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The recent fall in the price of oil is primarily the result of investors unwinding speculative positions that helped drive up oil prices earlier this year, Alan Greenspan has told the Financial Times.
The former Federal Reserve chairman said speculation was "importantly responsible" for the rapid move up in oil prices in late 2007 and early 2008.
But he said this was "good speculation" of the kind that ultimately moderates a change in prices, and not "bad speculation" of the bubble-creating kind.
Greenspan said financial speculation in oil was unlikely to resume in the near term and "there is little prospect of a renewed spike in oil while cyclical weakness continues".
If he is right, central banks around the world need not worry about the risk that oil prices might rebound in the absence of a positive surprise on global growth. All other things being equal, this would imply a looser path for monetary policy.
Greenspan said that while the long-term rise in oil prices was "wholly a physical phenomenon", financial speculation influenced the "timing and profile" of price increases.
"Financial speculation did play a significant part in the rapid increase in oil prices," Greenspan said.
From 2004 onwards financial investors identified a one-time opportunity to profit from the expected increase in the price of oil caused by pressure of mounting demand on constrained supply.
"It was classic stabilising speculation," he said. "It brought forward the price increase that would have otherwise taken place over a much longer period of time, reducing demand sooner and ultimately cutting the top off the intermediate peak price."
Many experts reject the idea that financial speculation played a significant role in driving up oil prices, arguing that it did not affect the underlying balance of supply and demand for oil.
Greenspan disagrees. He said the data suggested that financial investors from 2004 onwards built up a large net long position in crude oil futures.
The counterparties to their net long positions were owners of oil inventories, who in effect sold forward some of their existing stock of oil.
In order to compensate, the owners of oil inventories stepped up their acquisition of new oil. "This showed up as a significant rise in the stock of usable crude - that is, oil inventories over and above that needed to keep the pipelines, tankers and refineries operating."
Increasing demand
Over the past year, he said, owners of inventories continued to bid for oil, but their attempts to replenish their owned stocks were largely thwarted by increases in demand from China and other emerging economies.
Greenspan said financial investors began to unwind their net long positions in July to realise capital gains amid indications of slowing global growth, removing the upward pressure on oil.
This reinforced the "demand destruction" caused by high prices sustained for long enough to allow consumers and businesses to change their behaviour.
However, Greenspan said the underlying supply/demand balance suggested "we will not go back to $80 or lower". Once the current economic downturn was over, "oil could go back to $150 or higher" unless oil producers significantly increased their capacity.
But he said: "Future price increases will probably be stretched out over a longer period of time than the increases from mid-2007 to mid-2008."
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