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current weakness in the world’s stock markets

That is, the rights to a single barrel of oil are bought and sold many times over, with the profits or losses going to the traders and speculators. Given the current weakness in the world’s stock markets, the falling value of the dollar, and the credit crunch caused by the sub‐ prime mortgage crisis in the US, speculators are putting their funds into such safe havens as gold and oil, spiking up their prices. The large purchase of crude oil futures contracts by speculators have, in effect, created an additional demand for oil, driving up the price of oil for future delivery in the same manner that additional demand for contracts for the delivery of a physical barrel today drives up the price for oil on the spot market. As far as the market is concerned, the demand for a barrel of oil that results from the purchase of a futures contract by a speculator is just as real as the demand for a barrel that results from the purchase of a futures contract by a refiner or other user of petroleum.

 Speculation Driving the Oil Crisis A June 2006 US Senate Permanent Subcommittee on Investigations report on “The Role of Market Speculation in rising oil and gas prices” noted, “... there is substantial evidence supporting the conclusion that the large amount of speculation in the current market has significantly increased prices” One geo‐political expert confirmed ‘Today 60% of crude oil price is pure speculation driven by large trader banks and hedge funds and with the development of unregulated international derivatives trading in oil futures over the past decade, the way has opened for the present speculative bubble in oil prices.’ Hence when speculators purchase a contract to buy oil at a given date, they do not actually buy or sell the oil but merely buy and sell the right and take the price differentials, physical oil is not traded. This is what has caused oil to reach astronomical levels; it has led to riots and inflated prices well beyond the common person.

This is why it is no surprise to see in a May 6th 2008 report from Reuters that Goldman Sachs announced oil could in fact be on the verge of another “super spike,” possibly taking oil as high as $200 a barrel within the next six to 24 months. A large number of futures contracts where taken out as soon as the news went public. That headline, “$200 a barrel!” became the major news story on oil for the next two days. Many speculators followed with their bets? A common strategy speculators are using desperate for more profitable investments amid the US sub‐prime disaster is to take futures positions selling ‘short’. By selling a commodity or any financial instrument short in essence this is betting on the price of the commodity or financial paper to fall. Short‐sellers do not own anything they sell ‐ they borrow them from pension funds and insurers. A common example is where; a hedge fund would borrow a million shares in Megabank for a fee. It would then sell those million shares at the prevailing market price of £8 a share, making £8 million in total. The hedge fund is betting and hoping that Megabank's share price would then fall. If it falls ‐ to £4 a share the hedge fund then buys a million shares for £4m and returns them to the lender.

This means that the hedge fund has banked a real cash profit of £4m. Lehman Brothers, the investment bank, has estimated that fuel is 30% overpriced because of an influx of money into the oil market from investment funds. It believes that hot money accounts for between $20 to $30 of the recent increase in oil prices and that about $40 billion has been invested in the sector so far this year — equal to all the money pumped into oil last year. Understanding the ‘Fundamentals’ Most analysts and experts continue to interpret the price of oil price movements due to fundamentals – in the oil industry the fundamentals are factors that influence the supply of, and demand for, oil. Things such as the increasing demand from China and India, as well as fears that a stand‐ off between the US and Iran could interrupt supplies are considered as having a bearing on oil prices. Alternatively, financial factors may be at work, such as a hedge fund having to sell a particular oil contract so it does not end up receiving a tanker‐load of oil. However most fundamental information is not freely available.
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