Should we blame energy traders for high oil prices?

An Indian official telling a New York Times reporter he’d like to see the trade in crude oil banned from the New York Mercantile Exchange is kind of extreme, but not surprising given the context. One of the unique features of this period of high oil prices is that oil derivatives (basically contracts such as ...

598261_071108_oil_05.jpg
598261_071108_oil_05.jpg

An Indian official telling a New York Times reporter he'd like to see the trade in crude oil banned from the New York Mercantile Exchange is kind of extreme, but not surprising given the context.

One of the unique features of this period of high oil prices is that oil derivatives (basically contracts such as futures and options) are now being traded on a massive scale. Like never before, paper oil is changing hands, to the point where crude oil has become an asset class. You've got to have it in your portfolio the way you have to own gold, stocks, and bonds. Back in the 1970s, there was no IntercontinentalExchange (ICE) where oil was traded globally. Nor were there as many different ways for investors, such as exchange-traded funds, to play crude. Around 85 million barrels were actually consumed in the world Wednesday. But on the same day, over 600 million barrels worth of crude futures were traded via ICE (adding up the contracts for two kinds of crude traded, West Texas Intermediate and Brent).

With so many factors affecting prices—not least the fact that oil is a commodity denominated in the declining dollar—there's a big debate among energy analysts about whether and to what extent all this trading is responsible for the high prices we've been seeing. Many people in developing country behemoths such as China and India certainly think it is. On a recent visit to China, I met with several energy analysts and policymakers who perceived the massive trading volumes as distorting prices upward. Same in India. They look at the supply and demand fundamentals and don't believe that they justify nearly $100 per barrel.

An Indian official telling a New York Times reporter he’d like to see the trade in crude oil banned from the New York Mercantile Exchange is kind of extreme, but not surprising given the context.

One of the unique features of this period of high oil prices is that oil derivatives (basically contracts such as futures and options) are now being traded on a massive scale. Like never before, paper oil is changing hands, to the point where crude oil has become an asset class. You’ve got to have it in your portfolio the way you have to own gold, stocks, and bonds. Back in the 1970s, there was no IntercontinentalExchange (ICE) where oil was traded globally. Nor were there as many different ways for investors, such as exchange-traded funds, to play crude. Around 85 million barrels were actually consumed in the world Wednesday. But on the same day, over 600 million barrels worth of crude futures were traded via ICE (adding up the contracts for two kinds of crude traded, West Texas Intermediate and Brent).

With so many factors affecting prices—not least the fact that oil is a commodity denominated in the declining dollar—there’s a big debate among energy analysts about whether and to what extent all this trading is responsible for the high prices we’ve been seeing. Many people in developing country behemoths such as China and India certainly think it is. On a recent visit to China, I met with several energy analysts and policymakers who perceived the massive trading volumes as distorting prices upward. Same in India. They look at the supply and demand fundamentals and don’t believe that they justify nearly $100 per barrel.

Most market analysts would probably concede that at least some of the upward pressure is due to derivatives trading. What really captured this were comments Wednesday by Addison Armstrong, a leading energy-market watcher. He said that although he thinks oil should be around $60 on the supply-demand fundamentals, he thinks it’s going to $109 before it cools off. Why $109? Because it’s a “technical level” (derived from market data) that would signals traders to sell. It’ll be interesting to see if he’s right.

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