How Speculators Increase Oil Volatility

1/16/2007 article:
On Jan. 16 2007, oil prices tumbled yet again, dropping 3% to settle at $51.21 on the New York Mercantile Exchange. Oil is down 35% from its high of $78 in July 2006. It's already off 16% so far in 2007.

Financial firms remain influential players in the energy markets. Stephen Schork, energy consultant and editor of The Schork Report, says that speculators have wielded significant influence on oil prices over the past five years—and have played a major role in both July's price spike and the current slide. "Speculators are definitely playing the market," he says. "They were bullish last summer, and now they're pulling back."
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How Hot Money Inflames Oil Prices
- Without any major changes in supply or demand, the price of oil has been tumbling, dropping below $59 on Oct. 3. That's 25% off the peak of $78 in July. Natural gas prices have fallen even more sharply, to $5.80 per million Btus from $15 last December, a drop that likely precipitated the $6 billion blowup at hedge fund Amaranth Advisors (see BusinessWeek.com, 9/19/06, "Behind Amaranth's Sudden Swoon").

Out of every dollar that gets put in the Goldman Sachs Commodity Index, 70 cents goes into energy," notes Sol Waxman, who follows hedge funds for the Barclay Group financial advisory firm. "Does that have an impact on price? I would suspect so.

Hedge funds and other investors may have helped push oil prices up. Now, they're helping push them down—and fast.

How low could oil prices go? Despite the recent fall in prices, the consensus among Wall Street analysts is that oil will still average $65 a barrel in this year's fourth quarter before falling to $62 next year. Those estimates could be quickly adjusted downward if prices continue to slide. "If you see a lot of money getting out, it could get pretty ugly," says Dell. "You could see crude drop past $40." Good news for motorists, bad news for energy investors.