Markets & Stocks
    SAVE   |   EMAIL   |   PRINT   |   RSS  
Oil prices primed to climb: analysts
More than just speculation is driving record-high crude; it's old-fashioned supply, demand.
July 27, 2005: 11:04 AM EDT
By Grace Wong, CNN/Money staff writer

NEW YORK (CNN/Money) - Is it time to close the book on the speculation theory of crude oil prices?

As oil settles in near $60 a barrel, some analysts say it's time to dispel the notion that heavy trading is the culprit behind record-high prices. Rather than poised for a spectacular crash, oil could keep climbing, they say.

Light, sweet crude for September delivery closed Tuesday at $59.20 a barrel, just a few dollars off the record high for a front-month contract of $61.28, set July 6.

Last September, Federal Reserve Chairman Alan Greenspan said in testimony to the House Budget Committee that speculators taking larger bets on crude oil futures were one possible reason for higher oil prices.

That triggered fears that prices no longer reflect supply and demand but instead are being propped up by speculative buying. Oil's stunning rally since then, coupled with high volume trading on futures markets, has only fueled those concerns.

Show me the hot money

Any investment is at least partly speculative -- you buy a stock because you think its price is going to go up. But speculating on a large scale can disrupt markets as inflows of "hot money" artificially drive up prices.

"There is new money coming into [oil trading] in the number of open-interest contracts, but this is not necessarily a sign of speculation," said Jan Stuart, an oil analyst at Fimat USA.

Open interest refers to the number of contracts that are bought and sold each trading session and is used to measure the flow of money into the futures market.

"It's simply new money, not hot money," Stuart said, adding that some of these investments are there for the long haul.

But some analysts said there's still a lot of betting going on, and that's throwing prices out of whack against the fundamentals of supply and demand.

"A significant part of demand right now is based on speculation that something is going to happen in the future or near future to make supplies much more scarce," said Michael Darda, chief economist at MKM Partners.

That uncertainty is driving institutional players like trading companies that buy for countries, as well as large corporations, to place bets on the future direction of oil in order to manage the risk of a price change -- a practice also known as hedging.

Southwest Airlines (Research), for example, gained a significant price advantage against its rivals by locking in long-term fuel contracts at less than half of current spot-market prices.

As these players hedge ahead of the oil curve, they put a lot more pressure on the market and bid up prices, said Charles Gradante, managing principal of Hennessee Group, a hedge fund investing consultancy.

Demand-driven oil toil

But unlike profit-seeking speculators who enter and exit the market in seek of a quick return, these large hedgers are mainly businesses that actually take delivery of oil, Gradante said.

That's important because it points to an intrinsic demand force driving oil.

Peter Linder, an analyst at energy hedge fund DeltaOne Capital, said speculation about the future plays a role in the volatility of oil prices. But it's market fundamentals -- bottlenecks in refining capacity, increasing demand from China, as well as terror threats -- that are sustaining oil's high price.

Furthermore, buyers are taking delivery of oil as fast as suppliers produce it. That makes it difficult to make a case for a speculative surge, said Richard Anderson, economist and vice president of the research division of the Federal Reserve Bank of St. Louis.

While analysts agree that surging demand has changed the dynamics of world oil markets, they're split over how much higher prices can afford to rise.

MKM's Darda -- who thinks prices are frothy and should be around $40 a barrel instead of around $60 -- said prices are unable to sustain their current high levels.

Eventually they will reach a point where producers have an incentive to bring more supply online, and that will help prices fall more in line with market fundamentals, he said.

But Fimat USA's Stuart doesn't see that happening anytime soon.

"In the short term, there are going to be ups and downs, but over time the drivers of rising demand and tighter supplies are staying in place," he said. "I don't see why the rally should end or price collapse."

And with most oil companies continuing to post exceptionally strong gains this year, that will be good news for the likes of Exxon Mobil (Research), ChevronTexaco (Research) and ConocoPhilips (Research).


Where's all that oil money going? Click here.

Feeling gas pains? Click here for CNN/Money's special report -- "Oil Crunch 2005."

Is Texas Tea the new tech? Click here.

Click here for the latest oil prices.  Top of page


Oil and Gas
Manage alerts | What is this?