Speculation, and how high is too high for the economy?

Crude oil prices are up, up, up. This may be good news for oil producing countries and IOCs, but few want to see prices being driven high enough to harm the economy on pure speculation.

But how high is too high? BP yesterday said $60 to $90 is the “right sort of level” and Opec members and officials have hinted they agree. Merril Lynch last month suggested OECD countries could tolerate up to $80, and as we’ve seen, Ali Naimi, the Saudi Arabian oil minister, said last month that $75 to $80 was okay.

Now Deutsche Bank estimates that assets under management in US ETFs are higher than last year’s peak.

The Deutsche Bank commodities analyst team wrote:

Although this represents only a small share of total assets under
management in commodities it may provide a proxy for overall
fund flows in the complex.

At the end of June last year we stated that the forces that
had led to a doubling in oil prices during the previous 12
month period were either working in reverse or not
working in favour of even higher oil prices. Today we
believe a significant amount of the inflows into
commodity funds is based on the increasing appeal of
commodities in an environment where governments have
employed aggressive fiscal and monetary expansion
and
where capex spending has been severely curtailed by
many commodity producing companies.

Meanwhile, the IEA in its monthly oil report on Thursday also clarified its view on the controversial role of speculators. While it maintained fundamentals were the key driver of recent price rises, it stressed that this was “different from inferring they are the only driver”.

They say that the shift in non-commercial WTI positions from 11,000 net short in early May to 14,000 net long now should not be viewed as the reason behind price rises, because a longer term view doesn’t bear out such a strong correlation:

IEA

Source: IEA

The IEA report takes the middle path, saying that both an ‘only fundamentals’ argument and a ‘speculative’ smoking gun strain credibility. The organisation’s report also argues theories of oil prices being driven up by large stock builds in China and hedging against inflation and the falling dollar are not borne out by a subsequent weakening of the contango.

And back to the effect on the economy. The IEA appears comfortable with this, too, saying the price levels we are seeing now may help avert preventing the future price spike:

While rapid price swings can prove destabilising, higher prompt prices, if symptomatic of a gradually recovering global economy, in themselves may be no bad thing. If they coincide with cyclically weaker costs (which now seems the case), higher prices could also prompt a recovery in upstream investment. Notwithstanding a now‐lower cost base, a recent IEA report prepared for the G8 Energy Ministers Meeting highlights the risks for longer‐term supply growth if upstream spending curbs are sustained.

Related links:

Concerns for recovery as oil surges (FT, 10/06/09)
Oil prices caused the recession, redux, and what it could mean
(FT Energy Source, 25/05/09)
If high oil prices are what caused the recession, then lower prices should… (FT Energy Source)
Was the US recession caused by the oil shock of 2008?
(FT Energy Source)

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