Investors Driving the Price of Oil

Investors continue to drive the market for oil, pushing prices above US$86 a barrel Monday -- and this despite the opinion of no less an expert than King Abdullah of Saudi Arabia, who has said a couple of times over the past two years that US$75 to US$80 a barrel would do just fine, thank you.

As long as investors' enthusiasm for oil lasts, we live in a surreal world in which the fundamentals of supply and demand seem to have lost their traction. _FP

Peak oil doomers want to believe that shrinking oil supplies are squeezing world oil prizes higher. All of this is supposed to be the lead up to a gigantic economic crash costing hundreds of millions of lives around the world. But the reality is more mundane.

Supply seems ample, as well. Oil inventories in the United States are at above-average levels, and the futures market is quite happy to guarantee you delivery of oil in 2014 for only about three dollars more than it would cost you to buy a barrel today.

But neither slow-growing demand nor the market's expectation of ample supply for years down the road has been capable of shaking investors' enthusiasm for oil as an asset class.

"This raises a key question," says Bassam Fattouh of Oxford University in a recent paper on oil pricing. "If market participants attach little weight to current market fundamentals and if future market fundamentals are highly uncertain, at which price or price range should the oil market clear?"

His answer is that oil prices have become "indeterminate" -- a professor's way of throwing up his hands and saying you can no longer predict what's going to happen next. Oil's price depends upon a guessing game among major market players in which everybody is trying to guess what prices other players are guessing. If that is correct, oil investors can expect some neck-wrenching swoops in the years ahead as bulls and bears take turns in the pilot's seat._FP

World oil production is approaching the July 2008 peak -- at a much lower price per barrel -- despite all claims that oil production peaked in 2005. And most of the recent increase has come from non-OPEC sources, against all predictions by peak oil gurus.

When prices of a commodity are driven up by big investor speculation, it is called a price bubble. The oil price bubble that culminated in the collapse of 2008 was accompanied by bubbles in prices of other commodities and real estate, along with multiple financial instruments. The current oil price bubble would like to get other economic entities onboard in order to appear more convincing.

But when will demand destruction begin to kick in? And how much demand destruction can the hugely endebted economies of Europe, Japan, the US, and other advanced nations take before they sink back into another full-blown recession?

Demand destruction occurs because of the price of energy, not because of any shortage of supply. If the supply is ample but prices have been driven up by large investors looking for a safe haven, the demand destruction is the same.

Meanwhile, every policy of the Obama - Pelosi regime appears directed toward reducing domestic US energy production. Hang on, it could be a wild ride.