Page 56 - Aamir Rehman Gulf Capital and Islamic Finance The Rise of the New Global Players

CHAPTER 1 Floating on Wealth 41

contrast, will tend to be more conscious of cost and will be eager to uti-
lize the least expensive means for fueling their economic development.
A third basic driver of higher long-term oil prices is rooted in the
simple fact that fossil fuels are not renewable. Over time, reserves are
depleted, making the commodity scarcer. Advances in exploration
and production have the potential to increase the base of known
reserves, but the rate of growth in known reserves may not exceed the
pace of demand growth. In developed markets, where finding new
reserves can be especially challenging (such as in the North Sea in
Britain), investment in exploration tends to decrease when oil prices
are low. When prices rebound, exploration efforts come back—but
these efforts can take time to bear fruit. The reality is that fossil fuels
become scarcer with each passing day, suggesting that future prices
may well be higher than they are at the moment.
Besides the fundamental factors just discussed, the influence of
commodity investors (sometimes referred to as “speculators”) is criti-
cally important in shaping energy prices. Decades ago, oil was
bought almost entirely by companies that were end users of the com-
modity. Today, oil—like other commodities—has become an asset
class for investment by funds and other entities that have no interest
in actually using the oil. Financial investors buy oil futures because
they think their value will increase and sell them when they think
their value will decline—making decisions based on an outlook for
the market rather than a genuine need for the commodity.
This financial investment or speculation in oil can have the effect
of accelerating or amplifying volatility in the marketplace. As oil
prices rallied far above $100 per barrel in 2008, much of the buying
was being done by speculators who expected the price to rise even
further. As other speculators behaved the same way, the upward spi-
ral became a self-fulfilling prophecy. When, on the other hand, finan-
cial investors began selling oil futures, the price began to plummet
and continued falling based more on investor confidence than on fun-
damental oil supply and demand. 32 Especially as hedge funds and
other investment vehicles unraveled in the financial crisis of
2008–2009, commodity investors were forced to liquidate their
positions, and this speeded the decline in oil prices. A thorough
assessment of potential oil prices in the future must, therefore, also
take into account the key role that financial investors play in com-
modities markets. Their confidence in the oil market can drive prices
upward; a lack of confidence (or a lack of available capital by financial
investors) can drive prices downward.