The reasons for oil's climb above $100 a barrel are well-known, including rising demand from fast-growing Asian economies, along with the risks of continuing geopolitical turmoil in North Africa and the Mideast. But as my colleague Charles Wallace recently reported, a significant premium in the price of oil stems from speculation, which has recently skyrocketed as traders and fund managers seek out commodity and global growth plays.

With oil swinging from around $50 per barrel in 2007 to $145 a barrel in 2008 and then plummeting to $32 a barrel in 2009, this huge increase in speculative trading has led to tremendous volatility.

And that leads to this question: could oil slump sharply, despite all the reasons typically given for higher prices, mostly as a function of the speculative trade?

Speculation Does Not Equal Endless Bull Markets

The recent explosion in oil speculation can be seen in the following two charts. The first depicts volume -- the total number of futures contracts traded -- and the second charts open interest, the number of contracts outstanding. This data is from the U.S. Commodity Futures Trading Commission (CFTC), which regulates the futures markets for commonly traded commodities.

The chart below, showing oil price history, illustrates how massive increases in speculation do not guarantee endless bull markets: highly leveraged speculative trades can quickly reverse course when sentiment changes. Rising volume and speculative interest increase volatility, as extremes of sentiment are reflected in large positions being taken on the long (bullish) or short (bearish) side.

Notice both volume and open interest rose sharply from 2006. Since then, oil rose in a bubble-like spike to $145 per barrel, and then subsequently crashed back to $32 per barrel a few scant months later as the global recession took hold. It has since tripled to over $100 barrel.

The next chart might give the oil bulls pause: the Commitment of Traders (COT) commercial traders' long and short positions in oil. Many investors and analysts look at COT for three basic categories of traders: small speculators, the large speculators -- such as hedge funds -- and commercial traders (typically global corporations that hedge against big swings in commodity prices), and large financial institutions' trading desks.

A short position by a large firm, in other words, might act as "portfolio insurance" or a hedge against volatility. Thus a firm that owned long contracts for oil might buy a short position to protect against losses should oil fall.

Note how the short interest of the commercial traders rose above long positions in the buildup to oil, peaking in 2008. As the price of oil marched ever higher, commercial traders sought out more protection in the form of short positions.

But higher short positions might also reflect trading bets that the high price won't last, and that a reversal is imminent.

Recently, long positions have declined while short positions have jumped. The spread between the two has widened to the largest gap in the past decade. Clearly, major players are betting (or hedging) that oil could drop precipitously.

Fearful of a Decline, or Betting on It

A recent report from Goldman Sachs concluded there is about $10 per barrel of speculative premium priced into oil. That suggests if the speculation declined, oil might fall at best $10 a barrel. From this point of view, oil is still priced mostly by fundamental supply-and-demand issues, and speculation adds no more that about 10% to the cost at today's price of $104 per barrel.

Given an expected rise in demand for oil -- especially as Japan replaces the electricity generation capacity it recently lost, as a result of the earthquake and tsunami that damaged the Fukushima nuclear reactors --Goldman Sachs estimates there is no more than $10 a barrel downside in the price of oil.

Perhaps, but estimating the consequences of increased speculation is not a precise science. Given the above chart, it seems evident that some of the biggest players aren't taking any chances. The unprecedented spread between long and short positions suggests somebody is either fearful of a major decline in the price of oil -- or is actively betting on it.

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Bank of America violated the 21st Century Act: Final Amendments to Regulation CC Section:

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May 29 2011 at 12:23 AM Report abuse rate up rate down Reply

The ultra-rich backers of Obama and thugs have huge stockpiles of precious metals and very few actual dollars. What does that tell you folks?

April 12 2011 at 5:47 AM Report abuse +1 rate up rate down Reply

KEEP DREAMING !!!!!!!!!!!!!!

March 31 2011 at 4:50 PM Report abuse rate up rate down Reply

Breaking news from Nightly Business Report: ADP (payroll processing) just announced 201,000 jobs added to the private sector. That makes an average of 211,000 jobs per month for the last four months. LLC reports, “It’s pretty clear employment has in fact accelerated.” And tarp loans are in the black with $6 billion profit; 99% of loans paid back. Manufacturing and exports up for 19 months and unemployment declining.
Thank you President Obama!

March 31 2011 at 4:36 PM Report abuse +1 rate up rate down Reply
1 reply to inasctg56's comment

Keep drinking the kool-aid. Idiots.

April 12 2011 at 5:44 AM Report abuse +1 rate up rate down Reply

Could Oil Prices Be Headed for a Dip?

This should read "Could speculators be hung from trees!"....Could Goldman fail?!...Could nobama give a damn?!....

March 31 2011 at 3:44 PM Report abuse +3 rate up rate down Reply

**** OBAMA === 2012 *********** >>>>> A SURE THING <<<<<

March 31 2011 at 1:21 PM Report abuse -2 rate up rate down Reply

While price is a function of supply and demand, the market can be manipulated for short term gain. Buy oil at $100 a barrel, for peenies on the dollar, start a rumor or just watch the news for 15 minutes, then sell at the higher price. Let's say $105.00 a barrel. Eventually the rumors may not come true so you have a slide to real value.
Stockpiles are rising and people are already cutting back so they may rise more.
There is a great deal of emotion here.

March 31 2011 at 9:49 AM Report abuse +1 rate up rate down Reply

When the media refers to speculation most people have no idea what they are talking about. Simply put its still supply and demand. When investors compete
for inventories it drives up prices its that easy.
Its not a result of greed or some evil plan to bleed consumers.
Its like anything else in this world when more than one person wants something
the price goes up. No matter how you paint it there will always be a middle man and if they are domistic or not they will always be in play.
If government where to put restrictions on oil futures all it would do is keep americans from making the money and give control of markets to foreign

March 31 2011 at 8:02 AM Report abuse rate up rate down Reply

PS... Its important to note that all shortages and price fluctuations are artifacts of a manipulated "system"... There is no real shortage, Its all down to panic and greed in the markets... We need to end dependence on one source of energy unless they will regulate the oil market (and they wont).

March 31 2011 at 6:42 AM Report abuse +3 rate up rate down Reply

Well I read the oil reports daily, I like how one day its up and then the next we are lower.

Here is what we need - We need to send a notice to the so called people in congress - You all are fired, you was put into the spot for the people of the US.

Some have been there for over 40 years time to go. They have there hands in so many pockets, getting hand out to no vote on so call bills. Could they live like most of us do, nope, could they just take of on a vaction and not worry about the bills once they got back nope, why (we) pay there bills and wages.

Some of theses old timers need to go this is not the 50 or 60, times change. There sould be a limit on how long a term can be held, 2 terms is enough. We will never get ahead if the so called senior congress is kept there.

So people time for a change - Send a message - U are fired - that would be a change.

Oil would drop we really need to think - time for a change starts in congress.
What do you think ?

March 31 2011 at 6:39 AM Report abuse +1 rate up rate down Reply