Robert Bryce is one of the leading journalists on energy issues. He is Managing Editor of Energy Tribune, and in a recent article gave a mea culpa on oil speculators:
Back in June, I wrote a piece for The American in which I argued that oil prices were being driven higher by the immutable law of supply and demand. Today, with prices plunging to near $40 instead of the $145 level seen in mid-July, it’s abundantly obvious that speculators were a key driver, probably the main driver, of the surge in oil prices that occurred between late 2007 and July.
So, to be clear, I was wrong. The leaders of OPEC were right. So, too, was my pal, Ed Wallace. In May, Wallace, a savvy journalist from Fort Worth who writes for the Fort Worth Star-Telegram and Business Week, published several articles [in] which he showed how the unregulated futures market was being used by speculators to push prices upward.
Of course, it’s not politically correct to give OPEC credit for anything. But last summer, the leaders of OPEC were united in their pronouncements that there was no reason for oil prices to be as high as they were. Their claims were met with widespread scoffing. The response from the International Energy Agency, as well as some of the biggest oil companies in the world…was that the high prices were being caused by supply and demand. On June 30, during the World Petroleum Congress in Madrid, BP chief Tony Hayward, when asked why oil prices were shooting upward, replied, “It’s about fundamentals. Demand is outstripping new supply.” …
Oil prices have fallen to less than one-third the levels seen in July and the world has shifted away from worries about peak oil and shortages to concerns about oil surpluses that could last for years. That makes what I wrote back in June — “the easiest explanation for higher prices may be as simple as this: there are too many buyers in a market that has insufficient spare production capacity” – look, rather, well, dumb.
Now, as refreshing as it is to see a prominent commentator on politically charged matters admit to being wrong, I think Bryce has jumped the gun here. The mere fact that oil prices have collapsed in just a few months doesn’t prove that speculators were responsible for driving up the price. But before we proceed, we need to define our terms.
In the broadest sense, any price is caused by “supply and demand.” The prices for Las Vegas real estate in 2006, as well as for Dutch tulip bulbs in 1637, balanced the quantity demanded with the quantity supplied. Even at the height of a speculative bubble, sellers can only receive what buyers are willing to pay.
In the present context, however, it is common for people to contrast “the fundamentals” from mere “speculative demand.” In the case of oil, if demand has increased because factories need to run their machines harder or because refiners expect motorists to buy more gasoline, then that is deemed a legitimate, fundamental driver of higher oil prices. On the other hand, if hedge fund managers invest in oil futures contracts not because they forecast higher fundamental demand, but rather because they are simply betting that the market value of the contracts will appreciate, allowing the hedge fund to unload the contract before physical delivery, then that is considered pure speculation.
Market bubbles—in which speculators drive up the price in a self-fulfilling prophecy—are theoretically possible. Indeed, many analysts think that is (at least partially) what happened with dot-com stocks in the late 1990s and real estate during the mid-2000s. Of course, once the bubble pops, it quickly deflates, since it was only fueled by everyone’s belief in its continued growth. This is why Robert Bryce thinks the oil market was clearly in a bubble up until July 2008.
But there’s more to the story. Even though bubbles are certainly possible, they exhibit tell-tale signs. For one thing, if speculative activity in futures markets really were holding the spot price of oil $50 or more higher than the “true” market price, then there should have been a glut on the physical spot market. In other words, if the market price now equals the “correct” price of $40, whereas for much of 2008 it was above $100, then producers should have been delivering more barrels of oil to market, than ultimate end users wanted to purchase at such a steep price. Oil inventories should have been accumulating somewhere because of this (alleged) discrepancy that lasted for years.
Yet there is no evidence of growing inventories, at least in the official numbers tabulated by the EIA, as the chart below shows. Other theories, such as the claim that oil producers “stockpiled” barrels in the ground, don’t work either, since oil production increased precisely during the period when prices rose the fastest.
Those who claimed during the oil price run-up that speculation wasn’t responsible were relying on arguments such as the ones I sketched above; they weren’t merely saying “supply and demand” to excuse big profits for Big Oil.
Now it’s true, we still have to reckon with the collapse in prices. Bryce is ready to throw in the towel and admit it must have been speculators all along. But the fundamentals have changed sharply since July 2008. On the demand side, the world has entered a severe recession, which has curtailed physical demand for oil, especially in powerhouses like China. On the supply side, the U.S. moratorium on offshore drilling expired—and note that the two major events corresponded neatly with falls in crude prices. On top of it all, investors have rushed to the U.S. dollar as a safe haven, which has also contributed to a sharp fall in the quoted price of oil.
It is an empirical question whether speculative trading, versus changes in “fundamentals,” was responsible for the rise and collapse of oil prices. The collapse per se is not a smoking gun.