FUELLING OIL FEVER

As oil prices soar, many say it's time to curtail futures traders who fuelled the rise, writes Derek Scally.

THERE ARE no visible traces of the oil industry around the placid waters of Lake Zürich and Lake Geneva.

No grimy oil pumps work day and night, as they do in the Gulf of Mexico; no tankers hug the horizon as they do in Rotterdam, the world's largest oil port.

Yet these lakeside Swiss cities, far from the sticky, dirty reality of crude oil production, are home to a new kind of oil: dry, clean and virtual. In his office, Bernd Otto ignores the fantastic view over Lake Zürich and, in the distance, the snow-capped Alpine peaks.

Another set of peaks works its way across his computer screen, the price of oil on the Nymex commodities futures market in New York.

"The oil price used to just be an incidental thing," says Otto, trader and hedge fund manager at his own company, Investment24 AG. "Now the oil market is the most manipulated in the world." Otto knows a thing or two about manipulation: two years ago he blew the whistle on a German stock market guru who now stands accused of receiving kickbacks from dubious companies whose shares he pushed on his programme.

But the oil market is in another league entirely. The black stuff has doubled in price to over $145 (€92.40) a barrel in just a year. Fuel prices have kept pace, leaving consumers, businesses and governments wondering what the future holds.

The reality is that, in today's oil market, the future is no longer what it used to be. The day-to-day "spot" price of oil is, like never before, under the influence of the futures market.

The futures commodity market originated as a kind of insurance for buyers and sellers. A farmer could get a guaranteed sale price for wheat he had yet to plant from bakers who wanted to guarantee costs in case a bad harvest sent flour prices soaring.

But in the last few years, the commodities markets in Chicago and London have been invaded by pension funds, hedge funds and small investors, all fleeing the sub-prime meltdown to invest in gold, soybeans and oil.

The volume in oil futures trades has jumped tenfold in the last three years, driven by investors with no interest in the oil itself but rather the profit generated by selling on this virtual oil at a profit.

This speculation fuels expectations of higher prices and the futures are sold on again and again.

That's where Switzerland comes in, home to many of the world's biggest commodities traders who are happy to serve new customers and old.

Mercuria, one of the biggest players, is located in Geneva and pays for its expensive view over the lake with a trade in petroleum products worth almost $30 billion (€19 billion) last year.

But like its competitors, it declines all requests for comment.

Only one oil broker, Vitol, is prepared to even issue a statement, saying that it is "not interested in supporting higher oil prices and would prefer a much lower price for reasons of working capital requirements and overall credit control".

The big commodities players are anxious to avoid answering the burning question: are current oil prices realistic or, as independent traders like Otto claim, a bubble generated by big speculators chasing fast money?

Many seasoned analysts warn against the temptation of treating speculators as scapegoats or of looking for easy answers in the complex oil market.

Paul Harris, head of natural resources risk management at Bank of Ireland global markets, says there are many reasons why the current oil price is not pretty, but is still realistic.

The simplest reason, he says, is basic supply and demand. Since 2002, demand for oil has outstripped supply.

Last year's BP statistical review noted that 82 million barrels of oil were produced each day and 87 million consumed.

That scarcity is exacerbated by demand from Asia: Chinese oil consumption grew 4.7 per cent last year while India consumed 6.7 per cent more oil.

Then there's the lingering effect of the 1970s oil price pessimism. "People thought prices were going to go down to $12 (€7.64) a barrel. So, the required investment in exploration and refining capacity wasn't made because sums didn't add up and banks didn't give loans on what didn't seem like a viable proposition," says Harris.

Today, oil producers face a Catch-22 situation: if they don't invest more in finding and tapping new reserves, oil will become scarce and expensive. If they do invest, their huge capital outlay will be passed on to the consumer.

Back in Zürich, Otto dismisses these oft-cited explanations as "fairy tales".

"Every bubble begins with a good story," he says. The doubling in oil prices has arisen in just one year, he says, the demand for oil in China and India has not.

Otto expects rising Asian demand to be balanced by decreased oil consumption in Europe and the US through greater energy efficiency and lower-consumption cars.

What has really happened, he suggests, is that big oil players have managed to decouple the price of oil from the real world, aided by an overexcitable media and investment banks.

Goldman Sachs analysts have predicted oil prices of $100 (€63.7) and recently $200 (€127.4) a barrel. When prices rise, says Otto, the bank turns a profit by selling certificates to customers.

Goldman Sachs deny a conflict of interest, saying their analysts operate independently of their banking business.

Opinions differ on the causes of the current price of oil, but many market veterans say new arrivals in commodities are prone to what Alan Greenspan once called "irrational exuberance".

"When a pipeline burst in Canada, the price immediately jumped by $4," said oil trader Fadel Gheit of Oppenheimer in New York to Der Spiegel magazine. "I know that can be repaired in three days. Child's play. But the traders use every excuse in the book to drive up prices. It's pure hysteria."

As concern grows about the oil market, veteran investors like George Soros have rowed in with advice, calling for increased regulation to make it more difficult for pension funds and hedge funds to trade in futures.

One way would be to impose higher minimum investment requirements for speculative capital.

Harris favours such a plan but says a concerted effort is also needed to shore up the dollar. "When Organisation of Petroleum Exporting Countries (OPEC) can be assured that their incomes can be preserved, in dollars, or will recover or rebound, people will be more amenable to opening their taps," he says.

As the oil peaks on Nymex screens worldwide reach unheard of heights, Bank of Ireland's Harris is circumspect about the future.

"Speculators take advantage of markets. That's the nature of the job," says Harris. "You can't blame an animal for doing what comes naturally."

Back in Zürich, Otto is certain the oil bubble is close to bursting as money begins to flow back into a recovering stock market.

"It will get harder for the manipulators to hold up the oil price," he says.

"So many investors are sitting on huge, leveraged profits and no one want to be last in the row of sellers.

"But when we hear about price targets of $200-$500 (€127-€318) in the short term we know that silly tricks are being used to keep the bubble going. The end is near."