When Oil Prices Jump, Is Speculation to Blame?

By Fawley, Brett; Juvenal, Luciana et al. | Regional Economist, April 2012 | Go to article overview

When Oil Prices Jump, Is Speculation to Blame?


Fawley, Brett, Juvenal, Luciana, Petrella, Ivan, Regional Economist


Historically, the long-run primary driver of oil prices has been global demand.1 An expanding global economy demands more raw inputs, including oil, and that increased demand pushes up their price.

However, the past decade (2000-09) saw a rapid proliferation in the financialization of commodities, i.e., the creation and trading of financial instruments indexed to commodity prices. Estimates indicate that assets allocated to commodity index trading rose from $13 billion in 2004 to $260 billion in March 2008. Many people, including policymakers and economists, have posited that because this rapid and unprecedented growth in commodity index trading coincided with a boom in commodity prices, speculation by financial traders-and not supply and demand-drove the recent bubble in commodities.2 (See Figure 1.)

Such charges are perhaps strongest in oil markets, where large investment banks, hedge funds and other investment funds have invested billions of dollars in oil futures contracts over the past decade. In our current research, we investigate these allegations.3 Specifically, we disentangle the contribution of four factors to oil price movements. Successfully identifying the true drivers of oil prices over the past decade is critical for efficient resource allocation and policy design.

First Contributor: Global Supply

Unanticipated changes in the availability of oil inversely affect the price of oil. For example, prices increase when the Organization of Petroleum Exporting Countries (OPEC) unexpectedly decides to cut oil production.

Second Contributor: Global Demand

A booming world economy demands more industrial commodities, and at the top of that list is oil. For example, continuous growth in emerging countries such as China and India increases the aggregate world demand for oil and, consequently, its price.

Third Contributor: Oil Inventory Demand

Expected future shortfalls in oil supply, relative to demand, motivate the storage of oil for future use. Either the possibility of a sudden shortage in production or of a new source of demand can create an expected shortfall. For example, uncertainty about future oil supply may arise from political instability in key oil-producing countries, such as Nigeria, Iraq, Venezuela, Libya or Iran. Such uncertainty increases demand for storing oil, driving up the current price.

Fourth Contributor: Speculation

Speculation is the act of purchasing something today with the anticipation of selling it at a higher price at a later date. Financial markets allow traders to speculate on oil prices in the following way: Traders buy a contract for oil to be delivered at a later date (a futures contract), sell the contract before the oil is due for delivery and use the proceeds to purchase another futures contract for delivery at a more distant date. Expectations that the price of oil will be higher in the future motivate investment funds to take positions in these contracts, and as demand for futures contracts increases, so does their price, which also moves the current oil price.

Decomposing Oil Prices in the Past Decade

Figure 2 illustrates the degree to which oil price trends over various parts of 2000-09 are attributed in our model to each of the four elements discussed above. We identify periods by the beginning and end of distinctive trends, rather than by evenly spaced time intervals, in order to best capture the net contribution each factor made to each trend. (See shading in Figure 1.) The black line shows the modeled percent change in real oil prices during each time period, and the bars illustrate the percentage point contribution made by each of the four elements.4 For example, factors related to global supply pushed modeled oil prices about seven percentage points higher between 2000 and 2004 than they would have been otherwise, while changes in global demand drove modeled oil prices about seven percentage points lower over the same span than they would have been otherwise. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

When Oil Prices Jump, Is Speculation to Blame?
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.