A year ago oil peaked at $147 a barrel, when most oil trading volume came from speculators. Certainly then, as now, the economics 101 explanation for oil prices -- that prices should rise if demand exceeds supply -- made no sense. And now, with oil having nearly doubled since the beginning of 2009 from $33 a barrel to $62, supply and demand offers no explanation for the rise in oil prices.
How so? Daily U.S. supply in 2009 is expected to exceed demand by 0.92 million barrels per day. There are oil tankers full of oil moored in the Gulf of Mexico as the global recession that has removed 6.5 million jobs from the U.S. economy drags on. U.S. demand is forecast to be down 0.65 million barrels per day (mm-bpd) in 2009 to 18.85 mm-bpd while U.S. supply is expected to end 2009 up 0.28 mm-bpd to 8.78 mm-bpd. So based on lower demand and higher supply, it would make sense to see a drop in oil prices.
So why has oil been rising? People who borrow money to trade -- like hedge funds and investment banks -- are shorting the dollar and going long oil. This is a nice trade because it creates a doubly strong force to push up the price.
That's because oil is traded in dollars so shorting the dollar helps weaken it -- along with the enormous boost in U.S. borrowing -- and a weaker dollar means that it takes more dollars to buy a barrel of oil. This weakens the economy, causing the U.S. to borrow more money to stimulate the economy. Traders profit from the weaker dollar and the rising oil price.
It turns out that these speculators account for the vast majority of the oil trading volume. In May 2008, as oil was rising to its July 2008 high of $147 a barrel, I found a source suggesting that 60 percent of oil trading was from speculators. That figure was too low. In August 2008, the Commodities Futures Trading Commission (CFTC) found that speculators accounted for 81 percent of trading volume.
There is a political problem with reining in the oil speculators. In the last decade they've contributed $5 billion to the Washington money game. Average Americans -- who suffer from higher gasoline prices and pay more for everything linked to the price of oil -- have no such lobby to look out for their interests.
And since the Treasury has already created a government program to further enrich those speculators -- the $1 trillion Public Private Investment Partnerships (PPIP) -- it is hard to imagine that the U.S. will turn around and cut off oil speculation -- which would hurt the very speculators PPIP is designed to enrich. As I posted, PPIP will lend taxpayer money so that hedge funds and investment banks can buy bank toxic waste -- giving the profits to the speculators and the losses to the taxpayers.
So it is far more likely that there will be hearings about speculators trading oil and then nothing will happen to change that easy money. But it's too early to tell what will happen.
The outcome of this political struggle will help us see whether the U.S. is the best political system that Wall Street can buy or whether it represents its 306 million citizens.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing.