Canadian Plastics

Speculation driving high oil price

By Michael LeGault, editor   



Imagine you made a product so desirable that you were guaranteed to sell as much as you could make. Moreover, it is the nature of this product that, not only will you always be able to sell everything...

Imagine you made a product so desirable that you were guaranteed to sell as much as you could make. Moreover, it is the nature of this product that, not only will you always be able to sell everything you make, your price will be more or less independent of production capacity or inventory. In this special world, with its own rules, price is dictated not by your ability to supply the needs of the market, but by the threat that your ability to supply it will be debilitated at an undetermined point in the future.

No you haven’t entered the economic equivalent of the twilight zone, but rather the strange, shadowy reality of the oil market. While the price of oil is still tracking below the all-time high set in 1980, the equivalent of US$80 today, oil has been in the high $50 range for most of the spring. According to one Wall Street forecast, oil in this new “super spike” style market may soon reach a $100 a barrel.

High demand arising from economic growth in places such as China and India is the common explanation for rising oil prices. On the surface, this seems to make sense. Oil demand, currently about 83 million barrels a day, is expected to rise to 90 million b/d by 2010, and 103 million b/d by 2020, according to modeling done by OPEC.

Such numbers have revived the dire predictions of oil shortages, or worse, in the near future. You may vaguely remember some of these. In 1979, the International Energy Agency warned that the world’s 645 billion barrels of known oil reserves would be largely depleted by 1985. Yet, by 1990 only 320 billion barrels of that oil had actually been drawn down, and known global oil reserves had grown to 1 trillion barrels. Today, although no one really knows how much oil is below the surface, best guesses are that, at current rates of consumption, at least 650 years of oil remains for the use of future generations. Moreover, as the price of oil rises, it becomes economical to exploit other energy resources. Liquefied coal, heavy oil and tar sands could provide 3.5 trillion additional barrels of oil. Oil shale could provide another 2 trillion barrels.

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Oil supply is not presently limited by dwindling oil stocks but by the ability (and willingness) to pump. The OPEC cartel, for example, wants us to have enough oil, but not too much. And by all signs there is enough supply on the market. The strategic oil reserve maintained by the United States has grown for four straight months.

The run up in the price of oil is, in large part, a result of “long” contracts on crude oil futures. Owning these contracts is a bet that oil will rise. This speculative pressure can actually be measured. Data from the commodity Futures Trading Commission shows how many futures contracts for the purchase of oil are held by noncommercial investors, including hedge funds. The data shows the numbers of these long contracts have been rising steadily throughout the year. Money is also being pumped into the futures commodity markets by long-term investors, such as pension funds. For instance, money flowing into The Glodman Sachs Commodity Index since 2002 has more than doubled, to $25 billion.

As you are undoubtedly aware, the high price of oil is spinning into higher costs for resin and energy, and, at last, seems to be adversely affecting consumer spending. A person can absorb higher gas prices for a time, but when everything costs more, something has to give.

Conservation will help, but that’s another topic for another time. In the meantime, the question is, will oil come down? I predict $35 or less a barrel by this time next year. If not, it’s not because there’s not enough oil.

Michael LeGault, editor

e-mail: mlegault@canplastics.com

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