Magazine article The International Economy

Paper Barrels

Magazine article The International Economy

Paper Barrels

Article excerpt

Forecasts by the International Energy Agency and other analysts assume that the speculative demand for oil will not get out of hand one way or another. Demand for "paper barrels" will continue to exercise an autonomous influence on oil prices. In the recent past, this took the form of massive investments in the futures markets in pursuit of large-scale gains as oil, and commodities more generally, turned into a major asset class for hedge fund and other investment fund portfolio managers. The sum of open interests on the NYMEX and ICE futures markets jumped from 950,000 contracts (equivalent to just under one billion barrels of oil) in 2004 to 2.7 million contracts (2.7 billion barrels of oil) in 2008. According to LCM Research, adding exchange-traded options and futures contracts to the latter figure represents no less than seven billion barrels of oil. The deleveraging that took place in the second half of 2008 reduced this amount to about 1.7 billion barrels. Over-the-counter crude oil contracts exacerbated this speculative spike, adding a full 120 percent to the peak figure as opposed to a fraction (on the order of 80 percent) before and after the spring 2008 episode. Similarly, passive investment into index funds also rose and fell spectacularly, from about $75 billion in 2006 to $280 billion by mid-summer 2008, and back to the 2006 level six months later. The Goldman Sachs-fed allure of $200-per-barrel oil has laded, and it is unlikely that the next couple of years will see an episode of exuberant investing comparable to the year 2008 that is still remembered for oil at $147 per barrel. Nevertheless, the fourth quarter of 2009 saw sustained investment in oil futures, and there may be other reasons why paper markets may not remain neutral for long. In particular, oil recently became a major instrument in efforts to hedge against a fall in the dollar. …

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