TOPICS > Economy

Oil Market Focuses Attention on Mideast Conflict

July 21, 2006 at 6:25 PM EDT

PAUL SOLMAN: Bedlam as usual at midtown Manhattan’s Man Financial, one of the world’s top commodity brokers.

FUTURES TRADER: Give me that. I’ll give him a shout. I’ll get him rolling.

PAUL SOLMAN: In the Middle East, Hezbollah versus Israel. Hanging on every headline, it seemed, the oil futures market, which, opened for electronic trading Sunday night at 6:00 p.m., would start trading on the exchange floor in less than an hour on Monday. We asked Andy Lebow for recent prices.

ANDREW LEBOW, Man Financial: Yager (ph), what was last night’s range?

FUTURES TRADER: It was from $77.74 to $75.60.

PAUL SOLMAN: That’s a $2 difference within minutes, a 3 percent plunge, about 300 points if this were the stock market.

And that was because the Israelis said what right over here at 6:00 in the morning?

ANDREW LEBOW: That they may very well wrap up the military offensive in a couple of days.

PAUL SOLMAN: And then that was denied?

ANDREW LEBOW: Came to here. It’s up here now. There’s a refinery on fire in Venezuela right now, so the market has rallied up further.

PAUL SOLMAN: And that chart only went up to 6:00 a.m. What’s the price right now?

ANDREW LEBOW: It’s about the same.

PAUL SOLMAN: The same, unless, of course, the Mideast crisis spreads and drives the price up above last Friday’s record $78 bucks a barrel. And that gets us to the key question of this story: What moves the oil market? Lebow’s answer: the usual suspects.

ANDREW LEBOW: It’s supply and demand, lack of spare production capacity, lack of spare refinery capacity, geopolitical fears.

PAUL SOLMAN: In short, a familiar story: the geopolitics of the Middle East; too few refineries; surging demand for oil in China and India; supply problems in Iraq, Nigeria and Venezuela.

But before we take things further, either here or at the actual futures market itself, an even more basic question: What are futures for? Why not just buy and sell oil in the present, like you do mittens or melons? Well, imagine you bought a million barrels of oil at $76 a barrel and the tanker toting it is a week away from port.

Predicting the future

ANDREW LEBOW: If I'm worried that the price of oil in that boat is going to go down, then I am going to want to sell futures in order to protect against my downside.

PAUL SOLMAN: The downside that the price will sink by, say, $5 a barrel to $71 before the boat docks. With a million barrels, that would cost him $5 million. But on the futures market, he can make a side bet, which will pay him the difference between $76 and the lower price -- in our made-up example, $71 -- the price on the day his ship comes in. So he locks in $76 with this so-called futures contract.

ANDREW LEBOW: And if the price goes down, I'm going to profit on the futures markets. If the price goes up, I'm going to lose money on the futures, but my physical barrel is going to be higher.

PAUL SOLMAN: So Lebow would be hedging, protecting the price of the physical oil he's already paid for. But, of course, he can only buy oil at a price in the future if someone's willing to sell at that price.

And that's why there's a futures market: the NYMEX, the New York Mercantile Exchange, where traders like those in the pit match up orders from oil suppliers and users with investors and speculators willing to take risks. What's new these days is the flood of investment and speculation money flowing through this floor.

Half of Man Financial's trades are done for oil users and suppliers, called commercials. They phone folks like Lebow; he relays their trades to the Man men on the floor, the ones in blue and red jackets.

But the other half of Man Financial's clients are now investors and short-term speculators, who've jammed an extra $100 billion into the market in just the past few years, often investing your and my money via mutual funds. Some think these investors are driving up the price, but not Lebow.

ANDREW LEBOW: Ultimately, the price will respond to supply and demand. And speculators don't control supply and demand; the commercials do, and the end users do, and governments do.

PAUL SOLMAN: Ultimately. But what about now, with the Middle East again in flames right there on TV? Dave Shapiro had been on the desk for 16 hours straight.

Are investors and speculators driving these huge swings?

DAVID SHAPIRO, Man Financial: Oh, without question.

PAUL SOLMAN: Economic theory says the more investors in a market, the more stable it is. Shapiro doesn't see that these days in oil.

DAVID SHAPIRO: Any time you get a piece of news like this, that is a market-moving piece of news, these moves get exaggerated because people are like, "I've got to get out. I've got to get out, and, you know, damn the price." And they'll just sell into it, if they feel they have to get out. If they sell it hard now, and they think it's going to go down another dollar in the course of a day, they'll hit it hard now and, you know, damn prices. "I got to cover my positions."

PAUL SOLMAN: What do investors themselves say? Eric Bolling, tossing a completed trade into the pit, makes side bets for his own account, based on, among other factors, geopolitics. But though a rocket had just hit Haifa in Israel, neither he nor the market took much notice.

ERIC BOLLING, Energy Trader: Although terrible, a building hit in Haifa has really no impact on the price of oil. There's no oil in Haifa; there's no production, per se.

Iran produces probably in the top-four producing nations in the world. They produce oil that the world needs, and it's such a tight supply-and-demand situation going on right now that any sort of supply disruption from the Iranians would cause prices to spike.

Who's driving up the price of oil?

PAUL SOLMAN: While Israel versus Hezbollah wasn't disrupting supply, yet. And how much of today's price is driven by investors, does Bolling think?

ERIC BOLLING: My guess would be somewhere around 10 percent of the barrel, $7, $8.

PAUL SOLMAN: And if you shave that $7 off today's price? Subtract another $15 or so for geopolitics -- Iraq, Nigeria, Venezuela -- says Bolling, and yet another $7 to $10 due to fears of a terrorist attack on America, you're left with a long-term base price of oil of $40 to $50.

At the NYMEX show-and-tell exhibit, oil analyst Larry Goldstein agreed with the $40-to-$50 range. How much does he attribute to speculation?

That guy behind you is presumably taking an order from some investor somewhere to buy or sell a futures contract in oil. How much are those investors behind that guy driving up the price of oil?

LARRY GOLDSTEIN, Petroleum Industry Research Associates: We believe, in the short term, they're having a dramatic impact on driving up the price of oil. But the price of oil, with or without them, would be historically high.

PAUL SOLMAN: But by how much is just a guess. Meanwhile, back in the pit Monday, it was 3:00 and trading had ended.

ERIC BOLLING: We're closed.

PAUL SOLMAN: And what happened?

ERIC BOLLING: Well, we're down about $1.80 right now. The final price hasn't come up yet. There we go, $75.30. So it's $1.75 lower on the day.

PAUL SOLMAN: Even though war is possibly raging in the Middle East?

ERIC BOLLING: Right. Well, again, it has less to do with Israel and Lebanon and more to do with the Iranian response to Israel and Lebanon, and the Iranian response to the U.N. Security Council asking them to back off that uranium enrichment program.

PAUL SOLMAN: On Monday, and in the days immediately after, the Iranian response wasn't that bellicose, so the price subsided, said Eric Bolling, and...

ERIC BOLLING: .. and that's a very good thing. It's a good thing for the world. It's a good thing for the price of oil. It's a good thing for the economies in the world.

PAUL SOLMAN: A good thing, for the moment.