OIL PRICE: BEWARE THE HUNT FOR SCAPEGOATS

With the high price of oil, consumers and politicians are lashing out in every direction. Fishermen in France have been blockading ports and pouring oil on the roads in protest. British truck drivers have paraded coffins through London as a token of the imminent demise of the haulage industry. In response, Gordon Brown, Britain's prime minister, is badgering oil bosses to increase production from the North Sea, while Nicolas Sarkozy, the president of France, wants the European Union to suspend taxes on fuel. Italy’s finance minister believes that there is a “magnum of speculative champagne” included in the price of each barrel of oil. Austria wants the European Union to impose a tax on speculation.

In America, too, politicians are haranguing oil bosses and calling for tax cuts. Congress wants to prevent the government from adding to America's strategic stocks of oil, and is contemplating a bill to enable American prosecutors to sue the governments of the Organization of the Petroleum Exporting Countries (OPEC) for market manipulation.

But the most popular scapegoats are “speculators” of the more traditional sort. OPEC itself routinely blames them for high prices. The government of India is so sure that speculation makes commodities dearer that it has banned the trading of futures contracts for some of them (although not oil). Germany's Social Democratic Party proposes an international ban on borrowing to buy oil futures, on the same grounds. Joe Lieberman, chairman of the Senate's Homeland Security Committee, is also mulling regulation of some sort, having concluded that “speculators are responsible for a big part of the commodity price increases”. The assumption underlying such ideas is that a bubble is forming, and that if it were popped, the price of oil would be much lower.

Those who see speculators as the culprits point to the emergence of oil and other commodities as a popular asset class, alongside stocks, bonds and property. Ever more investors are piling into the oil markets, the argument runs, pushing up the price as they do so. The number of transactions involving oil futures on the New York Mercantile Exchange (NYMEX), the biggest market for oil, has almost tripled since 2004. That neatly mirrors a tripling of the price of oil over the same period.

Those blaming speculators for high crude prices reason as follows. The marginal cost of producing a barrel of oil is about $75 a barrel. The current price is almost double that figure. Clearly, a lot of money has gone into commodities in the past few years. Therefore, speculation explains the “excess” in the oil price, and clamping down on it should cause prices to fall.

The impact of passive investors on the oil market is subtler than that. Typically, an index-tracker buys, say, a futures contract three months out, sells it as it approaches maturity, and then reinvests the proceeds in another three-month contract. Rolling this way earns a profit when the forward curve slopes downwards (”backwardation”).

All that money heading into the futures market, however, has pushed the price of futures contracts above the spot price, resulting in an upward sloping curve (”contango”). This affects spot prices. When futures enjoy a positive spread over the spot price, it makes sense to store oil now and sell it forward. Higher inventories dampen spot prices by allaying fears of immediate shortages.

Barring passive investors from the futures market, therefore, would send the curve back into backwardation. Oil inventories would be liquidated, as there is little point in storing crude in anticipation of lower prices. That would result in higher spot prices – perhaps as high as $200, according to economist Philip Verleger. If active speculators, who take long and short positions, were also curbed, you could also expect a spike in volatility, as liquidity drained from the market. The irony is that by squeezing inventories and curbing market participants’ ability to manage their risk, Washington’s crusade against “speculators” would make us all much more dependent on the world’s major oil producers. OPEC would surely applaud.