With oil the fundamental things apply

By Liam Halligan

Are “fundamentals” – supply and demand – keeping the price of oil so high? Or is it those nasty “speculators”?

With crude prices breaking new records last week (again), it’s a crucial question. After all, if it’s “just speculation” as many say, then even quicker than they’ve risen in recent months, prices could rapidly fall. And were that to happen, Western politicians, central bankers – and consumers – would breathe a mighty sigh of relief.

I apologise, then, for reminding readers that I’m a “fundamentals” man. As this column has argued for many years now, the main reason crude prices have increased sixfold since 2002 is that unstoppable force – “globalisation”.

The Opec exporters’ cartel has little incentive to raise production significantly, even if it could. Most members are actively opposed to Western oil majors helping them exploit their crude – not least since the invasion of Iraq. And the same majors are having huge problems finding big new fields in places where they can drill.

The naysayers say nothing “fundamental” has recently changed to push oil to the previously unthinkable levels we’re now enduring. That’s not true.

Firstly, the intellectual climate has been utterly transformed. For years those of us writing about concepts such as “peak oil” and “Saudi’s dwindling reserves” have been dismissed as cranks. But these ideas have leapt from “conspiracy theory” to “conventional wisdom” in just a few months.

Until very recently, powerful vested interests ensured such views were unfashionable. But, they’ve finally – irrevocably – punched through into the mainstream. That’s a fundamental change.

The second, related, development is that whereas commodity prices have always been subject to speculative pressure, the type of money entering these markets is now different.

For years, short-term cash has jumped in and out of commodity index funds – thereby affecting crude prices. And it still does. But recently, as the alarming oil reality we face has dawned, very serious institutional investors have started using these indices to gain exposure to rising crude.

Since 2003, the sums stashed in these commodity funds have ballooned twentyfold – to about $290bn. And this is long-term money controlled by pension funds, endowments and other bespoke investors – not fleeting speculative flows.

The alarming reality, as the dollar weakens, is that oil, along with commodities more generally, is increasingly being used as a store of wealth – a proxy reserve currency. Again, that’s a “fundamental” change.

Over the coming months, oil could feasibly fall $20-$30 as some hot money leaves the market. But it is my belief we’ve now got to learn to live with crude at $100-plus.