Did speculators fuel the oil run-up?

Marketplace Staff May 28, 2008
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Did speculators fuel the oil run-up?

Marketplace Staff May 28, 2008
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Kai Ryssdal: Whether oil prices are going to go up or down is one of those random things we can’t really know until it happens. Anybody who tells you otherwise is probably trying to sell you something.

But even after you factor out supply, demand and the dollar, there’s a lot of speculation out there that speculation might be driving the run-up in crude.

Commentator David Frum says that might not be far from the truth.


David Frum: Maybe it takes a speculator to recognize a speculative bubble?

Over the weekend, George Soros gave an interview to the Daily Telegraph in which he described today’s oil prices as a bubble ready to pop. Most analysts pooh-pooh the role of speculation in today’s oil market, but some new evidence suggests that Soros may well be right.

My American Enterprise Institute colleague Desmond Lachman observes that institutional investors own and hold more than a quarter trillion dollars worth of oil today, up from virtually zero half a dozen years ago. If these positions were ever unwound they could exert an abrupt downward jolt to the price of oil.

Here’s how it could happen: Imagine that you’re a speculator. You own a bunch of oil you bought at prices ranging from $75 to $125 a barrel. You are hoping that the price will go to $200. But nothing lasts forever; already Americans are driving less and switching to more efficient cars. A recession in the United States would slash Chinese export earnings and slow the growth of the Chinese automobile market. As the U.S. and Chinese economy weakens and oil consumption dips, the price of oil begins to soften. It dips back below $125, then $120, then $115. As a speculator, you’ve lost money on your last purchases, yet you could still score a huge profit on the earlier ones if you act fast. But uh oh: your competitors have the same idea. You all rush for the exits at once and after a year of frenzy on the buy side, it’s pandemonium on the sell side.

It’s happened before. Between December 1985 and July 1986, the price of OPEC oil plunged by more than half, from $23.29 to under $10. They still remember the shock in Texas. I wonder if they remember it at the trading desks in London, New York, and Hong Kong?


Ryssdal: David Frum is a resident fellow at the American Enterprise Institute. His latest book is called “Comeback: Conservatism That Can Win Again.”

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