News / Economy

Oil Price Rise Fueled by Investment Funds

Prices posted at a US gasoline station, April 20, 2011
Prices posted at a US gasoline station, April 20, 2011
Greg Flakus

As the price of crude oil rises on world markets, complaints from consumers, industries and politicians are also on the rise. Some blame the Organization of Petroleum Export Countries, the cartel known as OPEC, while others blame unrest in the Middle East and North Africa and still others blame market speculators.

U.S. Attorney General Eric Holder has formed a Financial Fraud Enforcement Task Force Working Group to look into possible fraud in energy markets, but the price may be driven more by investment trends.

Energy analysts see some of the usual factors driving oil prices this year, including increased demand in rapidly developing nations like India and China, restrictions on drilling in some areas like the eastern coast of the United States and unrest in oil-producing countries like Libya.  But petroleum has also become a favored asset for investors looking for future profits and their dollars sometimes distort the market.

Most investment money these days, from individual investors as well as from institutions, charitable groups and even governments, is now in various types of managed funds. Tom Kloza of the Oil Price Information Service says the managers of those funds can have a big impact on commodity prices, including the price of oil.

"Probably no one is breaking any rules, but a couple of key strokes by a money manager can move millions and billions of dollars into a market, and affect the price of something which is a life blood for consumers and people on the margins of society all over the world," said Kloza.

He says governments can't eliminate all speculation from the market, but that some kind of regulation is needed, especially outside the United States.

"I think unfettered is unforgivable and oil futures markets, particularly offshore, are largely unfettered," he said.

Speaking at a meeting in Kuwait this week, OPEC Secretary General Abdalla El-Badri said world oil prices are now being driven more by speculation than supply and demand.  Kloza and other analysts do not believe speculation plays a large role in the price rise, but they are not putting all the blame on OPEC either.

Saudi Arabia, the OPEC member nation with the world's largest reserves, has cut back on some of its production, thereby limiting supply and driving up prices, according to OPEC critics. But Tom Kloza believes OPEC leaders themselves are concerned about high prices.

"I think that many of the moderates, the doves within OPEC, are very uncomfortable with where prices are heading, because if we keep heading at this pace, we will open the door for some alternative technologies that would otherwise need subsidies or some sort of government give outs," said Kloza.

Some non-OPEC countries, particularly China, may be playing a big role in driving up oil prices and not just through their demand, according to Peter Zeihan, Vice President of Analysis at the global intelligence company Stratfor in Austin, Texas. He agrees with Kloza that investment in oil is the key factor, but he says the increase in money available to invest is also important.

"Back in the year 2000 the investing community as a whole made up about 10 percent of long positions in the oil market and now they are up to 40 percent," said Zeihan. "So you add that many new players and that much new money, but you do not add any more than a 10 percent increase in oil supply and, of course, you are going to have higher prices."

While that investment money comes from all over the world, Zeihan says one of the most significant contributors has been China, which takes in dollars from the United States and other nations that import its products. He says China has put much of that money into oil futures.

But the Stratfor analyst says the fundamental laws of supply and demand always win out eventually and then, as happened in 1998, 2001, and, most recently and dramatically in 2008, the price drops.

"Sooner or later the fundamentals are going to overpower the investor fervor," he said. "It happens every few years. Eventually the fundamentals will overpower any exuberance on the market and you will have a sudden, rapid sustained price drop over the course of a few weeks."

Zeihan is not predicting when that will happen. In the meantime, he sees signs that higher prices are encouraging more conservation and driving sales of fuel-efficient cars, but he does not see the development of an alternative to oil any time soon.

"In the United States we have proven that high prices were certainly exactly what was necessary to make hybrids very popular, but in terms of any other energy source, there is really nothing on the horizon," he said.

Zeihan says there is no other transportation fuel as dense in energy, as flexible and as easy to transport and use as petroleum.  Natural gas from shale  may help alleviate some of the U.S. demand, he says, but that will require a big investment in infrastructure.  He says electric cars, recharged from power supplied by expanded nuclear plants, looked promising until the recent nuclear accident in Japan. For the foreseeable future, Zeihan says, the world depends on oil and consumers will have to put up with the frequent price fluctuations.

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