Are hedge/investment funds artificially boosting oil/gasoline prices?

Date: Monday, April 7, 2008
Author: Joseph Lazzaro, Bloggingstocks.com

One of the most intriguing questions amid the stock market's recent slump and the three-year-plus bull run in commodities, especially oil, concerns whether or not investment funds and hedge funds have artificially boosted commodity prices.

One camp argues that hedge/investment funds now have the capacity to "distort" prices beyond what a sector's fundamentals suggest the price should be. Another camp argues that the valuation of "distort" is subjective, and in any case the market will quickly self-correct for the error, when the bubble or trough, ends.

When making arguments before Congress and other groups, the price distortion camp can point to two recent data points to make their case. First: the $23 per barrel rise in the price of oil to $111.80 from about $87 from mid-February 2008 to mid-March 2008. Second: the 14 cent jump in wholesale unleaded gasoline to $2.77 per gallon on April 2, 2008.

Inventory data

Concerning oil, there has been no fundamental change in global oil supply or demand in the past quarter. If anything, demand growth moderated in the period. Further, oil inventories in the world's largest consuming nation, the United States, rose during the period. Still, oil prices rocketed 26% during the period to record highs.

The daily gasoline price move on Wednesday April 2, 2008 also provides food for thought. On a day when weekly U.S. oil inventories showed an increase, gasoline rocketed 14 cents higher, or 5.1% to $2.77. To be sure, weekly U.S. gasoline stockpiles registered an unexpected 4.53-million-barrel drop to 224.7 million barrels, but there is no shortage of gasoline in the United States: seasonal stockpiles are well within 5-year averages. Still, the price Thursday soared to a new high.

On Friday, oil rose $1.51 to $105.34 per barrel, while unleaded gasoline fell 1 cent to $2.71 per gallon.

Two interpretations

Rachel Ziemba, analyst with RGE Monitor, says investors are boosting oil's price. "The surge in prices over the last month was not driven by any change in the oil-market fundamentals," Ziemba told Bloomberg News. "The primary reason for the rise in prices was the flow of funds by investors looking for a safe haven in the face of the credit crisis.''
Still, the market valuation camp argues the high price may have been driven by other factors (geopolitical) and that any "artificial boost" in price, if it occurred, will end when investors/speculators realize that oil or gasoline's fundamentals dictate that the price should be lower. For the market valuation camp, market errors, when they occur, don't last long, and under most cases the market price reflects a commodity's or service's real value.

Market Analysis: Absent systematic, longitudinal data, it's difficult to form a conclusion regarding the issue of investment/hedge fund sector's ability to "distort" prices. That said, the alarming increase in both oil earlier this year and gasoline this month -- when sector fundamentals suggest the price should be falling -- provides observational support to the theory that some investment players in search of return are boosting prices. At the very least, it certainly provides fodder for additional study.