Something funny has happened to the price of oil: It no longer reflects reality. The reason, according to Fadel Gheit, one of Wall Street's top energy analysts, is that “financial players have seized control of the oil markets”. Find out how they did it in this week’s Seven Questions.
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Marginalized: It is global energy traders, not oil cartels, that set the price of oil these days.
Foreign Policy: The price of oil has come close to reaching $100 recently. What does that $100 figure mean?
Fadel Gheith: It’s a psychological number. I mean, what’s the difference between $100 oil and $99 oil? There are a lot of futures contracts tied to hitting this number of 100, but it’s only another number; it really doesn’t mean much.
FP: The International Energy Agency is now saying that it’s really growing demand from China and India, not tight supply, that is driving these high oil prices. What do you make of that argument?
FG: Well, that is also true, but does it change the equation so much that we see oil prices up 60 percent in less than six months? Obviously not. I’ve been in this business for 30 years, and I can tell you, I try to justify $60 oil and I can’t find any plausible reason to think that oil prices should be a dollar above $60, let alone above $90 or $100.
FP: So what about derivatives trading—
FG: That’s exactly what I’m focusing on. I truly believe that major investment banks and a large number of very high-risk-taking financial players have seized control of the oil markets, especially in the last six months. During that time, oil prices moved in one direction and market fundamentals really moved sideways or even lowered. Demand has slowed down significantly. We have seen all kinds of indications that we are reaching a breaking point here. We’ve seen what happened to gasoline margins on the West Coast; they’ve dropped to an almost 18-year low. All this is an indication that something is wrong with the system, that supply and demand fundamentals do not justify the current price. But if the current price is based on speculation, there is no limit to how high oil prices can go. Basically, as long as there is somebody willing to bid higher, the price of the commodity will move higher.
FP: How much of the price of oil right now is really a “risk premium” associated with political turmoil in places like the Middle East, Venezuela, and Nigeria?
FG: Well, it’s very difficult to really quantify it. I wish there were a scale or a yardstick that one can use to do that, but one can deconstruct the $97 oil price and compare it to the $67 oil price only three months ago and see what happened in the world to push oil prices by $30 over a very short period of time. And basically, I can cite a few: The sharp drop in the U.S. dollar because of the Federal Reserve cutting interest rates; increased tension in the Middle East with tough talk by the administration against the Iranians; also, the dispute between the Kurdish rebels and Turkey—all of these things basically gave the financial players additional ammunition, if you will, to push the fear factor to a higher level. I do believe that oil prices are inflated, and significantly. If I were to quantify how much, I would say at least $40.
FP: So, in other words, our own fear is driving up the price of oil?
FG: Well, if you are a commodity trader, you want to do your best to push the commodity price in the direction that you forecast. And obviously, when you have a lot of financial players making bets on much higher oil prices, they would like to see a self-fulfilling prophecy. They want to see oil prices reach the level that they put the bet on. So, they can spread rumors. And if the glass is half empty or half full, they will say it’s empty.
To my knowledge, there is no oil shortage. Any willing buyers will not have a problem finding oil. Global inventories are over 4 billion barrels. In simple math, that is the equivalent of all the oil produced in the Middle East for six months. So, the fear premium, in my view, is totally exaggerated; it’s not justified by logic or market fundamentals. Again, it’s very difficult to quantify fear. But that is the psychological factor, in my view, that is bringing oil prices to these unprecedented levels. For instance, I don’t believe that Iran is going to cut oil exports, because Iran needs the revenue more than the world needs Iran’s oil. We have to be logical in assessing the risk. And obviously, financial players want to exaggerate the situation so that the risk premium increases and they make more money.
FP: Are you saying that without all that exaggeration, oil would be selling for less than $60 a barrel?
