I made no prediction about the current oil price in my last Saturday report because the markets seemed to be spinning out of control. Things have calmed down since then—the calm before the storm? Nymex oil sits at $85.37 per barrel, and the price has moved in a narrow range in the mid-80s for most of the last two weeks.
There is no change to the alarm level.
Oil Alarm Level —Yellow
The CFTC is holding hearings to determine new rules for oil trading (e.g. higher margin requirements, position limits). These new rules are already late. We've seen the commission stall as long as humanly possible before it must comply with the Dodd-Frank legislation. No doubt they're hoping they will not need to do anything at all. These hearings are part of the foot-dragging. MarketWatch reported on the testimony.
WASHINGTON (MarketWatch) — Financial activity in the futures market can significantly destabilize oil prices, a Belgium-based academic told the U.S. futures regulator on Friday as part of a debate the agency held as it weighs new rules.
“In 2007 and 2008, destabilizing financial activity caused oil prices to respectively over- and undershoot their fundamental values by significant amounts,” Ine Van Robays, an academic at the Department of Financial Economics at Ghent University in Belgium, told the Commodity Futures Trading Commission at a conference about commodity markets.
However, she added financial activity in the futures market only typically produces a short-term impact.
“This implies that financial trading matters, although its effect on spot oil prices is only short-lived,” Van Robays said.
Her comments were backed up by David Frenk, research director for progressive watchdog group Better Markets. “Financial flows can and do dominate commodity price formation, not all the time, but enough of the time to make a real difference,” he said.
Frenk said that financial speculation is excessive and is causing higher, more volatile prices than would otherwise be the case.
“Given the enormous importance of commodities to the lives and livelihoods of people across the earth, facts should be more important in the debate and purely financial price increases of commodities should be stopped,” he said.
I agree with Van Robays' remarks here, but if financial considerations are always influencing spot prices and the front-month contract, what does short-lived mean? We recently witnessed a significant overshoot due to the Egyptian/Libyan disruption (chart above). If we have a global recession, I expect to to see a significant undershoot like the one we saw in 2009.
One of the least understood aspects of the 2007-2008 oil shock is that both speculation and the fundamentals drove it. At the time I thought the price of oil should have been in the $110-$120 range, but the price got to $147/barrel at one point. Supply-side pessimists chalked up the price spike to fundamentals alone. Those on the other side pointed to speculation as the only cause. It was both.
As expected, academic economist James Hamilton stood up for the fundamentals.
However, University of California economics professor James Hamilton told the CFTC that the big picture driving the price of oil has been stagnating global production of crude in the face of big increases in world incomes and a spike in demand for oil products in emerging markets — not financial speculation.
“Sure it is fine to talk about [financial] speculation, but we should all be able to agree on the big picture that the real story driving the price of oil has been stagnating world supply in the face of a big increase in world incomes,” Hamilton said.
Hamilton downplayed the impact of financial speculation by hedge funds and other traders on oil prices, insisting that market fundamentals are the key factor to consider when thinking broadly about the price of oil.
To back his conclusion, Hamilton pointed out that global production of crude oil, in millions of barrels of oil a day, in the past decade has stagnated, particularly between 2005 and 2009. He also cited International Monetary Fund data that showed global real gross domestic product increased 17.2% between 2005 and 2009, driven largely by growth in emerging economies.
“The big story is that global production of oil has stagnated and it is a very important event that everybody ought to be aware of and think about how this jives with tremendous demand for oil products in the emerging markets and fundamentals,” he added.
And I agree with Hamilton about crude oil production. It is stagnant. The oil supply appears to be in a long, bumpy plateau which could last several more years. Or not.
However, Black Or White thinking continues to dominate the debate about oil prices. Those blaming speculators can ignore "peak oil" concerns. Those blaming the stagnant oil supply can dismiss concerns about speculators. Both financial excesses and the oil supply are big problems we must confront. On and on it goes, this big exercise in futility. In the end, this debate demonstrates once again that humankind can not clearly identify these big problems and act effectively to solve them.
What will the price be in two weeks? Unless something untoward happens in the markets, I think it will be just about where it is now.