Tightening Oil Markets Will Bring the Speculators Back

With oil prices now already above $80 per barrel and likely to hit triple-digit levels within months, you can expect to hear a lot more about the role of speculators in the marketplace. It's always easier to find a convenient whipping boy than to recognize that depletion and the prospect of ever more costly fuel in the future are the real problems.

For many people, the fact that oil prices fell below $40 per barrel during the depths of the last recession meant that oil had no business ever trading at triple-digit levels in the first place. For them, $147-per-barrel oil was just a speculative bubble that, like all bubbles, inevitably burst.

Few could deny that speculators weren't long oil when it soared to almost $150 per barrel, just as they were short oil when prices came crashing down. But focusing on the role of speculators is very much putting the cart before the horse.

What folks don't mention is that when oil prices eventually crashed during the recession, so did oil demand -- and not just speculative demand, but real economic demand. That's what happens when essentially oil-powered economies experience severe contractions. In 2009, global oil demand fell for the first time since 1983 -- a testament to the severity of the last recession.

While drivers may have liked the pump prices that came along with the recession, oil producers certainly didn't. Investments in future production, from Brazilian deep-water to Canadian tar sands, were slashed literally overnight as the price of oil fell well below the cost of developing new supply.

As I've said before, peak oil isn't a problem if the economy it's powering is shrinking. Triple-digit oil prices are only a problem if we want the economy they're fueling to grow. And most of us do.

As I've also said previously, the first thing you identify in an economic recovery, even the most anemic one, is that the economy starts burning more oil. The next thing is that oil prices start rising rapidly. Already they're at more than double the levels of the last recession's lows, and that's with most major oil-consuming economies (including the world's largest oil guzzler, the US) still operating well below their pre-recession levels.

Movements in oil prices have never been linear in the past, and there's no reason to expect them to be so in the future. The interaction between genuine market forces and financial speculation is a fact of life in virtually all commodity markets.

Speculators have been in the oil market before, and guess what? They'll soon be back. And it will be the same pull as ever -- that of a world ever more desperate for the increasingly expensive fuel that got them on the price bandwagon last cycle and that will soon draw them back again.