Just speculation

| July 08, 2008

There’s no shortage of opinion on the reality behind the high fuel prices we’re all dealing with today, but one thing is clear: it’s driven by the rapidly rising price of crude. Since May 2002, that price has boomed from $23 a barrel to more than $130 today, a nearly 600 percent increase.

From public fear about future world supply to today’s environment of tight (though adequate at this moment) supply and growing demand in the developing nations, many factors figure into the reason for the rapid rise, but one has been examined in the mainstream press of late much less than the others.

When Robert Hirsch, Management Information Services senior energy adviser, told CNBC’s “Squawk Box” host Becky Quick on May 20 that analysts were predicting a rise in per-gallon prices similar to the one hypothesized in the illustration above, he was paraphrasing February remarks made by institutional investor Weeden & Co.’s Charles Maxwell, a well-known energy investment expert. That same day, the business press and congressional hearing rooms were abuzz with speculation, yes, on how speculation in the world’s commodities markets were affecting the prices of everything from corn to, you guessed it, oil.

Institutional investment practices by Wall Street banks (managing long-term products such as pension funds) have shifted in recent years. Though the traditional commodities futures exchanges have always included some speculators, hedge fund manager Michael Masters told the Senate Committee on Homeland Security and Governmental Affairs these speculators were comprised of entities involved directly in buying and selling real commodities, in this case actual oil. Today’s “index speculators,” Masters said, were capitalizing on a loophole in the Commodity Futures Trading Commission regulations identified in a Senate Permanent Subcommittee on Investigations report on the role of speculation in the price of oil back in 2006.

Before and particularly since then, as the failure of subprime mortgage-backed securities has hit many Wall Street banks hard and as the value of the dollar has fallen, some of these same banks, basing their investments on the major commodities indices, have poured long-term investment money into the commodities markets. And unlike traditional speculators, said Masters, index speculators “never sell

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