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Don’t Blame The Speculators Alone

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  • 1. DON’T BLAME THE SPECULATORS ALONE Presented By RAMYA KRISHNAMURTHY (76) SONICA DALMIA (95)
  • 2. WORLD VIEWS ON OIL PRICES
    • American Politicians – “Finger speculators for feverish rise in oil prices”
    • OPEC – “Speculation driving oil prices”
    • Italian Finance Ministry – “Magnum of speculative champagne included in the price of each barrel”
    • Austria – “European Union must impose tax on speculation”
    • Saudi Arabia & Other big Oil Producers – “Prices are to be blamed on frothy markets rather than idle wells”
    • International Energy Agency – “ Supply and Demand and not speculation drive oil prices”
  • 3. SUMMARY: KEY TAKEAWAYS
    • As the price of crude oil has continued to hit new record highs, many investors have questioned whether the gains are justified by supply-demand conditions or are the result of investor speculation.
    • The largest driver of crude oil prices in 2008 appears to be the growing recognition of long-term supply constraints, as the production at some of the world’s largest oil fields has matured while new discoveries have been smaller and costlier to develop.
    • Investor interest in oil has played a role in pushing prices up in the relatively small oil futures market, but it is impossible to calculate to what extent these investments represent near-term speculation or a reaction to the long-term supply – demand outlook.
    • The five-year increase in crude oil prices is the fastest ever, has contributed to a fall in U.S. gasoline demand, and presents a growing challenge to the global economy.
    • With increasing recognition that the world’s era of “cheap oil” may have come to an end, a meaningful and sustainable decline in oil prices may only be possible in the near-term if demand growth decelerates in fast-growing developing markets, such as China and Saudi Arabia.
  • 4.
    • Discoveries of large, low-cost oil fields have been increasingly rare.
    • The relatively small market capitalization of crude oil futures means investor moves can result in big price swings.
    • U.S. consumer spending on energy reached 20 year highs, though it still has remained below early-1980s peaks.
    • Oil price is only “Speculation”.
    • Follow the oil, not the futures.
    • It takes two to Contango.
    SUMMARY: INSIDE
  • 5. SUPPLY CONSTRAINTS INCREASINGLY EVIDENT
  • 6.
    • Growing demand and continuously rising oil prices in recent years have failed to spur a significant increase in crude oil production, leading to growing recognition that future supply growth may be lower than anticipated
    • With few new discoveries of giant, low-cost fields since the 1980s, future supplies are increasingly dependent on maturing older fields and smaller new discoveries
    • Incremental oil output costs more
      • Smaller oil fields are generally more costlier
      • Discoveries have tended to be of lower quality and tend to be located in less-accessible places
    • Production growth has been constrained by government intervention and instability
    SUPPLY CONSTRAINTS INCREASINGLY EVIDENT
  • 7. RELATIVELY SMALL CRUDE OIL MARKET SUSCEPTIBLE TO LARGE PRICE SWINGS
  • 8. RELATIVELY SMALL CRUDE OIL MARKET SUSCEPTIBLE TO LARGE PRICE SWINGS
    • The total market capitalization of crude oil futures is relatively small (less than half of the size of Exxon Mobil—the largest U.S. oil company).
        • rising investor interest in oil can contribute quickly to disproportionately large price swings.
    • It is difficult to gauge whether the recent surge of investment in oil is “speculative” or driven by growing recognition of tight supply/demand conditions
        • new investment in crude oil markets is coming from institutional investors, that typically have long investment horizons.
        • In addition, a tighter long-term supply-and demand outlook provides motivation for countries to build inventories
  • 9.  
  • 10. US CONSUMER SPENDING ON OIL ROSE TO 20-YEAR HIGH
    • Consumer spending on energy—for transportation and home operations—hit a two-decade high in March 2008, both as a percentage of consumer spending and income
        • At 6.4% of disposable personal income, energy takes up a greater share of household earnings than at any point since 1985.
        • Energy accounted for 6.6% of consumer spending—its highest level since 1986.
    • There have been some signs that prices are beginning to curb demand growth in the U.S.
        • In March, miles traveled on U.S. roads fell 4.3% on a year-over-year basis, the first decline since 1979 and the steepest fall on record.
    • However, developing countries—including China and Saudi Arabia—continued to account for the bulk of global demand growth
  • 11. OIL PRICES ARE ‘ALL’ SPECULATION
    • Government has strong views on commodity market speculation; introduced ‘Commodity Speculation Reform Act, 2008’
    • Supply and Demand cannot lead to sudden rises; there are more contracts than barrels
    • From 1998 to 2008 the share of ‘long interests’ - market positions that benefit when prices rise – in commodities held by financial speculators has gone up from 1/4 th to 2/3 rd of the commodity market
    • From 2003 to 2008, investments in index funds tied to commodities has grown twenty-fold from $13 billion to $260 billion
  • 12. FOLLOW THE OIL, NOT THE FUTURES
    • Barclays Capital calculates that “index funds” account for only 12% of the outstanding contracts on NYMEX and have a value equivalent to just 2% of the world’s yearly oil consumption
    • Neither speculators nor index funds buy physical oil; instead ‘place bets’
    • No oil is held back from the markets making these bets like bets on a football match
    • If speculators managed to push prices to unjustified heights, demand would contract leaving unsold pools of oil
    • “ All producers bar Saudi Arabia are pumping oil as fast as they can”
    • Price rise through speculation will either cause demand to fall or stockpiles to rise; neither has happened
  • 13. IT TAKES TWO TO CONTANGO
    • Speculators help airlines and other big consumers to hedge against rising prices, and so to reduce risk – a massive boon amid the economic turmoil
    • Provide oil producers with more predictable future revenues, and so allow them to expand more confidently and borrow more cheaply
  • 14. Reference
    • The Economist (July 5 th 2008).
    • The Analyst (June 2008).
    • Wikipedia.
    • Forex News.
    • International Energy Agency Report.
    • Staff Report, Senate Permanent Subcommittee on investigation committee on homeland security and government affairs.
    • CNN Money.com
  • 15. THANK YOU