Speculators are driving up oil prices

It seems obvious that speculators are driving up prices of commodities, particularly oil. However, Paul Krugman doesn’t think so. I still don’t understand the weird chart he drew, nor do I understand any of his argument. Take a look at the chart I drew from data gathered by the Dept. of Energy. From 2000 to today, world oil consumption and production has gone up 19%, whereas prices have gone up about 450%. A big chunk of that price rise is due to the dollar falling hard in the last few years, like 40% against the Euro. Dollar goes down, prices on imports go up. The reason speculators are in the market is because there’s about $70 trillion of global savings looking for something to buy. They tried to put it into global housing markets, but they created a huge bubble that has now burst. Now some of that money has drifted into commodities. If traders bid wildly against each other for oil future contracts, it drives the price up just as it did in the Internet bubble. Ultimately the traders have to sell their oil contracts to real oil consumers like gas refineries. The refineries buy the oil at any price, turn it into fuel and pass the cost down to consumers who pay $4/gallon of gas. The big problem is that demand does not go down in the face of far higher prices, and there’s no substitute for oil. So how high can prices go? It will continue to climb until demand goes down. Once demand edges downward, speculators will dump their contracts and the price of oil will collapse to something more reasonable. If this is such easy money for traders, why didn’t they jump in before? Don’t know, but a friend at an investment bank says hedge funds and banks didn’t start trading heavily until about 2003, which is where the chart below really soars. Speculators and a falling dollar are the main reason oil prices are going up. [ed: Barron’s cover story agrees with me.]



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