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Authors say crisis forces remain at work on oil price

Bob Tippee

If you think stability has returned to the oil market, two Rice University researchers have a message that should slosh your coffee: The crisis isn’t over.

The latest oil-price gyration, say Mahmoud A. El-Gamal and Amy Myers Jaffe, was part of a lingering triangle of forces that have shaken economies in the past.

El-Gamal, chair of the Rice economics department, and Jaffee, director of the Energy Forum of the James A. Baker III Institute for Public Policy at Rice, treat the subject in a new book from Cambridge University Press: Oil, Dollars, Debt, and Crises. They discussed their thesis recently at the Baker Institute.

Two of the three forces they identify have received new attention lately: financial trading and oil markets.

“Financial investors think of energy as an asset class,” El-Gamal said. In 2004, with demand for the physical commodity rising, oil was one of a relatively few tradable assets with prices moving enough to offer attractive returns, he said.

Oil also seemed to provide protection against a dollar weakening under the strain of US trade imbalances with China. So big financial investors, hedge funds, borrowed heavily to buy oil derivatives in what El-Gamal called a “double bet.”

The increased buying amplified the upswing in oil prices through mid-2008 and the downswing that followed in a slumping economy.

As Jaffe explained the phenomenon, “dollar pessimism” grew with the US trade deficit. And the trade deficit grew because the US had no way to avoid buying oil of escalating price.

“It was very clear in 2007 that we were on a collision course with a crisis,” she said.

Although the oil industry seems to be “breathing a sigh of relief because the down cycle only lasted 6 months,” she said, instability lingers.

Past crises coincided with the third force noted by the coauthors: geopolitical upset, such as the Yom Kippur War in 1973 and the Iranian Revolution in 1979.

In financial and oil markets following the most recent disorder, E-Gamal warned, “The dynamics that caused the crisis are still in place.”

And, Jaffe pointed out, “Iranians are back in the street.”

(Online Jan. 8, 2010; author’s e-mail:

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