The IMF sees no downturn in the price of oil or commodities more generally. (image: abclive.in)

The International Monetary Fund (IMF) released its latest World Economic Outlook on Wednesday, reported Bloomberg, and forecast that commodity prices would stay “high by historical standards.” While the prediction applies to all commodities, Bloomberg reported that crude oil and copper were pivotal in leading commodity markets higher.

The IMF’s analysis of commodity markets agreed with the conventional wisdom in oil markets that economic growth to come later in the year would boost demand and strain the ability of oil producers to keep up:

The tension between rapid demand and sluggish capacity growth is therefore likely to re-emerge once the global recovery matures into a sustained expansion, thereby keeping prices at elevated levels by historical standards.

Many predict higher oil prices, but some oil industry insiders—most recently the CEO of Exxon Mobil, Rex Tillerson—are concerned that higher oil prices will lead to demand destruction as consumers alter their behavior in response to the rising cost of heating oil, gasoline, or other finished petroleum products.

Oil analyst Peter Buetel believes that speculation is the main force currently driving up oil prices, and is concerned about what high prices might do to the US economy. (image:msnbcmedia.msn.com)

Writing for the news network’s business news site, MSNBC producer John W. Schoen reported on Wednesday that speculation is driving up oil prices at great cost to American consumers and the economic recovery in the US. This is, of course, a story that dates back to the summer of 2008, when many believe excessive speculation caused the price of oil to skyrocket to $147 a barrel before it crashed due to the financial collapse. The story of speculation driving prices faded in the year after prices collapsed, as low crude prices brought lower gasoline prices that allayed consumers’ cost concerns. As President Obama put it in his recent speech on energy security, “When gas gets expensive at the pump, suddenly everybody is an energy expert. And when it goes back down, everybody is back to their old habits.”

While the president makes a good point, it’s not as true today as it once was. The recession led American drivers to seriously cut back on gasoline consumption. Today, cost-conscious conservation and other factors (like the growth of the biofuels industry) have led many analysts to declare that US gasoline consumption reached its all-time peak in 2007. It appears as though Americans’ “old habit” of gas-guzzling may in fact be gone for good. New consumption habits and a global recession have seriously reduced the world’s demand for crude oil and petroleum products, despite continuing demand growth from developing economies like China’s. More than a year of reduced demand has led to a build up of petroleum supplies that today remain well above average levels in most parts of the world.

Which brings us to the latest iteration of the debate over oil speculation and how it affects oil prices. In a world of low demand and high supplies, why have crude and heating oil and gasoline prices been rising steadily for the last 12 months? A growing number of journalists, analysts and politicians have said the answer is simple: oil speculation. Some analysts in this camp, including Schoen’s main source for his report, Peter Beutel at Cameron Hanover, warn that the stakes are even higher in today’s debate, as speculation-inflated prices are not only taking a bite out of consumers’ wallets, but also slowing the sorely-needed economic recovery in the US that is still in its infancy. The gravity of such concerns is clear in a quote from an OPEC minister included in Schoen’s article:

“Prices above $85 for a sustained period of time could well be harmful,” one OPEC delegate told Reuters. “We have to be aware that the economic recovery is still fragile.” (MSNBC, March 31st)

When members of OPEC, a group of nations whose lifeblood is oil sales to the world, say that prices are too high, it’s well worth listening to them. To address its concerns, OPEC has allowed its production levels to slip above official quota levels to sneak more supply into the market in an attempt to put a damper on oil prices. But if the engine of speculation keeps churning out higher prices, added supplies may have little effect on the market.

Some say the only way to reign in rising prices is to place limits on oil speculation. In the US, the Commodities Futures Trading Commission is considering imposing just such limits—the policies are currently in a public comment period and should be unveiled in their final forms at the end of the month. But plans to limit speculative activity have been met with strong resistance, primarily from institutions and individuals who participate in oil trading. This week Jeffrey Sprecher, the chairman and CEO of London’s Intercontinental Exchange (Europe’s main commodities market) called blaming speculators “a crutch for why prices went up instead of looking at the underlying supply and demand and fears.” Sprecher referred specifically to the price peak of $147 reached in July of 2008, but curiously omitted any comment on the current situation, when the evidence for speculation, not supply and demand, driving up prices is arguably stronger than it was two years ago.

Whether new limits on speculation in the US and/or UK will be adequate to curb volatility and reassert the influence of supply and demand over oil prices remains to be seen. But considering the strained budgets of heating oil and gasoline consumers and the fragile state of our economy, it is clear that lowering oil prices is more crucial than ever, no matter how they are brought about, as Peter Beutel explained:

Higher oil prices—even oil prices at existing levels—represent a tax on the American consumer at absolutely the worst possible time when we’re trying to fight our way out of a recession. We would still be producing plenty of oil at $50 and give consumers a reasonable relief that would allow this economy to grow much more substantially and put us on a much firmer footing.

Crude oil prices over the course of today, March 29. (image: ft.com)

Oil prices increased sharply today, boosted by the falling value of the dollar. A weak dollar tends to lead to higher oil prices, since it makes commodities priced in dollars cheaper for investors who hold other currencies. The euro zone’s agreement to offer aid to Greece helped boost that currency, which in turn pushed down the dollar. The price of heating oil followed crude on its upward trend, even though the heating season is drawing to a close.

Today’s closing prices on NYMEX

Crude oil (May 2010 contract): Up 2.7 percent, $82.18 per barrel.
Heating oil (May 2010 contract): Up 2.4 percent.

Heating oil prices this week are closely tied to the IMF and its potential involvement in bailing out Greece’s economy. (image: matanews.com)

Last week brought major increases in heating oil prices early on, but falling prices offset those gains on Thursday and Friday. The same factors that brought down prices late last week will likely do the same early this week: Greece’s financial crisis continues to put a drag on the euro, which will continue to drive up the value of the US dollar. As the value of the dollar increases, oil becomes a less attractive investment to foreign traders, usually leading to lower crude and heating oil prices.

The next development in Greece’s fiscal drama will be the meeting of EU ministers on Thursday and Friday. Ministers will discuss, among other things, how best to rescue the Greek economy. If a plan involving only EU support is hammered out, the euro will likely strengthen and bring higher oil prices. If the rescue plan requires assistance from the International Monetary Fund (IMF), the value of the euro will continue to drop, taking oil prices down with it.

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(image: s.wsj.net and Nicholas Whitaker via heatingoil.com)

Oil prices continued to be buoyed by the Federal Reserve’s announcement on Tuesday that interest rates would be kept at low levels, which contributed to a weaker dollar yesterday. Because crude and heating oil futures are priced in dollars, a weak dollar makes them cheaper for investors who hold other currencies and drives up demand. Higher oil prices got further support from the EIA’s inventory report, which showed a decline in supplies of distillates, which include heating oil and diesel, and in supplies of gasoline. Despite rising crude inventories, traders took this as a sign of growing demand. OPEC also announced that it would maintain its current production quotas, even as it anticipates growing global oil demand.

Today’s average retail heating oil price in the Northeast is 2 cents higher than Wednesday’s average price.

Qatar is one OPEC member that produces more oil than its OPEC quota allows, but excess production has not brought down oil prices. (image: dubainews.biz)

Oil futures prices have rallied lately, which might lead some to think that the demand for oil must be greater than the supply of oil. On the contrary, oil producers like OPEC are trying to gauge whether there is too much oil on the market. If prices were determined by supply and demand, then the prospect of too much oil would bring prices down; however, as Reuters reported on Thursday, oil prices have risen despite plentiful supplies, demonstrating (again) that the fundamentals of supply and demand have a limited influence on the price of oil.

David Hufton, an oil trader with the firm PVM, puts it another way: “Anybody who still believes that oil futures prices are a reflection of the true state of the physical market is living in a time warp.”

Neither Hufton nor Reuters emphasized the point, but many careful observers of the oil market agree with Hufton that supply and demand do not determine oil prices, and place responsibility for higher prices on speculators who treat oil as a financial rather than a physical asset. Whether you believe speculators perform a useful function—by anticipating future changes in the supply of or demand for oil—or not, their influence in oil markets moves the emphasis away from the physical market.

Who benefits from this? OPEC does, says Reuters. OPEC members are now routinely surpassing their production quotas. According to an energy adviser with PFC Energy, Paul Tossetti, “If you get on the ground and look at the fundamentals, you see too much crude oil production by OPEC.” But OPEC hasn’t suffered from this oversupply, since physical supply hasn’t dragged down oil prices. When OPEC meets this Wednesday, all expectations are for them to maintain their current production targets, even as member nations violate those targets. And why would OPEC try to curb production? If they can produce more and sell it at the same (or higher) prices, then added production only further boosts their profit.

For consumers of heating oil and other oil products, it can be frustrating to pay more for oil now because traders expect oil demand to rise in the future, but that’s what has been happening. While supply and demand can still have an impact on oil prices—the collapse of crude prices from $147 a barrel to $33 a barrel in 2008 was attributed to the recession, which choked off oil demand as the economy contracted—consumers are often at the mercy of investors who are more concerned with the value of the dollar than with how much heating oil people are using. The Commodity Futures Trading Commission (CFTC) has proposed new rules to try to limit the impact that speculators have on the market, but they may not be stringent enough to affect oil prices.

If supply and demand gained a more decisive role in determining oil prices, whether through CFTC regulation or otherwise, consumers would reap the benefits of lower oil prices—at least for now, when there is no shortage of oil supply. However, some oil analysts, like Jeff Rubin, think that significantly higher oil prices are inevitable in the next few years, because supply will be unable to keep up with demand.

So while prices determined by supply and demand are not necessarily low prices, they do give consumers a fighting chance for fair prices. It’s hard to imagine a scenario in which speculators keep oil prices artificially low. If consumers bear the burden when supplies are low and demand is high, they should catch a break when there’s more oil on the market than anyone wants.