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It is time we started paying attention to the oil price. When the banking crisis bit last year and it became obvious the global economy was going to be hit, oil plummeted. From its peak of $147 a little over a year ago, it fell all the way down to $40, and there it stuck in a narrow trading range.
In the past few weeks though, it has begun to move up again - it is now well over $60, which means it is more than 50% above its lows. Now there are signs the pace of decline is slowing in some industries, and there are green shoots - or at least a rebuilding of inventories - in others. It may be the global economy is over the worst. But it is almost impossible to believe that the revival of activity in the global economy we have seen so far is sufficient to generate the additional demand which has pushed the price up.
It is similarly hard to believe that Opec's production curbs lie behind the rise. Opec is forever trying to restrict output but it never really works because too many of its members cheat, and there are major suppliers outside the cartel. Of course it claims its cuts are working, but that is just part of the game.
What seems much more likely is that the talk of green shoots has spurred speculative interest in oil, and the weight of such buying lies behind the price rise. If this is true even in part, there is reason to be alarmed because the lesson of the oil-price spike of 18 months ago is that the market is too thin to cope with the weight of money which can be directed at it.
Let us remember what happened last time. Between August 2007 and spring 2008, the price of every tradeable commodity soared. Gold went from $650 an ounce to more than $1000; oil hit $147, rice and other foodstuffs doubled. The Dow Jones AIG commodity index rose from 167 in the summer of 2007 to 240 in March 2008.
The price of oil may well have been the engine driving the other commodities because it is such a big factor in their production costs, but it was generally assumed that the main driver was booming Chinese demand. However, there was another factor - speculation.
The suddenness and extreme nature of the oil surge surprised almost everyone, as well it might for a subsequent analysis said the increased demand for oil caused by Chinese growth after 2002 should have pushed the price only from $20 to $60 by 2007. There should also have been a further $20 on the price to compensate for the weakness of the dollar in that time. Thus the maximum price brought about by growth in physical demand caused by the Chinese boom should have been to $80. The price hit $147. The conclusion was that the excess was the result of financial speculation. The indices and measures of the market tell the same story of that time. The total value of commodity-futures contracts rocketed from $2 trillion in 2004 to $9 trillion in 2007. The number of commodity futures transactions rose from 150 million a year in 2005 to 450 million a year by 2007.
In 2003, there were just 28 hedge funds in the world specialising in commodities. By 2007, this number had swelled to 310, and by 2008 to 450.
A number of pension funds also came, though they tended to buy the index rather than the underlying contracts. Nevertheless, it all adds to the pool of money sloshing round in the asset class, and for the record the money invested in commodity indices grew from $10 billion in 2002 to $250 billion by March 2008. Now there is no doubt among economists that the spike in the oil price delivered a shock to the global economy and started its current slowdown - made worse, of course, by the banking problems.
The other side of the coin is that the subsequent fall in the price of oil is one of the most positive things pushing global recovery - a fact frequently mentioned by Goldman Sachs chief economist Jim O'Neill.
What we must surely seek to avoid - and indeed it would be tragic were it allowed to happen - is for the oil price to be pushed up by hot money to a level where it acts as a brake on our faltering efforts at recovery. The people regulating the markets have the power to demand increased collateral from investors when they think the level of speculation is unhealthy. Perhaps they should think about it now.
Misdirected over the Royal Mail
It would be hard to imagine a situation where the Government's effort to privatise the Royal Mail could become yet more farcical, but the news over the weekend that private-equity house CVC has slapped in a £2 billion bid for a third of the business achieves that.
This is not a reflection on CVC, which does what a private-equity house will do. However, it makes a nonsense of the Government's claim that the purpose of the sale was to bring in expertise from other postal operators so that the magic of their management would rub off on the Royal Mail. CVC may be very good at buying cheap and selling dear, but it has limited experience running national postal systems with a public service obligation.
We must hope that an election comes along before this tawdry Bill has completed all its stages through Parliament, or that Lord Mandelson moves to another department and his successor has less stomach for the fight. With all the problems the Government has, and all the more important things it could be doing, it beggars belief that this project has got this far.
Reader views (1)
Governments printing money will cause inflation in commodities. You can't blame people for wanting to invest in something that can be easily debased. Preventing people from insuring themselves against currency debasement and inflation is pathetic. And, it wouldn't work, other countries wouldn't allow it. No, governments just need to realize that they can't borrow their way out of debt. That and stop trying to re-inflate a housing bubble - that won't work either.
- Michaell, Teddington, England, 02/06/2009 00:19
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