How much of what is happening with the price of oil is a result of speculation and how much is generated by the interplay of supply and demand? That is the question of the day for energy geeks -- whether they be economists, regulators, industrial consumers, gas station customers or bloggers. How that question is answered has immense implications -- if speculators shoulder the blame, then there is the possibility that price relief could arrive in the short term, if regulators wield a big enough stick. But if supply and demand are the guilty parties, then the only way that energy consumers can bring down prices is to use less oil.
Two new pieces of the puzzle took more defined shape today. An informative story in the Financial Times sheds light on what happened at the end of last week, when the price of oil jumped a phenomenal $16 in just 36 hours. Short-sellers desperate to cover bad bets on where oil was headed provided the catalyst, reports Javier Blas. Reacting to news that Asian countries were beginning to cut their energy subsidies, traders assumed that prices were set to drop. So they started unloading their "long" oil positions -- their bets that prices would rise -- and piling up "short" positions. By selling high and committing to buy low, they planned to make a killing.
But they bet wrong -- worries about the dollar and tough talk on Iran from Israel pushed the price up, putting the short-sellers in a bind. The longer they let their bets ride, the more they stood to lose, but by giving in and covering the bets, they created even more short-term demand, pushing the price even higher.
The F.T. concludes:
The fact that short-term prices appear to have been influenced so much by speculators -- both on the way down and the way up -- is likely to intensify calls for regulation.
But behind that backdrop of speculative froth, the real numbers on world supply and demand, provided by the International Energy Agency's monthly report, still aren't encouraging, no matter what regulators end up doing.
The bottom line is this: Although demand for oil is declining in the U.S. and Europe, overall global demand is still rising, fueled primarily by China and India. Overall demand growth has slowed, to be sure, but still totals 86.8 million barrels per day. And that's 200,000 barrels a day greater than current supply -- 86.6 million barrels a day, according to the IEA. Perhaps most alarming -- although global supply rose by 490 kb/d in May, the added production came primarily from OPEC. Non-OPEC oil production is down.
The fact that non-OPEC oil production is slumping, with oil prices setting new records nearly every week, is just another datum of proof indicating that no matter how high prices go, you can't squeeze ever more oil out of a peaking oil field. To a certain extent, the world is returning to where it was in the 1970s, when OPEC ruled the market. But back then, high prices encouraged the development of non-OPEC sources of oil and broke the back of the cartel's pricing power.
The decline of those newer non-OPEC oil fields is one reason why U.S. politicians are now begging OPEC to boost production. OPEC is back in the driver's seat. But is the OPEC spigot as potentially free-flowing as it was 30 years ago? That's another question everyone wants to know the answer to. One imagines that it would not be in OPEC's interest to precipitate the kind of global recession that sustained record-breaking oil prices will inevitably deliver. And according to the IEA figures, OPEC has been boosting production.
But whether OPEC is still holding back to keep prices high, or facing the same cold realities of depleting resources that the non-OPEC world is slamming into, the fundamental dynamics of the supply and demand equation are unchanged. A difference of just 200,000 barrels a day between demand and supply doesn't seem like all that much when measured against the total energy consumption of the world, but as long as that disjunction exists, as long as there are more buyers than sellers, there will be long-term support for high prices.
In a way, the short-sellers made the right long-term bet, even if they blew it in the short term. The decision to start cutting subsidies by India and Malaysia and other Asian countries is clear evidence that high prices will work their way through the system. Demand will fall.
Which brings us to the last question everyone wants an answer to. When will the bubble pop? If we concede that speculation has been driving prices up, but we are also convinced that high prices will ultimately squelch demand and finally bring an end to this energy rally, then we must conclude that there will be at least a short-term pop, followed by a dramatic drop in prices, before the long-term cycle of economic growth and energy demand and declining resources resumes its narrative.
But if that bubble pops in the run-up to the U.S. presidential election, and gas prices suddenly start to decline just as voters begin paying real attention to the campaign, we will be venturing into the most fertile territory for unrestrained conspiracy theory since the grassy knoll.