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April 29, 2006

How hedge funds tax gas

The New York Times has a terrific article on the effect of speculation on oil prices. It may sound familiar to regular readers of this blog:

[C]rude oil is not merely a physical commodity that fuels the world economy; powers planes, trains and automobiles; heats cities; and provides fuel for electricity. It has also become a valuable financial asset, bought and sold in electronic ex-
changes by traders around the world.
… In the latest round of furious buying, hedge funds and other investors have helped propel crude oil prices from around $50 a barrel at the end of 2005 to a record of $75.17 on the New York Mercantile Exchange last week.
“Gold prices don’t go up just because jewelers need more gold, they go up because gold is an investment,” said Roger Diwan, a partner with PFC Energy, a Washington-based consultant. “The same has happened to oil.”
Changes in the way oil is traded have contributed their part as well. On Nymex, oil contracts held mostly by hedge funds — essentially private investment vehicles for the wealthy and institutions, run by traders who share the risks and rewards with their partners — rose above one billion barrels this month, twice the amount held five years ago.
… “Five years ago, our futures exchange was a small group of physical oil players,” said Jeffrey Sprecher, the chief executive of Intercontinental Exchange, the Atlanta-based electronic exchange where about half of all oil futures are traded. “Now there are all sorts of new investors in trading commodity futures, much of which is backed by pension fund money.”
… “Clearly the big attraction of commodity markets like oil is that they’ve been going up,” said Marc Stern, the chief investment officer at Bessemer Trust, a New York wealth manager with $45 billion in assets. “Rising prices create interest.”
This year alone, oil prices have gained 18 percent; they were up 45 percent in 2005 and 28 percent in 2004, a performance far superior to the Standard & Poor’s 500-stock index, whose gains in these years have been in the single digits. And to some extent, the rising price of oil feeds on itself, by encouraging many investors to bet that it is likely to continue doing so.
“The hedge funds have come roaring into the commodities market, and they are willing to take risks,” said Brad Hintz, an analyst with Sanford C. Bernstein & Company, an investment firm in New York.
… While all this new money has contributed to higher prices, by some estimates perhaps as much as 10 percent to 20 percent, the frantic trading ensures that even the biggest players — including the major oil comp-
anies — cannot significantly distort the market or tilt it artificially in their favor. It also makes oil markets more liquid, meaning a buyer can always find a seller.

“As much as 10 percent to 20 percent” means that with oil at $72, speculators are imposing a "tax" of up to $14 on every barrel sold. Let’s hope they’re feeling lucky:

“Everybody is jumping into commodities, and there is a log of cash chasing oil,” said Philip K. Verleger Jr., a consultant and a former senior adviser on energy policy at the Treasury Department.
“The question is when does the thing stop. Eventually they will get burned.”

The entire (lengthy) article is definitely worth reading.

Posted by Stephen at 12:52 AM in Energy + environment | Permalink | TrackBack (0)

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