ROBERT SIEGEL, host:
The steady increase in the price of oil is usually explained in a fairly straightforward way. Fast growth in places like China and India has created a market in which supply just barely matches demand, a market where all the buyers are worried about possible disruptions - anything from political unrest in Nigeria to corroded pipelines in Alaska.
Well, that's the typical explanation, but some in the industry think it's leaves too much out, that there are other factors that are just as important as the relationship between demand and supply.
NPR's Adam Davidson reports.
ADAM DAVIDSON reporting:
There is a word that more than likely you've never heard before and more than likely you'll start hearing a lot, because this word helps explain what's going on in the oil markets. The word, contango.
Mr. TIM EVANS (CitiGroup): It's the dance of love.
DAVIDSON: That's what it means?
Mr. EVANS: Well, no. I'm comparing it to the Argentinean dance.
DAVIDSON: Which it is not.
Mr. EVANS: Which it is not.
DAVIDSON: That's Tim Evans, who studies futures markets for CitiGroup. He explains that contango exists when the future price of oil is higher than the current price of oil. Let's say you owned a barrel of oil. You could sell it to someone today for the going rate, or you could sell them a futures contract, a promise to give them that oil in, say, six months for a price you agree on today.
Oil companies and others like to buy these futures contracts to make sure they've got oil coming to them well into the future. But lately, people who have nothing to do with the oil industry are buying these oil futures. Why?
Oil analyst Phil Verleger.
Mr. PHIL VERLEGER (Oil Analyst): This is like taking candy from children. This is risk-free returns of 15, 20 and 30 percent.
DAVIDSON: With contango, with a future price higher than the current price, you buy oil today for $71. In the same day, today, you sell a futures contract, a promise to deliver that oil in six months for $76. All you have to do is hold onto the oil for those six months and you have made a guaranteed, locked-in profit of $5, which is an annual return of 14 percent with virtually no risk. That beats just about every other investment - stocks, bonds, treasury bills.
So, Phil Verleger says, big investment banks, which normally don't buy oil, are buying a lot of it.
Mr. VERLEGER: And that would be Morgan Stanley, Goldman Sachs -
DAVIDSON: These are some smart investment banker looking around the world for opportunities. It could have been the Vietnamese shrimp harvest. It could be nickel from Cuba. It could be anything.
Mr. VERLEGER: That's right. I mean, they look and if shrimp in Vietnam look like a better investment, that's where they'll put their money. But right now, the risk-free returns being offered by the oil market are pretty terrific.
DAVIDSON: The investment banks are making so much money from oil futures that they've become a hot investment for all sorts of big-money players. Pension funds, for instance, are putting billions of dollars into oil futures. Ben Dell is an oil analyst at Sanford Bernstein.
Mr. BEN DELL (Oil analyst, Sanford Bernstein): I think if you saw all the pension funds walk away and just even stop buying increments, you'd probably see a $20 drop in the crude price.
DAVIDSON: They're that big an impact?
Mr. DELL: It'd be like losing the whole of Chinese incremental demand.
DAVIDSON: This is surprising. Dell is saying that oil prices are high not just because China is gobbling up more oil, not just because Iran is arguing with the world or Iraq is in chaos, but because U.S. pension funds - maybe your pension - are buying a lot of oil and just storing it. But the headlines keep telling us that oil is high because of Iran, Iraq and Nigeria.
Mr. DELL: They've become the scapegoat for everything else. Yeah, oil prices go up. Why is it? Well, it's got to be Iran because I can't come up with any other reason for it.
DAVIDSON: Dell's views could be good news for consumers. The world can only store so much oil, and when all the oil tanks are filled, the investment banks will no longer be able to make that easy money. They'll start buying some other investment, demand for oil will go down and so will prices.
There are many oil analysts who disagree though, and say oil prices will stay high as long as there is trouble in the Middle East, and that could be for a very long time.
Adam Davidson, NPR News.
NPR transcripts are created on a rush deadline by Verb8tm, Inc., an NPR contractor, and produced using a proprietary transcription process developed with NPR. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of NPR’s programming is the audio record.