Another Reason Oil Prices Are Falling?

Last August, economist Robert McCullough examined the volatility in the crude oil market surrounding the price spike on July 3, 2008 and the subsequent fall in energy prices.  In his final report McCullough examined the many events and announcements that had the potential to impact oil prices over this period.  He found that fundamental factors of supply and demand were not statistically significant, but found (on page 13 of the pdf):

The proxy for the short-lived Commodity Markets Transparency and Accountability Act of 2008 was highly significant. Interestingly, this was the only variable that would have affected excess speculation as opposed to supply and demand fundamentals…. One conclusion to be drawn from these statistics is that the news stories cited by pundits to explain the dramatic spike in oil prices have little or no explanatory power.

In other words, the prospect of regulation of the futures markets had a statistically significant impact on prices.   Let’s fast forward to the steep drop in crude this month.  While there’s certainly been negative news on the economy, we had some negative news at various points while oil doubled from February.  It is at least worth noting that the recent drop in oil coincided with a period in which Washington is seriously considering constraints on excess speculation in the energy markets. 

To the degree that excess speculation is a factor in artificially inflating oil prices, it needs a constant inflow of new money to sustain those prices, just like a Ponzi scheme needs new funds to keep the game going.  It’s hard to imagine money managers continuing to commit capital to commodities at the risk that they might be forced to liquidate if position limits are imposed.

Tags: crude oil, excessive speculation