The Price of Fear in your Gas Tank

Ever wondered how much of the oil price is pure hype or fear? Well there is an interesting article in today’s New York Times, which quotes Michael Rose, the director of the energy trading desk at Angus Jackson in Fort Lauderdale, Florida who says that “Crude is coming down because it was way too high,” Mr. Rose said. “We had so much fear put into this market, that somewhere between 10 and 20 dollars were fear premium.”

Yes, read that again – so up to a third of what you have been paying for a barrel of oil has been fear – fear of supply disruptions hurricanes in the Gulf of Mexico or fear of war with Iran. As crude trades at its lowest level since March because “today the weather is nice and the Iranians are lowering their aggressive posture.”

While you have been paying more at your gas station, traders such as Mr. Rose have been making a quick buck, selling short stocks and futures contracts. In many cases, traders are betting against the very bets they made only a few weeks ago.

Betting on the future price of oil is now big business. Oil contracts held by hedge funds, the private firms run by traders who have large stakes in the risks and rewards of their clients, have doubled since 2001 as oil prices spiked. The growth in the number of big investors, like pension funds, in futures trading has led to large and rapid capital inflows into crude oil.

In a research note on Friday, Wells Capital Management predicted that oil prices would head for about $50 a barrel. “An oil crisis based on excessive oil dependence is hard to reverse, but one based on excessive risk premiums could quickly reverse.”

Some predict the price of oil could rapidly fall. “On the way up, there is buying greed,” said Gary Pokoik, who manages Hedge Ventures Energy, a Los Angeles hedge fund. “And on the way down there is a selling panic. The drop could snowball.”

One thing making traders more relaxed are the recent huge finds of oil by Chevron in the deep waters of the Gulf of Mexico. But if these turn out to be over-stated then the price will rise again. Someone will be betting on that right now.