Oil demand and speculation

According to a Lehman Brothers study, for every $100 million new inflow of funds, crude oil prices go up by 1.6% or approx $ 2.2 a barrel.The amount of Commodity index futures held in 2003 was 0.4 million and in 2008 its over 2.8 million. Out of 2.8 million futures currently held , the number of contracts held by physical hedgers is approximately 1.6 million contracts. The remaining 1 million odd contracts are held by speculators.

As per a study held by a wall street investment bank. In 1998 the value of Commodity Index futures contract held by physical hedgers was 79% compared to 34% in 2008.In the case of Crude Index speculators have increased their share holdings from 12% to 31% and crude oil futures from 16% to 32%.The economist data reveals that the Annual change in world oil consumption peaked in 2004 to 2.5 million barrels a day , since then it has slowed down to 0.8 million barrels in 2008

In an testimony before US senate comittee on Homeland security and Govt affairs, Masters showed that index speculators have a stockpile of futures equivalent to about 847 milion barrels of oil. To have an idea of the amount of speculation. China and india who are blamed for increase in the crude oil prices consume approx 2550 and 910 million barrels respectively per year.

Petroleum Minister for India Mr. Murli Deora while addressing the World petroleum conference in Madrid on Thursday rubbished the Wests theory that the rise in demand for Oil and gas was fuelled by China and India. He said that China and India account to less than 13% percent of worlds oil consumption. He also said that both the countries have registered rapid economic growth with a less than propotionate demand for Oil.

Experts say that speculation plays a major role in the crude oil prices and the future holds high risks.Crude oil closed at $145.3 a barrel on NYMEX exchange.

Oil Bubble ?

Are Oil prices driven by economic fundamentals (supply and demand theory) or are speculative investors (pension funds, index funds and hedge funds) to blame for the very high rise of oil prices in recent months?

China is one of the cornerstones of the energy bull story. It is widely assumed that it will have an almost endless appetite for oil over the next few decades. An economy very dependent on industrial production combined with rising living standards, or so the argument goes, will demand enormous quantities of the black gold.In reality, though, Chinese oil consumption has actually decelerated in recent years. The chinese have accumulated a lot of disel in the first quater of 2008 in view of the Beijing olympics. Once the games are over there will be a big surplus of diesel inventories.

According to Morgan Stanley, half the world’s population currently enjoys fuel subsidies of some kind. As the price of oil continues to rise, the situation becomes increasingly vulnerable for most of the governments providing these subsidies.Egypt raised petrol prices by 40% only a couple of weeks ago. So did Indonesia (+33%) ,Sri Lanka (+25%) and India (+10%).

Saudi King Abdullah told UN Secretary General Ban Ki-moon last Sunday that the kingdom would do everything it can to bring “abnormally high” oil prices to “adequate levels.” OPEC blames speculators for inflating oil’s rally and adding to volatility and wants increased regulation of futures markets. Investment funds have pumped billions of dollars into oil markets as they look to diversify holdings and flee other poorly performing asset classes.

Saudi Arabia’s oil meeting on Sunday is key to setting the direction of the oil price, which this week hit a record high of $139.89 a barrel. On Friday, oil prices closed at $135.13 a barrel, up 40 per cent since January.Saudi Arabia could announce some kind of production increase together with a reduction in the prices it charges refines around the world, particularly to the politically sensitive US, but also to Asia.

The Oil prices are bullish in the long term ( based on the growing economies and GDP growths of India and china) but in the short term oil is heading for a sharp correction. Oil may correct to levels of $110 a barrel or less in the coming weeks.

Investing in Commodities

Investing in commodities can be done in a number of ways like …

Investing in companies that produce commodities
Many investors already hold shares in such companies or hold units in collective investment schemes such as unit trusts which invest all or part of the fund assets into such companies

Buying or selling commodities on the ‘spot market’ for immediate delivery.
This involves high transaction costs and is not a suitable method of investment for individual investors

Buying or selling thru commodities exchanges for later delivery.
Most trading in commodities is done through ‘futures’ and ‘options’. Taking positions in individual commodities is essentially speculative and should only be undertaken by professional investors who can afford to lose large sums of money if things go wrong.

It seems an obvious statement but commodities make a return for investors if prices rise after purchase. They generate losses if prices fall. Unlike financial assets, commodities offer no gain from interest income or dividends.

What are Commodities?

Commodities are bulk products, such as Coffee, Beef, Gold, Oil, Copper and Wheat, to mention just a few. These are the raw materials that are economically profitable enough to be traded on special commodity markets. They are split into ‘hard’ commodities such as Gold, Copper, Zinc etc, and ‘soft’ commodities such as Cocoa, Coffee, and Sugar etc.

There is strong demand for commodities from the emerging economies, particularly those referred to as the BRIC countries, that is, Brazil, Russia, India and China. This strong demand, combined with a finite and inelastic supply has created a bull market.

Emerging economies generate a disproportionate demand for natural resources. They need hard commodities such as steel, nickel, tin and copper, for their industries and soft commodities, such as cocoa, coffee, soybeans, potatoes, wheat and barley, to feed an increasingly urban population.