Column Speculation or fundamentals?

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: The time has come to return to fundamentals. There is understandable perplexity as to why the price of crude oil has jumped from around $80/barrel in February this year to close to $140/barrel today. Demand has certainly not shot up and there have been no significant interruptions in supply. Speculation by the paper traders on Wall Street seems to be the explanation and there is evidence to support that view. The volume of oil futures contracted on the NYMEX has increased significantly and the Commodity Futures Trading Commission (CFTC) has estimated that 68% of the NYMEX oil futures contracts are now held by speculators—up from 57% three years ago.

The question, however, to which there is still no unambiguous answer is whether speculators are alone in driving up the price or whether their actions are reinforcing an underlying trend. The CFTC has done an analysis of the factors behind the surge beyond $120/b. Their early conclusions are that the commercial participants (i.e. oil companies, airlines and utilities) are the first to respond to new market information and that the non-commercial participants have only consequently adjusted their futures position. Two other studies have also in some sense suggested that there is no “oil bubble” similar to what we saw in tech stocks and real estate and that speculators are not alone in driving the price of oil beyond its fundamental value. UBS surveyed 1,048 equity analysts and strategists. 56% of the respondents said there was no bubble. A second poll of 324 energy investors saw 67% vote for “no bubble”. The voting pattern does reveal, of course, that a significant number believe otherwise. Consequently, it would be wrong to conclude that speculators are not responsible. But it would be right to perhaps say that there is no conclusive answer and that people simply do not know why prices are so volatile.

It is against this backdrop of opacity and confusion that I am advocating that governments now focus on underlying long-term fundamentals. I believe it is important to do so because the choices that governments make today are what will shape production and consumption patterns in the long term.

There are three underlying long-term fundamentals.