Oil Speculators and OPEC: Temporary Allies

(top image: blackagendareport.com)

(bottom image: Reuters via irvinehousingblog.com)

Usually, OPEC does not look favorably upon oil speculators. But that is now changing

The OPEC cartel enjoys the position of being the world’s most important oil producer; by deciding how much oil to produce, OPEC has significant control over the supply of the world’s crude oil, which means OPEC has significant control over the price the world pays for crude oil. And, as heating oil is ultimately derived from crude oil, it affects how much we pay to heat our homes.

But speculators (investors who trade oil contracts hoping that prices will either rise or fall depending upon their outlook) also influence the world’s oil market. The world’s oil is traded as a “future,” which means investors sign a contract locking in a price of oil for an amount of time. If the price of oil either rises or falls, futures holders can then sell that contract for a profit. And, keep in mind, that’s all speculators are after; they never have any interest in physically holding any quantities of oil. But if speculators continue to flood the commodities market, they can also alter the price of oil, as explained in this February HEAT Zone post.

In the summer of 2008, the physical demand for oil dropped while the production of oil increased; normal economic behavior suggests that, as a result, the price of oil should have fallen. However, the exact opposite happened: oil prices climbed to record highs. Many have blamed speculators for the dramatic increase of oil prices in 2008, claiming that they kept on betting that the price of oil would rise, which artificially pumped prices skyward.

As a result, OPEC, while its member nations’ economies greatly benefitted from increased prices, was upset by the fact that it lost influence over the price of oil. And, when speculators started to feel the price of oil was too high and bet that prices would drop, the cost of oil fell dramatically. This further upset OPEC, as some of its members planned to use oil profits to fund a variety of projects. But as prices fell, these nations were left hanging, wondering what the next step should be. And now, as the worldwide demand for oil has continued to shrink due to the ongoing recession, oil inventories have swelled.

Under most circumstances, oil-producing nations would continue to cut oil prices, which would reduce revenue. However, once again, price speculators are betting in large numbers that the cost of oil will rise. And, as a result, they’re actually causing the price of oil to rise, as explained in a recent Wall Street Journal article. Now, oil producers have an incentive (rising prices) to keep on producing oil, despite the presence of large inventories.  Higher prices plus increased production equals more profits for OPEC, so the cartel has nothing to complain about when it comes to oil speculators these days.

However, this partnership might not last. There is a good chance that demand for oil will continue to slow in the upcoming months. Soon, OPEC’s inventory might build up so much that it will reach maximum capacity. Then, most likely, OPEC would be forced to sell off oil quickly, which would rapidly deflate the price per barrel.