized and removed from the buying and selling of real oil.

But the supply-demand challenges facing the world are much more serious than the speculative and other factors contributing to the present run-up in price.

It’s hard to imagine why the United States — or the world — would need more incentive than responding to climate change to invest in renewables, mandate much tougher efficiency standards for cars and a switch away from the internal combustion engine, and massively scale up public transportation. But climate change doomsday scenarios have, so far, not proven enough. Perhaps the prospect of $200/barrel oil will.

Robert Weissman is editor of the Washington, D.C.-based Multinational Monitor, and director of Essential Action. Copyright © 2007 Robert Weissman Read other articles by Robert, or visit Robert's website.

12 comments on this article so far ...

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  1. Clifford J. Wirth said on July 1st, 2008 at 5:12am #

    Global oil production is now declining, from 85 million barrels per day to 60 million barrels per day by 2015, while at the same time demand will increase 14%. This is like a 30% drop. No one can reverse this trend, nor can we conserve our way out of this catastrophe, because the demand is so high that it will always be higher than production; thus the depletion rate will continue until all recoverable oil is extracted. We are facing the collapse of the highways that depend on diesel trucks for maintenance of bridges, cleaning culverts to avoid road washouts, snow plowing, roadbed and surface repair. When the highways fail, so too does the power grid, as highways carry the parts, transformers, steel for pylons, and high tension wire, all from far away. With the highways out, there will be no food coming in from “outside,” and without the power grid nothing works, including home heating. This is documented in a free 45 page report that can be downloaded and distributed/ emailed:

  2. Newsdesk Helsinki Finland (NDHF) Net said on July 1st, 2008 at 6:09am #

    Oil prices are in direct one-to-one correspondence with the deterioring of the situation in Iraq.

    While the media may be able to downplay the truth on the ground in Iraq, they cannot alter the fact that the truth is widely known & understood.

    You’re welcome to follow the NDHF Net Iraq war coverage presented by the Iraqi Resistance on our address

    NDHF Net (media squad)
    United Nations (Finland)

  3. bozhidar balkas said on July 1st, 2008 at 6:10am #

    clifford j wirth,
    thanx for the imput.
    if u wd look at me u wd instantly know i’m not the man who looks like he knows everything.
    but to me cheney, tho not bush, looks like he knows everything.
    so, let’s stop worrying.

  4. evie said on July 1st, 2008 at 7:45am #

    Any decline in production is not due to peak oil but companies sitting on oil, speculators, intentional, etc. – which may be a good thing as it drives up consumer price – forcing folks to conserve or find alternatives whether from lack of income or out of fear.

    The NAFTA superhighway is moving along on schedule – you will have your highways – or I should say toll roads.

    As for the “Iraqi Resistance”, after watching a few of their propaganda videos, I wouldn’t believe them anymore than I do BushCo, or the UN for that matter.

  5. brs said on July 1st, 2008 at 9:28am #

    Supply and demand assumes free markets. Free markets are a fiction. Speculation is not demand. It is driven by the Federal Reserve creating money out of thin air to bail out the big investment banks. These banks do not make productive investments. They are simply trading up prices to get something for nothing. The bush junior tax cuts and Federal Reserve bailouts are not being used to invest in manufacturing, R and D or infrastructure. They are just used to bid up prices. They can no longer do so with real estate in the U.S. They are now doing so with food and oil at the expense of people everywhere who do productive work. This is leading to food riots and will wreck the economy while the fat cats game the system. The bankers huge paycheck is based on the assumption that he will act responsibly. The bankers are supposed to be guardians of the stability of the economic system. They have made a mockery of this role grabbing short term gains in asset inflation and laughing at the poor suckers who work for a living. It is Enron repeated. Look at some of the remarks the Enron boys made. Conservation and control over demand are necessary. So is control over speculation and manipulation. Unfortunately with wealth so concentrated there is little difference between the two. Controls were placed on markets and banking in the 1930’s. It was not desired then but proven necessary. It is being proven necessary again. People who are born to money cannot be trusted to behave responsibly because they never have had to work for their ill gotten gains. They do not have anything to relate to value. Everything has been handed to them.

  6. evie said on July 1st, 2008 at 9:36am #

    Business is booming, investments are being made – just not much in the USA.

  7. rosemarie jackowski said on July 1st, 2008 at 1:45pm #

    Follow the money.
    Arrest the speculators.
    Nationalize the oil companies.

  8. lynette said on July 1st, 2008 at 3:49pm #

    Rosemarie nailed it.

  9. Robert Laps said on July 1st, 2008 at 8:49pm #

    Dear Mom

    My job at the Inter Continental Exchange here in Atlanta is going great. I have made a lot of money here for uncle Abdullah. I have learned a lot from

    these commodity speculators here in America. They have shown me how to make lot’s of money for myself as well. You see these people here in

    America want to buy all of Uncle Abdullah’s oil. They only want to pay 35 dollars for a barrel of it though. You know It cost uncle Abdullah 10 dollars

    to get it to them and he wanted that new home in Dubai so I will do all I can to help out. I found out that I can buy 30 barrels for 5% or less than 2 dollars a barrel on the

    commodities exchange and he doesn’t even have to pump it out of the ground or even ship it. They buy it with there guaranteed pension and insurance

    funds so uncle Abdullah’s money is real safe. And when I purchase it is so easy to hide you see they don’t have transparency. That means I can buy and

    sell it raising the price each time and know body knows its me. It even gets better you see these purchases are called contracts and I get paid for each

    contract . This is such a great country.. Sometimes I buy and sell a barrel as many as 30 times before Uncle Abdullah’s ever gives one barrel to the oil

    company. My supervisor said there are no rules beyond the ones that we make here in Atlanta. He said they have a watch dog group called the CFTC

    that has some silly rules, that makes it wrong for me to corner the market, but there leader is Mr Lukken said we don’t have to abide them. He said we

    were a foreign exchange and for that reason those rules don’t apply. I don’t think he knows where Atlanta is though. LOL He is great it takes him 3

    months just to generate a report. Maybe he should run for there president. But know matter by then I will have made so much money that I can start up

    my own exchange when I get home. I am going to call it the Dubai Exchange. I miss you and will write you later.


  10. hp said on July 2nd, 2008 at 7:24am #

    Who said the truth was hard?

  11. Bob said on July 2nd, 2008 at 8:39pm #

    After reading the article and posts, it’s obvious to me none of you have even the vaguest idea of how the commodity markets work. Anyone who believes speculators can have any long term affect on prices is just plain nuts. Speculators are gamblers trying to make a fast buck, and it doesn’t matter if the price goes up or down. Some people prefer commodity markets to the horse track . I know all of you believe I’m stupid and that your enlightened, so your insults won’t bother me.

  12. evie said on July 2nd, 2008 at 9:35pm #

    Tell us Bob. I’d like to know.

    The closest I ever personally came to the markets was years ago when a friend in Denver worked in a gas/oil land lease company, or something like that. She said if I gave her $100 she would pick up a “lease” for me so I did. Shortly after that she said I should sell, seems it was only a few days but may have been weeks or months, and she gave me $800 after selling the “lease” I was holding. I’m not sure if I used the correct terminology above, but that’s how my memory serves me. She made a lot of money in the ’80s.

    But the company closed and she was subpoenaed b/c of company dealings, and eventually moved overseas.