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EDITIONS
Friday, 22 September, 2000, 09:13 GMT 10:13 UK
Oil: New rules of the trading game
City dealers
Derivatives trading has gained an undue influence on oil prices, Opec says
Market speculators using sophisticated financial instruments are having an increasing influence on oil prices. Could their activities bring about the world's next financial catastrophe? Rodney Smith investigates.

The secretary general of the Organisation of Petroleum Exporting Countries (Opec), Rilwanu Lukman, says the world oil market is held captive by the derivatives markets. The old rules of supply and demand have been distorted, he says, by the creation of what he calls "paper barrels" of oil.

Opec president Ali Rodriguez says that at least $8 of the oil price is due to speculation.

They are both articulating the anxiety at the loss of control felt by the Opec oil producers. They can no longer manipulate the market mechanisms that have made them lots of money recently, but which no longer respond to the old fashioned rules they prefer.

Thus, says Mr Lukman - and he should know - the time has long gone when the complex trading systems that are responsible for moving oil around the world from producer to consumer were only governed by the rules of supply and demand.

Mr Lukman was for many years Nigeria's oil minister and representative at Opec, and as one of the organisation's oldest hands, has watched the oil market closely for almost three decades.

Evidence of what he means, he says, is the way the world called for 700,000 barrels of new output to stabilise prices several weeks ago.

Opec produced 800,000, and still oil prices rose.

Little shortage

Many oil experts say this is simplistic. Much of the 800,000 barrels was already in the market, and the rest would not come on stream until the start of October, and could not, therefore, be counted against current shortages.

But the same experts agree that there is little evidence of real major oil shortages worldwide.

There is misallocation - the wrong types of oil are in the wrong places - and there is oil in transit that still has to reach destinations that need it.

But the fact is that there is enough oil.

It is hard not to sympathise with Opec when its officers say the derivatives markets are to blame.

Then we have the small but budding industry of experts who warn that the next international financial catastrophe will be brought on by the derivatives market.

Their arguments can be compelling - they say the complex instruments involved are rarely understood by the people who buy them, and the collapse of only one or two could trigger long chain reactions throughout the financial universe.

These are the people who remember with undiluted horror the astonishing ease with which the leading derivatives designer, Long Term Capital Management, went spectacularly bust two years ago, threatening for a while a very wide financial fallout zone.

Dangerous effect

If oil prices are pushed to $40 and beyond by speculation - paper demand for non-existent paper-barrels - the effect on the world economy would be dangerous.

Like the run on petrol and diesel fuel in the UK over the past two weeks - the shortage was much less severe than the fear of shortage made it seem - the reaction could be more damaging than the event itself.

There would be fuel shortages, real or imaginary, prices of other goods would be increased to compensate for higher costs and soon the pieces could be in place for an uncomfortable Christmas in the northern hemisphere.

The French budget is evidence of damage already - a government anxious to show how well its economic management is progressing has had to guess its growth forecast for next year - 3% to 3.6% depending on what happens to the oil price.

David Naude at Deutsche Bank in Paris is one of many who thinks even that may not be a prudent calculation, and could be over-optimistic.

One of the worst effects of an oil shock could be its impact on that extraordinary but fragile flower, public confidence.

Public confidence

The extraordinarily good performance of the US economy in recent years has owed much to new technology, as Federal Reserve Board chairman Alan Greenspan never tires of repeating - and to public confidence in that technology - hence the astonishing multiples at which many of the new tech companies still trade.

Dent that confidence and the pack of cards could collapse. Remember the collapse of World Online's share price? Not because the company had done anything, good or bad, but because the founder had sold shares at a discount outside the lockup. That is loss of confidence.

Many will remember the awful feeling in the last recession, in the early 1990s - or the 1987 stock market crash, or the British property bubble - where you know nothing fundamental has changed - but people who spent freely before, took chances before, stop doing all those things, and everything slows down, share prices fall - confidence ebbs away.

There is a model right in front of us; we don't look at it very often because we don't speak Japanese. But the people of Japan have endured ten years of recession - the alleged recovery even now may owe more to government spending programmes than real investment - in which they have seen some of their best known manufacturers slip into foreign hands.

Tokyo's magnificent and opulent department stores have been replaced by thrift and economy shops.

All because the people lost confidence in their economy 10 years ago.

It could happen here - and an oil shock could do it.

Links to more Business stories are at the foot of the page.


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