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Researchers doubt oil speculator impact Article in The Energy Journal looks at relationship between commodity trading, steep rise in crude prices from 2003 to 2008 Wesley Loy For Petroleum News
Were financial speculators responsible for sending the price of crude oil soaring in recent years?
Most likely, no.
That’s the thrust of an article in The Energy Journal (Vol. 34, No. 3), a quarterly publication of the International Association for Energy Economics.
The authors, Ron Alquist and Olivier Gervais, are with the Bank of Canada.
“Overall, the available evidence points to global demand and supply conditions rather than financial speculation as the explanation for the surge in the price of oil between 2003 and 2008,” the journal article concludes.
Asian demand The authors write that “macroeconomic models of the global market for crude oil show that the bulk of the increase in the price of oil during the past ten years is related to the cumulative effect of a sequence of shocks to global real activity. These increases in demand are related to increased demand for crude oil emanating from emerging Asia, especially China and India.”
The article begins by noting investors in recent years have come to view commodities, including crude oil, as a new asset class.
“Since 2003 many investors have chosen to diversify their portfolios by buying commodity index funds and similar financial instruments,” the authors write. “This portfolio shift has led to large financial flows into the oil futures market as well as other commodity futures markets.”
At the same time, the price of oil reached unprecedented heights, increasing from $32 per barrel at the end of 2003 to $147 in July 2008, the article says.
“To many observers, the conjunction of these two trends suggests a causal connection between financial speculation and the increase in the price of oil,” the authors say.
‘A modest role at best’ The authors define speculation as “the holding of a net position, either long or short, by a firm that is not a commercial user of oil in the expectation of a positive return.”
“By contrast, we define ‘hedging’ as a firm’s transaction in a commodity futures market for reasons related to that firm’s use of the physical commodity in its operations, including the processing, merchandising and marketing of the commodity,” they write.
The volume of oil futures contracts have increased over the past 10 years, the article says.
“Between January 2003 and June 2008, open interest in West Texas Intermediate futures contracts more than doubled, rising from about 600,000 contracts to about 1.3 million,” the authors note.
Oil prices also increased from 2003 onward.
However, there is “no statistical evidence” that changes in investor positions preceded oil price increases during the period when speculation was thought to be an important driver of the price changes, the article says.
The researchers examine oil inventory as part of their study.
“Another way to store oil is to leave it in the ground, so it is also important to consider the possibility that financial speculation altered the incentive to supply oil,” they write.
A graph shows global oil production remained flat between 2004 and 2008.
“This could be interpreted as evidence that suppliers either withheld oil from the physical market or postponed new projects in anticipation of higher oil prices, but several arguments cast doubt on these claims,” the researchers say. “First, the constraints on oil supply were not necessarily related to changes in the price of oil during that period. They are the legacy of the decline in oil investment from the mid-1980s until the late 1990s, a period during which the price of oil was relatively low. As the price of oil increased from 2003 onward, there were renewed efforts to bring new oil wells on line. The pace of drilling for new oil wells accelerated in response to the increase in the price of oil in 2007-08, and it did not abate until after the price reached its peak in July 2008. Typically, there are lags of ten years or more between the initial discovery of oil and when the oil field is ready to produce.”
Another factor behind production constraints was that oil fields in several important areas, such as Russia, reached maturity, the article says.
“As the price of oil increased between 2003 and 2008, it became increasingly common in the press and among policymakers to attribute the appreciation to financial speculation, especially given the contemporaneous financialization of commodity markets,” the authors write. However, they argue financial speculation “seems to have played a modest role at best.”
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