Yep, Speculators Caused Last Year's Oil-Price Spike, Rice Says

A couple of researchers at Rice University's Baker Institute for Public Policy have released a study that gets close to proving that speculators caused oil prices to shoot up in 2008.

This theory is nothing new, but the Commodity Futures Trading Commission, the agency that regulates U.S. futures markets, is expected to release a report that details how speculators played a part in the price spike, the first time that the agency has admitted as much. According to the Baker Institute's Kenneth Medlock, who has researched this issue for years, the Baker study was released to coincide with the trading commission's report.

"The reasons for high oil prices last year is a difficult issue to digest, but these are inescapable facts that need to be part of the discussion," Medlock tells Hair Balls.

Medlock adds that it's impossible to definitely prove that speculators drove up the price, because "the data is not transparent enough." Electronic and noncommercial exchanges aren't tracked, Medlock says, so the data available doesn't represent a complete picture of the market.

The most shocking finding was the strong relationship between the price of oil and the value of the dollar. In fact, the Baker Institute has hosted speakers who said there is no such correlation between oil and the dollar, but those researchers, Medlock says, were analyzing data over several decades. But since the Commodities Futures Modernization Act was passed in 2000, allowing a huge influx of noncommercial traders to get involved in oil futures, the correlation is strong.

"Rising oil prices definitely have a negative impact," Medlock says. For example, oil imports account for a large percentage of U.S. trade deficit, so high oil prices can decrease the value of the dollar. Traders will often hedge these changes with commodities, further increasing commodity prices like oil, creating a vicious cycle. 

The commodities modernization act needs "to seriously be reviewed," Medlock says, because while it probably wasn't intended, it has created negative consequences. He doesn't believe competent change is coming, though, but instead believes there will be a new wave of regulations placed on top of existing regulations that will no doubt result in more adverse consequences.

But Medlock doesn't think oil prices will skyrocket anytime soon. Many paper traders, he says, think that today's price -- about $70 a barrel -- is the right price, and people who trade oil physically think the price should be lower. Medlock thinks $50 a barrel is the right price, and if new regulations are added to the commodities modernization act, he says the price should start to drop.

"The last time the market was this loose was in 1998," Medlock says. "I'm not saying we should be back at $10, but it's hard for me to believe that $70 is where we ought to be. You kind of have to run the experiment, and if I'm right, prices will come down."

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