Casino Economy

It's nice to know that this is all just a giant slot machine.

Analysts say that the oil market looks overheated, and a number of factors could puncture the price bubble. Most important, speculators have played a key role in driving up crude prices this year, and if the trend reverses they'll get out fast. Certainly, global demand remains strong for now. But a number of factors—technical indicators, an economic slowdown, lower demand—could prompt investors to exit en masse.

"Oil prices are in uncharted territory," says Peter Fusaro, co-founder of the Energy Hedge Fund Center, which tracks commodities hedge funds. "My worry is that if the market tanks, everyone will want out at the same time. The market would collapse, and who knows what the bottom is."

Speculators have played a growing role in the oil market in recent years (BusinessWeek.com,1/17/07). There are 595 hedge funds that engage in at least some energy trading now, more than triple the 180 funds involved just three years ago. Fusaro estimates the assets involved in such trading total more than $200 billion, up more than 60% from the beginning of the year.

It's tough to get a firm handle on the speculation. A large portion of trading takes place in the unregulated, over-the-counter market. Still, some of the trading in crude oil takes place on the New York Mercantile Exchange (NYMEX), and there the market is approaching a record in terms of the number of crude oil contracts that predict a price rise. Traders have committed to 135,000 contracts—each representing 1,000 barrels of crude—betting that prices will continue to rise. That's just shy of the record 155,000 contracts reached this summer.

Some analysts say that if the number of contracts rises sharply, oil prices could fall. "The exit signal for investors could be breaking through the 150,000 or 160,000 contract barrier," says Joel Fingerman, president of OilAnalytics.net, an energy consulting firm. "At that point investors could feel they're using all their bullets."

In the meantime however, investment continues to flood the crude oil market, as well as commodities in general. "The mentality now is very bullish," says Fingerman. "As long as money keeps flowing in, people will keep buying [oil] as though it's going to go to the moon."

The optimism has helped the stocks of the oil majors. ConocoPhillips (COP) is up nearly 40% (BusinessWeek.com, 10/26/07) over the past year. ExxonMobil (XOM), Chevron (CVX), British Petroleum (BP), and Royal Dutch Shell (RDSA) have posted similar if somewhat smaller gains.

So speculators and hedge-funds, not exactly discouraged by the oil companies themselves, have overvalued oil futures to their own benefit. Real supply is probably either peak or past-peak, and China's demand (and ours, of course) is only accelerating. Since oil companies have profiteered handsomely this entire time, once future specs do correct themselves and drop (assuming they do, which is no guarantee, given demand and supply issues), they're not going to let their own valuations be adversely affected. They'll find other modes of price support if they have to.

Trickle-down enthusiasts informed us, usually as condescendingly as possible, that if the people at the top made money, the people at the bottom would also make money. What they never want to admit is that not only is the profit-taking never commensurate with labor input, thus enhancing income disparity, but that since it's their casino, they also make money even when (frequently because) we don't.

The house always wins.