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Posted by Monitor on June 12, 2009, 4:02 am
Should Congress investigate why oil is nearing $70 in a recession?
Friday, June 12 2009 - DailyFinance.com
Is it time for the U.S. Congress to systematically investigate the oil
futures market?
Market absolutists cry no, but an oil price pushing $70 per barrel
amid the worst U.S. recession since 1982, the
first global recession since World War II, and 10-year-high inventory
levels argue otherwise.
After hitting a record high of $147.27 per barrel during the leverage-
fed investment and trading frenzy of 2008,
the price of oil collapsed with the onset of the U.S. recession and
then the implosion of the financial crisis, the
latter of which took numerous hedge fund and investment fund oil
futures buyers out of the market. Prices plummeted
to a low around $35 in December 2008.
Historically, $30 is a high price for oil
Further, it's significant to note that although crude's price
collapsed, $35 is still, in historical terms, a
strong price for oil, which has averaged $25-30 per barrel, in current
dollars, over the past 150 years.
Moreover, many experts expected oil's price to recover only slowly in
2009. U.S. gasoline demand declined for much
of the past 12 months, on a weekly basis. Emerging market demand
growth -- a major factor in oil's price rise
during 2003-2007 -- was low, and the world was set to record its
second consecutive decline in global oil demand.
But the incremental rise in oil's price did not occur: instead, the
price of oil skyrocketed in the past six weeks,
essentially doubling in a very short period of time, in macroeconomic
terms.
Oil bulls say the oil futures market, like the stock market, is merely
pricing in likely oil demand conditions six
to nine months out: investors and traders sense a bottoming recession
in the U.S. and better economic conditions
internationally, and its implied rising global oil demand, and are
pushing up oil's price accordingly. Under this
thesis, a $70 (or higher) price is justified given likely, future
economic conditions.
However, oil industry analysts, among others, are increasingly citing
investment funds as the primary reason for
the rise.
"It's the funds that are pushing the market higher," Jonathan
Kornafel, director for Asia at options trader Hudson
Capital Energy in Singapore, told Bloomberg News Friday. "When
everyone reads the same report and comes to the same
conclusion, then you're going to have the market moving in one
direction. The general trend is for the dollar to
get weaker and for crude to get stronger."
Or, in other words, some, if not many institutional investors are
buying oil futures as an alternative asset =96 a
perfectly normal deployment of capital in free markets, and one that's
largely innocuous (except for the speculator
or the hedger) if you're investing in oat futures or cotton, so says
economist Peter Dawson. However, if the asset
is the world's most important commodity - one on which the developed
world's, and now much of the developing
world's - economy hinges, depending on its price =96 the deployment of
capital could become a concern, particularly
if it is concentrated, Dawson told DailyFinance. At least in theory, a
sector-wide concentration of institutional
investors could 'artificially boost' the price of a commodity well
above what supply and demand would typically
dictate =96 in effect grossly distorting its price.
"No conspiracy or collusion need occur. Just concentration," Dawson
said. "Concentration is enough to cause a price
bubble, and the U.S. housing sector is an example of that. There was
no 'conspiracy' to cause U.S. median home
prices to rise to dizzying heights, but rise they did, and a bubble
formed, due to the concentration of players, in
housing's case, a lot of buyers due to the availability of subprime
loans."
Tail wagging the dog?
Dawson said he wants price discovery to continue in markets,
particularly in oil, "but what could be occurring now
is not price discovery, but 'pack mentality.' " The U.S. Congress,
Dawson said, should begin a formal, long-term
study on the relationship between the rise in futures trading and
oil's price, "and systematically research whether
the ten of thousands of new oil futures players have led to higher
prices than they would have been, under similar
supply/demand conditions, with these players absent."
The oil market today - if prices don't moderate in the coming months -
also "is capable of exhibiting
characteristics that border on 'The Twilight Zone,' " Dawson added.
"The problem with the futures activity is that it's pushed prices up
so high that, if a $60-70 price holds, it will
further dampen consumer spending and crimp corporate budgets to the
point that the economic recovery will be hurt,"
Dawson said. "And if that's the case, the futures activity will have
the affect of eliminating the very economic
recovery that prompted the oil futures buying in the first place. And
when you think about it, that type of market
behavior is just absurd and irrational, from an economic development
standpoint."
http://www.dailyfinance.com/2009/06/07/should-congress-investigate-why-oil-=
is-nearing-70-in-a-recessio/
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