OIL PRICE DRIVERS
1,000 1,500 2,000 2,500 3,000 3,500
Figure 1: Total & Speculative NYMEX Open Interest ’000 contacts (including forwards & options)
Total Open Interest Non-Commercial (Speculative)
the spot market for commodities, increasing current demand for commodities. Despite the compelling economic logic
of this reasoning, however, there is little evidence in favour of it. Both macroeconomic variables (e.g., global real activity) and microeconomic variables (e.g., inventories) play a role in determining commodity prices. However, evidence indicates that negative interest rate shocks account for only about 5% of the variability in oil prices.2
500 0 2000 2005 Sources: NYMEX, Bloomberg, Morgan Stanley Commodity Research
(iii) Financial firms’ open positions affected market expectations of future spot price increases and, hence, distorted the incentive to store oil.
The authors also assessed the extent to which
macroeconomic fundamentals explain the recent run-up in oil prices by considering two prominent explanations: (i) Persistently low real interest rates; and, (ii) Rapid increases in the demand for oil driven by unexpectedly strong growth in the global economy.
“Our own analysis suggests that there is
no empirical evidence to suggest a strong relationship between the positions of speculators and price changes”
“Overall, we find that financial speculation
does not seem to have played an important role in the price run-up. Currently, the available evidence supports the view that macroeconomic fundamentals explain the increases in the price of oil witnessed during 2007/08,” say the authors.
Fundamental Macroeconomic Conditions Driving Crude Prices The first explanation attributes the increase
in oil prices to the effect of historically low Real Interest Rates on demand and supply conditions. Low real interest rates simultaneously increase the demand for storable commodities and decrease the supply through three main channels. First, low real interest rates increase the refiners’ incentive to carry inventories by reducing the opportunity cost of doing so. Second, they decrease the oil producers’ incentive to extract oil today by increasing the future value of oil deposits. Third, they encourage investors to shift investments out of the risk-free asset and to
12 September 2011 2010
Global Demand & Supply Conditions The second explanation based on
macroeconomic fundamentals attributes the increase in the price of oil to stagnant global supply conditions and large increases in demand from emerging market economies – which tend to have more energy-intensive
production methods than OECD countries. Most of the increase in demand since 2006 has
come from the emerging markets. On the supply side, conditions in the oil market during this period remained tight. The evidence thus lends credence to the argument that rapid increases in demand, in conjunction with a sluggish supply response, contributed to the run-up in the price of crude. Alquist and Gervais conclude that the evidence
indicates that macroeconomic fundamentals can explain the 2003/08 increase in oil prices, while financial speculation seems to have played a modest role. “Our own analysis suggests that there is no empirical evidence to suggest a strong relationship between the positions of speculators and price changes. Although there is debate about the appropriate way to estimate demand and supply elasticities in the global crude oil market, this technical discussion should not distract us from the fact that global macroeconomic conditions are capable of accounting for the persistent increase.” Overall, the available evidence points to global demand and supply conditions rather than financial speculation as an explanation for the surge in the price of oil between 2003 and 2008 – albeit exacerbated by financial speculation in the short-term. Nevertheless, markets need to become more
transparent with limits imposed on trading positions – as are being formulated by the CFTC and others. •
Guy Isherwood is Publisher and Editor-in-Chief, Commodities Now
Footnotes: 1.
See:
www.bankofcanada.ca
2. Anzuini, A., M. Lombardi & P. Pagano. 2010. “The Impact of Monetary Policy Shocks on Commodity Prices.” European Central Bank Working Paper No. 1232.
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