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Interim Report: Fundamentals Driving Oil Prices

00:00AM Jul 23, 2008

via a special arrangement with Informa Economics, Inc.

But CFTC Commissioner Bart Chilton Disagrees

NOTE: This column is copyrighted material, therefore reproduction or retransmission is prohibited under U.S. copyright laws.

The Commodity Futures Trading Commission's Interagency Task Force on Commodity Markets released an interim statement on crude, saying that fundamentals of supply and demand, not speculative trading, explain the record rise in crude oil prices.

The task force was formed by the CFTC in June to evaluate developments in commodity markets -- notably, investor practices and fundamental supply and demand factors. The group is composed of staff members from the departments of Agriculture, Energy and the Treasury, the Board of Governors of the Federal Reserve, the Federal Trade Commission, and the Securities and Exchange Commission, and is chaired by CFTC Chief Economist Jeffrey Harris.

Studying the period between January 2003 and June 2008, the group noted that while the price increase was due largely to supply and demand factors, it coincided with a significant increase in activity on the crude oil futures markets. Other have said that the increase in volume -- mostly from passive institutional investors -- has overheated commodities markets and driven up prices.

However, the interim report said that while these increases “broadly coincided with the run-up in crude oil prices, the task force's preliminary analysis does not support the proposition that speculative activity has systematically driven changes in oil prices."

Rather, it observed that "the world economy has expanded at its fastest pace in decades, and that strong growth has translated into substantial increases in the demand for oil," particularly in emerging markets. The report noted that world economic activity has expanded at close to 5 percent annually since 2004, "marking the strongest performance in two decades." Between 2006 and 2007, global oil consumption grew by 3.9 percent, owing mainly to increased demand from developing countries such as China and India.

The report added that production of oil has become "sluggish," and it cited geopolitical unrest in oil producing countries as a main factor. "As it is very difficult to rely on substitutes for oil in the short term, very large price increases have occurred as the market balances supply and demand," the report said.

The report discounted the notion that speculation was responsible for the run-up in prices. "If a group of market participants had systematically driven prices, detailed daily position data should show that the group's position changes preceded price changes," the report said. However, it said its analysis suggests that has not happened.

It added that while speculative trading has increased, speculative traders tend to alter their positions after price moves, "suggesting that they are responding to new information - just as one would expect in an efficiently operating market." If those traders were driving prices, the report added, their trading positions would have changed before price moves.

New data that CFTC requested from swap dealers and commodity index traders -- such as pension funds -- were not available for this report but will be gathered and analyzed for a following report in mid-September. The report also said it could only look at trader groups as a whole and not individual traders or intra-day relationships between prices and positions.

But the currently available data show swap dealers have held a "balanced" position of trades that benefited from higher prices and lower prices and have not "systematically driven" price changes, the report said. The task force report said its preliminary analysis "suggests that changes in the positions of swap dealers" and other traders most often followed price changes. "This result does not support the hypothesis that the activity of these groups is driving prices higher."

Harris and Acting CFTC Chairman Walter Lukken have testified several times in the House and Senate, seeking to dispel the notion that excessive speculation is causing the price inflation. Instead, like the interim report, they both have pointed to the fundamental economic factor of supply and demand. The two also have cited the weakening dollar as another factor for the rising prices.

The CFTC said the task force will report further later this year. Here is a link to the report.

Meanwhile, CFTC Commissioner Bart Chilton released the following statement following release of the interim report:

"An inter-agency 'task force,' recently set up to review possible causes of the unprecedented rise in energy markets in the U.S., issued today an "interim report" regarding its analysis to date. The findings are, to say the least, disappointing. Senior Administration officials, including but not limited to the Secretary of Treasury and the Secretary of Energy, have already opined in recent weeks and months that speculators are not having an impact on the record rise in crude oil prices. I'm not surprised, therefore that the staff who work for them, and who comprise the staff of the 'task force,' have not contradicted their superiors in this study. The simple fact remains that there is nearly $250 billion in America's commodity futures markets that wasn't there just a few years ago, held primarily by non-traditional long investors. There has got to be, to some degree, impact from this significant new influx of trading, and I'm hopeful that a more thorough analysis will thoughtfully look at this question in an unbiased and comprehensive fashion, so that the public is assured these markets are operating in a fair and effective manner for consumers and businesses."

NOTE: This column is copyrighted material, therefore reproduction or retransmission is prohibited under U.S. copyright laws.