Two Hofstra University economists have thrown down their gauntlets at Paul Krugman, regarding the ever-popular question of how much speculation has contributed to the price of oil. In his column and blog, Krugman has repeatedly noted that for speculation to make a difference in the real, daily, spot-price of oil that buyers pay for physical delivery, someone has to be taking oil off the market and holding it in expectation of future profits.

If the price is above the level at which the demand from end-users is equal to production, there's an excess supply -- and that supply has to be going into inventories. End of story. If oil isn't building up in inventories, there can't be a bubble in the spot price.

And inventory levels, asserts Krugman, have been "normal."

But a new, math-heavy, study of oil prices and speculation by Lonnie K. Stevens and David N. Sessions takes issue with Krugman, stating flat out "there is empirical evidence of hoarding in the crude oil market." (Thanks to Paul Kedrosky's Infectious Greed for the tip, via Naked Capitalism.)

The link is subtle.

We would like to point out that the notion of high futures prices reducing physical supplies through "hoarding" has nothing to do with a "normal" level of inventories, but whether there exists a positive relationship between futures prices and oil stocks/inventories.

The authors found no significant correlation between next month's future's price and current inventories, but the calculus changes the further you go out. Specifically:

Thus, a ten percent increase in the six month futures price is associated with 1.35 percent increase in inventories which is in turn associated with a decrease in oil supplies of 5.16 percent....

These results imply that if the six months futures price were to fall by twenty percent, the real price of crude would decline by more than thirty percent from its present-day levels.

The authors conclude that if Congress wants to restrain speculation, regulators "should keep the shorter-term futures contracts and eliminate the more speculative six months futures contracts."

Better minds than mine can evaluate the math. Maybe Krugman will be encouraged to take another stab, seeing as how he is called out by name by the Hofstra professors. But I was distracted by how blithely the authors dismissed the problem of global supply in their introductory remarks. It seems clear that one of the major factors pushing oil prices higher and higher is the expectation that supply will be constricted in the future. You can call that speculation if you want, or you can call that rational analysis of the available facts.

But the authors wave their hands at this problem in a few sentences, citing news accounts of testimony before Congress by Cambridge Energy Research Associates in 2005.

Moreover, an analysis of global oil production and development demonstrates that the world is not running out of oil in the near-term, and a large increase in the availability of unconventional oils will expand global liquid hydrocarbons capacity by as much as one-fourth in the next ten years.

Another 20 million barrels of oil a day by 2015? That would be truly remarkable, requiring huge expansions of oil sands and oil shale resources, vastly increased production out of Saudi Arabia, and the discovery of replacements for the sharply declining production in Mexico, Russia and the North Sea. And in the unlikely event that such an expansion did come to pass, as testimony two weeks ago by CERA's chairman Daniel Yergin observed, it's not going to be cheap. Not only are the newer, "unconventional" sources of oil inherently more expensive to develop, but the oil industry is facing severe shortages of manpower and equipment. Ramping up current supply by 25 percent in just ten years will cost a pretty penny.

Speculate on that.