The oil price etc

In The World's Shifting Balance, a lucid investigation into the state of the global economy, Martin Wolf notes that oil prices are higher in inflation-adjusted terms than at any moment since the beginning of the 20th century. Why? One view comes from Charles Dumas, Chief Economist of Lombard Street Research:

DUMAS: One has to accept the existence of multiple causes when it comes to commodities. People are always trying to say it’s all speculation or it’s all China or it’s all peak oil or whatever. Truth is it’s quite a lot of these things put together. The price of oil is now twice what it was a year ago and what’s happened in the meantime is that the Western world economy has deteriorated sharply, as we all know. What has also happened is that the full overheated extent of the Chinese boom has become evident and that is probably a factor behind the oil price increase. But the fact is that the annual increase in Chinese oil demand is exactly half the annual reduction of US imports going on right now - so if you put the two together, bearing in mind that the US still consumes nearly three times as much oil as China, the net of it is a substantial reduction in the call on the world’s oil.

WOLF: So is speculative activity - trading on expectations of future prices of oil - at the root of the current price rises?

DUMAS: You have to say that the speculative story is a big part of it. And of course we can be polite and call it investment if you like, but the fact is that the over the counter positions in commodity futures in general, revealed by the end of 2007, were eight trillion dollars in volume, of which probably as much as half is oil, which is to say four trillion dollars, which is approximately the annual turnover of the oil business worldwide. So you’re looking at a situation in which the speculative interest is huge. And we know of course that from the moment when Ben Bernanke at the Federal Reserve started to cut interest rates in a very aggressive and frankly panicky way last October, we were looking at ten dollar increases in oil every time he lifted an eyebrow because the basic perception of the world is that the Fed is trashing the dollar. Or was trashing the dollar. They’ve turned around a little bit over the last two or three months. My personal feeling is that when the Chinese slow down - and it is very much when, not if, which is probably going to be this autumn and winter - then the speculative interest could quickly turn round. And of course it only takes one or two percent of world oil usage to turn the price round very sharply. It doesn’t take anything like four trillion dollars worth of activity. So if a very small piece of that over the counter activity turns negative on oil, the price could come crashing down.

WOLF: This view of the future path of commodity prices is rather optimistic, though far from inconceivable...