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By Robert Rapier on Jul 3, 2008 with no responses

The Speculation Question

I have grappled over the past year with the question of just how much speculation is playing a factor in runaway oil prices. I think it is primarily a supply/demand issue, but I feel that such a large flow of money into commodities is also driving the surge.

Not so, says a new article in Fortune:

Hunting for oil villains

NEW YORK (Fortune) — Atlanta hedge fund manager Michael Masters has been a star witness in two recent Congressional hearings on how speculators are supposedly driving up oil prices. Masters and I don’t see eye-to-eye on this issue, so I was surprised to get a call from him after my “Don’t Blame The Oil Speculators” column went up on Fortune.com last week.

Masters contends that without speculators, the price of oil would be $65 or $70 a barrel. He points out that the amount invested in commodities index products has risen from $13 billion to $260 billion in five years, a fact he thinks is key to understanding oil prices.

It certainly makes sense to me that large flows of money into a sector should impact the price. But the author argues that unless the speculators are taking physical delivery and taking product off of the market, then they won’t impact the price:

My own view is that speculators can’t materially impact prices if all they’re doing is making bets on the direction of oil prices by trading futures and not taking delivery of actual oil – hoarding stuff that would otherwise go to consumers.

Masters did pose an interesting question about how the Hunt brothers attempted to corner the market on silver:

In the end, Masters and I simply agreed to disagree. But there was one thing he said that really piqued my interest. “What do you think would happen,” Masters asked, “if the market went into liquidation-only mode [i.e. if speculators started unloading their futures contracts], like we saw with the Hunt brothers in 1980?”

I won’t give away the ending, but the author reviews the history of the Hunt brothers’ dealings. There was one key difference between their silver dealings and most oil speculators.

So, what do you think? Can speculators have such a huge impact on the price? And if not, what of JD’s suggestion at Peak Oil Debunked that it isn’t a supply/demand issue? Somebody is badly wrong here, or oil wouldn’t have broken through $145/bbl this morning. (I just noticed that JD also took on the article on speculation; will need to read it when I get a chance).