As oil prices soared to a record high in 2008, traders, politicians and regulators were stunned as oil made a move of historical portions. Some said we hit peak oil! Others said it was an oil company conspiracy! And others said it was a sign of pure market manipulation by speculators!
We heard from Michael Masters of Masters Capital Management who testified before a Senate committee saying that, “What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets: Institutional Investors. Specifically, these are Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors. Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant. In the popular press the explanation given most often for rising oil prices is the increased demand for oil from China. According to the DOE, annual Chinese demand for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion barrels; an increase of 920 million barrels. Over the same five-year period, Index Speculators demand for petroleum futures had increased by 848 million barrels. The increase in demand from Index Speculators is almost equal to the increase in demand from China!" Masters claimed that price of oil would quickly drop closer to its marginal cost of around $65 to $75 a barrel, about half the current $135 if Congress passed a law to limit speculation.
We heard from others like Fadel Gheit of Oppenheimer & Co., Edward Krapels of Energy Security Analysis and Roger Diwan of PFC Energy Consultants who said that as long as Congress would waive their magic wand and enact legislation to limit evil speculation that gasoline prices would be cut in half to about $2.00 a gallon.
Of course it is clear in retrospect that those gentlemen were totally wrong. Not one of them happened to mention that those evil speculators disguised as Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors were not driving the price of oil but were being driven to the oil market and other commodities that made similar moves without as much as a mention from these “anti-speculative heroes” because of what was happening as the global economy stated to come apart.
Speculators were not driving the price of oil but were being driven to the commodity markets as they feared that the US banking system was failing. There was a flight out of dollar based assets as the US sub-prime crisis was putting the value of their bond and dollar holdings at risk. The US was dramatically lowering rates and Europe was raising rates and the price of commodities had no choice but to rise.
Why did these “anti-speculative heroes” mention this or the value of the dollar? Did they miss what turned out to be the greatest economic crisis in modern times? Can’t they see that Fed actions and ECB actions made commodities more valuable by tanking the value of the dollar? Could they not sense the fear in the marketplace? Could they not see that other commodities were soaring as well!