Biggest dive for commodities in 28 years

By Javier Blas in London

Published: July 31 2008 23:35 | Last updated: July 31 2008 23:35

Commodities prices suffered their largest monthly drop in 28 years in July as crude oil prices nose-dived more than $20 from an all-time high of $147.27 a barrel.

The Jefferies-Reuters CRB index, a global commodities benchmark, lost 10 per cent, its largest monthly decline since it fell 10.5 per cent in March 1980, amid worries about lower economic growth damping demand for raw materials.

EDITOR'S CHOICE

Lex: China and commodities - Jul-31

Q&A: Fuelling a bubble? - Jul-28

Debate on oil speculators hits new pitch - Jul-25

The Short View: Oil and US banks - Jul-23

Thirsty markets eye water - Jul-23

Crude and food falls help lift equities - Jul-23

Natural gas, corn, wheat and freight costs plunged last month between 10 and 30 per cent, although from record levels. However, lead, used in car batteries, surged almost 25 per cent on tight supplies.

The fall in energy and agriculture prices will be welcomed, if persisted, by central banks facing rising inflation. But commodities have provided false price signals this year, with the CRB index falling 6.3 per cent in March only to rebound strongly. In spite of last month's fall, analysts are split on whether the commodities prices have set a peak for the year. But the general bullish outlook is, nevertheless, cracking, with Deutsche Bank's strategists warning today that oil prices would fall below $100 a barrel by the start of next year. West Texas Intermediate fell 2.1% to $124.15 a barrel by close in New York.

"We expect the short-term cyclical factors that drove the price of oil from $60 to $145 over the past year to reverse in the coming 12 months," said Marcel Cassard, of Deutsche Bank.

"The impact of the decline in commodity prices on global inflation will be significant."

Lehman Brothers is also forecasting lower oil prices, while Goldman Sachs, Merrill Lynch and Barclays Capital continue to be, in different degrees, bullish.

Ed Morse, head of commodities research at Lehman Brothers, said: "Fundamentals are weakening, particularly in the oil market." Investors have been worried about a deteriorating economic outlook and signs of fresh crude oil supplies arriving from Saudi Arabia.

The International Monetary Fund recently warned that although the global economy weathered better than expected the crisis during the first half of the year, "global growth is expected to decelerate significantly in the second half of 2008".

Traders warned the key commodity indices and energy markets closed the month below the previous month's opening, resulting in a strong technical bearish signal, which could trigger further sales in August.

Copyright The Financial Times Limited 2008

Flower exporters feel the heat of global slowdown

THE global flower export market, which is just over Rs 300 crore, has come down by 15-20% this year owing to global recession. With fertiliser costs also doubling, the industry is facing a crunch and foresees a price rise by 10% to pass the burden on to consumers.
    VSL Agro Tech's manager V Srinivas says: "Cost of production for a single stem of rose has increased from Rs 1.50 to Rs 1.70. We have stopped exporting to Japan and Europe which contributed to 60% of our export market till march 2008." The overall sales of the industry have also gone down by 25%. Of the total sales, exports contribute 80% in volume terms and 60% in terms of value.
    N Manjunatha Reddy, CEO of Pushpam Florabase, says: "Our profit margins have been reduced to half owing to higher delivery and production cost."
    However, the Rs 600-crore domestic market is largely unaffected with inflation and is poised to cross the Rs 1,000-crore mark in two years, say industry observers. This is despite fertiliser costs spiralling by 100-300% but the industry is yet to increase the price of flowers.
    The main sources of these fertilisers were imports from Europe and China. Earlier, the Chinese had provided 35% subsidy on export of fertilisers to their fertiliser companies. However, in order to control pollution levels for the Olympics, China has shut down most of these companies and imposed a 35% export duty on fertiliser exports. Moreover, the prices of phosphorous and sulphur have gone up in the international market and has further led to an increase in fertiliser prices by up to 200%.
    Besides, the increase in petroleum prices has led to the increase in packaging material, such as polythene PP covers. Even the price of corrugated boxes has doubled. All this has affected exports of floriculture industry to markets like Europe, Japan, China and the US.
    Shrivardhan Biotech's CEO Ramesh Patil says: "Flowers are considered to be a luxury item. The demand for flowers has gone down as buyers are not ready to spend much on them due to their perishable nature. It has badly affected our sales during Christmas, Valentine's Day and Ohigan (Japanese festival). Our flower sales have dipped from Rs 6.5 crore to Rs 5 crore in the current year."
    Venkateshwar Rao, owner of Iris Biotech, says: "It is not possible to increase the current prices due to supply and demand dynamics and so we are absorbing inflation, but we will foresee a price increase of 10% in the coming months."

Buyers to pay the price as govt tightens sugar supply

PITCH REPORT

Nidhi Nath Srinivas NEW DELHI

THE government has given a festival gift to sugar companies by holding back supply that has led to a double-digit push up to retail prices in July.
    However, for consumers things may get worse in these inflationary times. NCDEX futures prices show mills are betting the government will continue to allow prices to rise another 15% by year-end. Sugar is one food item in India where prices are completely controlled by the government through the monthly release mechanism.
    The food ministry, with Maharashtra supremo Sharad Pawar at the helm, has allowed mills to sell 37.50 lakh tonne sugar in the current quarter. This is barely enough to meet 70% of total demand in these three months.
    With the pipeline drying up and festivals round the corner, the market sentiment has become exceptionally bullish in year when India has produced 120 lakh tonne extra sugar. Prices have shot up by more than Rs 150/quintal at the wholesale level across India in the last four weeks.
    In the Delhi wholesale market, sugar was selling for around Rs 15.60/kg at the end of June.
    Now it available for not less than Rs 17.10/kg. The rise in retail prices is even higher, with most shops charging Rs 20/kg.
    Aware that prices are rising, food ministry officials had been keen last week to urgently release more sugar into the open market. But as the minister is learnt to have put the decision on hold, mills have got even more time to enjoy the price bonanza.
    What is even more alarming is the likely price of sugar in December, when production will be at its peak in the new marketing year 2008-09.
    NCDEX December contract is currently ruling at Rs 1837, Rs 210 or 14% higher than the August price of Rs 1626. Logically, prices should be lowest in December due to supply pressure. However, punters are obviously betting that the government will silently acquiesce to a continuing spiral in prices.
    "A large number of people are writing cheques today to pay a 14% carry from today's price till December. Since the open interest is around 47,000, which shows ample liquidity, it is not as if some punters moving the market one way. It is reflection of market expectation," said a trader here.
    While mills are making hay while the sun shines, for consumers sugar prices have been a bitter experience. On the one hand, the taxpayer has paid for buffer stocks and export subsidy, and on the other, higher retail prices. The International Sugar Organisation says the world will have 7.8 million tonne (mt) excess sugar in 2007-08, which is the third biggest surplus ever. Though the world has produced around 168.7 mt sugar, it consumed only 161 mt.
    nidhi.srinivas@timesgroup.com 

Oil may finally fall in line with reality

Higher Opec Output, Falling Demand Set To Keep Prices In $120-$130 Range

Soma Banerjee & Vinay Pandey NEW DELHI

    HIGHER oil prices are their own enemy: demand destruction caused by spiking energy costs will bring down global crude prices, with stepped up production lending a helping hand.
    Crude oil prices, which fell by almost 16% over the past few days, may soften further unless spooked by a disruptive geopolitical development. Increased Opec production, led by Saudi Arabia, coupled with a decline in demand in the developed world, especially the United States, is set to ease the tight demand-supply equation in the global oil market. Global crude oil prices, which were threatening to breach the $200 a barrel-mark by the year-end, are now likely to stay closer to the current price (between $120 and $130 a barrel), leaving aside a geo-political eventuality like an Israeli attack on Iran.
    In an exclusive chat with ET, British Petroleum group chief economist and vicepresident Christof Ruhl said: "Increased supplies from Saudi Arabia have already come into the market and the recent softening in prices is a direct fallout of that." Saudi Arabia had announced an increase in production by 700,000 barrels a day from July.
    On the demand side, growth in both OECD and non-OECD countries would be lower in 2008. While the US and European economies are facing a general slowdown, high oil prices are also beginning to bring in demand destruction in those economies where rising prices are passed on to consumers. Put simply, consumers are now beginning to go slow on demand (like SUV sales coming down in the US and growth of hybrid cars) as high energy bills are no longer sustainable. Demand is also expected to moderate in developing economies like China, India, Thailand, etc, because of lower subsidies and moderation in economic activity. "This year is thus expected to see softening in prices as tight market conditions ease," he said.
    "This year's Statistical Review shows clearly that markets do work, and that consumers and producers respond to changes in energy prices when given the opportunity to do so. However, in many places, policies interfere with market mechanisms. Further, in a number of countries, consumers are shielded from price increases via subsidies," Mr Ruhl said. Russia output fall unlikely to raise oil prices
    IN subsidising economies, consumption growth exceeded the 10-year average by 190,000 barrels/ day (b/d), while in taxing economies, it fell short by 360,000 b/d. Although production in Russia is expected to decline in 2008 by a marginal 50,000 b/d, after accelerating in the past few years, it would not have a major fallout as increased production from countries like Azerbaijan would net it out, Mr Ruhl said.
    Over a slightly longer time-frame of three-five years, Mr Ruhl feels prices could even moderate at $60-$70 a barrel. He also does not subscribe to the peak-oil theory. "There is enough material in the earth's crust to yield adequate hydrocarbon if we are willing to pay the price, monetary and environmental," he says. The rally in prices, which accelerated sharply in the second half of 2007 and over the first half of 2008, was largely triggered by a tight supply position, where growth in demand outpaced supplies. Production cuts by Opec in late 2006 and early 2007 reduced supplies by over 130,000 b/d, leading to higher prices.
    Global oil consumption grew 1.1% (1 million b/d) in 2007. Although OECD consumption dropped 0.9%, the steepest since 1983 due to high prices, the increase in demand from non-OECD countries — mostly ones that provide subsidies — by 1.4 million b/d led overall demand to remain high in 2007 despite high prices.

Has the global oil bubble burst? Not yet

New York: The price of oil recorded its biggest weekly drop ever, and a gallon of gas finally pulled back from its record high. So is it time to declare the energy bubble popped?
    Experts won't go that far just yet.
    "It's too early to say we've seen the worst of it,'' said Tom Kloza, publisher and chief oil analyst of the Oil Price Information Service in Wall, New Jersey. "We would be Pollyannish if we believe one week represents a trend.'' Still, with oil recording yet another drop on Friday, some industry experts who just days ago thought there was more juice left in oil's meteoric run are reconsidering.
    "If this is not the bubble's implosion, than it's a reasonable facsimile," analyst and trader Stephen Schork said in his daily market commentary. "Time will tell. Nevertheless, for the time being we no longer care to hold a bullish view.''
    Light, sweet crude for August delivery fell 41 cents Friday to settle at $128.88 on the New York Mercantile Exchange—well below its trading record of over $147 a week earlier.
    The average price of a gallon of regular gas fell about a penny for the day, to $4.105, according to auto club AAA, the Oil Price Information Service and Wright Express. Diesel prices dipped three-tenths of a cent to $4.842 a gallon. Some analysts said a nationwide (US) average of $4 or even lower could be in the offing—almost unthinkable in a summer when there has seemed to be no relief at the pump—although they cautioned that there is no guarantee prices will stay low. "We're going to see some relief from that relentless march higher,'' Kloza said. Gas may be getting just a bit cheaper, but major changes in how Americans live and drive are already in motion.
    Car buyers have been fleeing to more fuel-efficient models. US sales of pickups and sport utility vehicles are down nearly 18% this year through June, while sales of small cars are up over 10%. While slashing production of more-profitable trucks and SUVs, automakers have been scurrying to build their most fuel-efficient models faster.
    Toyota Motor Corp, which hasn't been able to keep up with demand for its 46-miles-per-gallon Prius hybrid, said last week it will start producing the Prius in the US and suspend truck and SUV production to meet changing consumer demands.
    Ford Motor Co and General Motors Corp also have announced plans to increase small car production, and GM has said 18 of the 19 vehicles it is launching between now and 2010 are cars or crossovers. Some brave traders used the week's pullback in oil prices as a chance to buy barrels that suddenly seemed to be on sale. But oil analysts were advising investors to beware. AP

Investors sell gold to tide over cash crunch

C A S H I N G O U T

Parag Dave AHMEDABAD

THE yellow metal has come to the rescue of the crestfallen investors. Burdened by heavy debt since the January bear hug, investors have been shedding off their gold to pay their outstanding dues. Amid increasing price of gold, bullion markets across Mumbai saw close to one tonne of gold ornaments being sold off by investors, pushing trade volumes up by 200%, while in Ahmedabad volumes jumped by 50%.
    While the Sensex nosedived 40% since January 2008, gold shot up by Rs 4,750 per 10 gm (between July 16, 2007-July 16, 2008), giving respite to investors. Mumbai bullion markets that used to buy back 10 kg gold jewellery from the market daily before January 2008, saw volume shoot up to 30 kg no sooner the market crashed. In Ahmedabad too, volumes surged from 8 kg per day to 12 kg.
    "Many players maintained their positions in the market till the Sensex touched 18,000 points. However, they gave up their positions once they started facing liquidity crisis. Under those circumstances, many players sold gold ornaments to sustain in the market," said Malav Shah, research head of Ahmedabad-based Monarch Projects and Finmarket, adding "The amount of difference to be paid also increased, compelling them to sell off their gold ornaments in the markets. Though real estate and fixed deposits could have been used, gold ornaments were the ideal alternative for them owing to high returns."
    Suresh Hundiya, president of the Bombay Bullion Association told ET that on account of heavy losses in the stock market, the investors had sold gold ornaments in the bullion markets. The investors sold about 400 kg of gold ornaments within two days in Mumbai following crash in the stock market on January 21, 2008. Since January, investors have sold nearly one tonne of old gold ornaments in the Mumbai bullion markets till now, he added. The gold proved to be a "boon" for investors in the stock markets said Harshvardhan Choksi, president of Manekchowk Choksi Mahajan (Ahmedabad).

HNIs see future(s) in exotic oil products

TAKING STOCK

HNIs see future(s) in exotic oil products

Aman Dhall & Dheeraj Tiwari NEW DELHI

INDIAN ultra high net worth individuals (HNIs) have discovered a new instrument to grow their wealth. Exotic oil products overseas such as crude-oil futures and oil exchange traded funds (ETFs) are their theme for the season. In fact, the investments by the ultra HNIs in the oil products space overseas has seen a 10-fold jump during the last three months.
The reasons are not hard to see. India's benchmark index, Sensex, has seen a dip of over 60% in the first half of 2008. Some would even say that it's the eagerness of the HNIs to invest in such products, which is driving up oil prices globally. "Though it's a very small niche who are investing in oil related products, the volumes are rising. Many of these HNIs actually lost considerable amount of money in the January crash of Dalal Street this year. They are now trying to make up for the losses by investing in crude oil futures and oil ETFs as a short-term ploy to book quick profits," a wealth manager told SundayET. While crude-oil futures soared to a new record of above $147 a barrel this week on the New York Mercantile Exchange, the energy-tracking ETFs were sitting atop in the first-quarter performance posting more than 40% returns. US 12-Month Oil Fund (43.4%), PowerShares DB Oil (41.3%) and Power-Shares DB Energy (40.1%) were the top performing ETFs on the New York Mercantile Exchange during April-June 2008. , - - dent (retail banking) and head of wealth management group at Axis Bank, with the markets continuing to remain volatile, HNIs are reluctant to take more exposure in Indian equities. "They're actively looking for new opportunities and now that they can legally invest a substantial amount in foreign ventures, they're more open towards taking exposure in exotic products such as oil ETFs," said Ms Bhasin. She said they've received a number of requests from their clients. However, RBI doesn't allow banks to offer any products which are non-rupee denominated. "But we've heard that some other companies in the wealth management space are offering such products," she said.
    Sudip Bandyopadhyay, CEO of Reliance Money, feels that it's not surprising that Indian HNIs are also now actively speculating in oil futures and oil ETFs. "These are savvy investors who are looking to sense every opportunity they can seize from the markets. Today they are investing in oil products, tomorrow you will find them investing in gold ETFs and probably the day after that they might be buying copper. They are a handful of people who are investing in these leveraged ETFs and short funds that allow them to profit from market pullbacks," he said. A CEO of a wealth management company, in fact, blamed this shortsightedness of HNIs worldwide for the rising crude oil prices in the world markets. "It's short-term money and they should understand they cannot live a life with it. Middle-East oil politics apart, the HNIs globally are to a great extent responsible for building speculative short positions in the crude oil futures, which is driving the prices up. With Indian HNIs also jumping into the bandwagon, it's only adding fuel to the fire already raging on," the CEO said.
    aman.dhall@timesgroup.com 

Govt scraps customs duty on cotton imports

New Delhi: The government on Wednesday scrapped import duty on cotton and withdrew incentives on exports to boost domestic supply for the textile industry.
    "The 10% customs duty on cotton imports has been abolished along with 4% special additional duty with effect from July 8. Besides, 1% drawback benefits (refund of local taxes) on exports of raw cotton have also been withdrawn,'' joint secretary in the ministry of finance Vivek Johri said.
    The abolition of customs duty is expected to result in revenue loss of Rs 100 crore in the remaining months of the current fiscal, though removal of export incentives would partly set off these losses.
    About 3,000 yarn mills had announced to go on a strike on Wednesday pressing for their demand to abolish customs duty on cotton imports and regulation of exports.
    While welcoming the decision of the government, deputy chairman of Southern India Mills Association J Thulasidharan said, "Since the strike call had already been given, workers have not turned up.''
    Textile ministry has been pressing for scrapping the customs duty saying that textile exports remained at about $20 billion against the target of $25 billion in 2007-08 mainly due to rise in input costs like a hike in cotton prices.
    According to industry estimates, the decision would not have any major impact on cotton producers, as the production has gone up to 35 million bales (one bale = 170 kg) as against 30 million bales in the previous year due to wide plantation of bt cotton.
    Cotton prices have also gone up hitting the spinning mills though there was negligible growth in cotton imports due to higher duties.
    India imported 6.5 lakh bales in 2007-08, against 5.5 lakh bales in the previous year.
    The industry claimed that the cotton prices have gone up by more than 42% since January this year.
    India, the second largest exporter of raw cotton, is expected to ship 10 million cotton bales in the crop year ending september, which will benefit traders and cotton growers. The industry said the move would not adversely affect cotton growers since no stocks have been left with them. AGENCIES

Financial Tech plans to set up commodity bourse in Singapore

NEW DELHI: Financial Technologies India, promoter of country's leading commodity bourse MCX, today announced its plans to set up an electronic exchange in Singapore.

Singapore Mercantile Exchange (SMX), a wholly-owned subsidiary of Financial Technologies India (FTIL), is expected to tap the rising demand for commodity trading in the region, the company said in a statement.

The new exchange, which is in the process of obtaining the necessary regulatory approvals from the Monetary Authority of Singapore (MAS), would offer trading in metals, currencies, carbon credits and agricultural items.

"Markets are the barometer of growth for any economy and SMX will be the growth engine for Asia from Singapore with rest of the world - through transparent price discovery, risk hedging and will propagate structured private and public investment deep into the economy," FTIL Chairman and Group CEO Jignesh Shah said.

Shah, who is also the Vice Chairman of SMX, announced the new exchange at the Global Financial Market Summit 2008 in Singapore.

Already, Singapore is Asia's price discovery centre for energy and rubber. With a growing interest in commodity derivative and increased focus on risk management following price volatility, SMX would reinforce the commodity trading and risk management infrastructure in the region, experts said.

After Dubai Gold and Commodity Exchange (DGCX), SMX is the second exchange to be set outside the country. FTIL launched DGCX in 2005 along with Dubai Metals and Commodities Centre (DMCC) in gold, fuel and freight trade.

Oil breaches $145 before US Independence Day

Saudi Arabia Vows To Pump More Oil If Required, Blames Weak Dollar For The Fiasco

Reuters/AP NEW YORK

    OIL prices hit a record above $145 a barrel on Thursday ahead of the Independence Day holiday weekend in the US before paring gains as the dollar recovered from a two-month low.
    US light sweet crude oil for August delivery was trading at $144.35 a barrel, up 78 cents at 00.20 am IST, after earlier hitting a record $145.85. London Brent was trading $1.03 higher at $145.29 after reaching $146.69 a barrel.
    "We pushed to a new high early and then backed off from that on some light profit-taking ahead of the long weekend that was encouraged by the strength that we've seen in the US dollar," said Tim Evans, energy analyst for Citi Futures Perspective in New York. US payroll data released on Thursday suggested the job market had not deteriorated as much as many investors had feared, helping the dollar recover from a two-month low against the euro hit earlier in the day.
    Comments from the head of the European Central Bank that suggested further interest rate increases in Europe could be put on hold also supported the greenback.
    Oil has risen nearly 13% since the start of June on concerns about Middle East tensions, tight supplies and investors buying crude as a hedge against inflation and the falling value of the dollar.
    Saudi oil minister Ali al-Naimi reiterated his belief on Thursday that the current rally in oil prices was being propelled by speculators rather than any shortage of crude oil. Naimi repeated promises that Saudi Arabia would pump more oil if there was demand for it. Oil refiners in the US and Asia have said official Saudi prices make it uneconomical to buy more barrels.
    Iran has threatened to block oil shipments through the Strait of Hormuz in the event it is attacked. Speculation has mounted in recent weeks that Israel may be preparing a preemptive strike against Tehran's nuclear program.
    Approximately 40% of the world's seaborne crude oil trade passes through the Strait of Hormuz.
    Tropical Storm Bertha, which formed on Thursday in the eastern Atlantic Ocean, was not expected to strengthen into a hurricane or threaten any US oil and gas production facilities in Gulf of Mexico.
    Meanwhile, Opec oil exporting group secretary general said it would be difficult to replace the crude output of Iran if the country was attacked, in a comment published on Thursday.
    "If something happened in Iran, it is difficult to replace 4.1 or 4.2 million barrels a day," Abdallah El-Badri told the World Petroleum Congress in Madrid. "The price (of crude) of course will go up," he added
    There has been a surge in speculation recently that Israel might be planning a military strike against Iran's nuclear sites after Israeli fighter planes carried out practice runs. Iran has been locked in a fiveyear standoff with the west over its nuclear programme, which it says is for generating electricity while western powers fear the development of nuclear weapons.
    "Iran, if there were any kind of activity of any sort, is not going to be quiet and would react fiercely," Iranian oil minister Gholam Hossein Nozari said, when asked what Tehran would do in the event of an attack.

We Can Lower Oil Prices Now

By MARTIN FELDSTEIN

July 1, 2008

Although most experts agree that financial speculation was not responsible for the surge in the global prices of food and energy, many people remain puzzled about the source of these remarkable price rises. Economics offers a simple supply-and-demand explanation and reason for optimism about the future of commodity prices. In the case of oil, economics also suggests how policy changes today that affect the future could quickly lower the current price of oil.

We all know that rising incomes in China, India and the Gulf states have increased the demand for oil and many other commodities. But how could the modest, one-year rise of these demands lead to 100% increases in the prices of oil and other commodities? Let's take a look first at perishable agricultural commodities.

Corbis

In the short run, there is little scope for increasing the supply of corn in response to a global increase in demand. For demand and supply to balance – for the market to clear – the price of corn must rise.

If the demand for corn were very price-sensitive, a relatively small increase in price would reduce global demand by enough to offset the initial rise in demand. However, since demand is actually quite insensitive to price in the short run, it takes a very large price rise to bring global demand into line with supply.

Here is a simplified picture of what happened in the past year. The quantity of corn demanded by high-growth countries rose gradually, increasing eventually by an amount equal to, say, 10% of the previous total global level of corn consumption. Since the supply of corn did not increase, the price had to increase enough to reduce corn consumption in other countries by 10%. If it takes a 10% increase in the price to reduce the quantity of corn demanded in the first year by just 1%, it would take a 100% increase in the price of corn to offset the initial 10% rise in the quantity of corn demanded.

In reality, the picture is complicated by the substitution in both supply and demand among different agricultural commodities, and by the role of the corn ethanol program. But the basic explanation holds: With a very low short-run price sensitivity of demand and little scope to raise supply in the short run, even a relatively small increase in corn demand by the high-growth economies can lead to a very large short-run rise in the price of corn.

Fortunately, the price sensitivity of both demand and supply will increase with time. This implies that the rising demand from China and other countries may eventually be accommodated with a price lower than today's level.

The situation for oil is more complex, but the outcome for prices is potentially more favorable.

Unlike perishable agricultural products, oil can be stored in the ground. So when will an owner of oil reduce production or increase inventories instead of selling his oil and converting the proceeds into investible cash? A simplified answer is that he will keep the oil in the ground if its price is expected to rise faster than the interest rate that could be earned on the money obtained from selling the oil. The actual price of oil may rise faster or slower than is expected, but the decision to sell (or hold) the oil depends on the expected price rise.

There are of course considerations of risk, and of the impact of price changes on long-term consumer behavior, that complicate the oil owner's decision – and therefore the behavior of prices. The Organization of Petroleum Exporting Countries (the OPEC cartel), with its strong pricing power, still plays a role. But the fundamental insight is that owners of oil will adjust their production and inventories until the price of oil is expected to rise at the rate of interest, appropriately adjusted for risk. If the price of oil is expected to rise faster, they'll keep the oil in the ground. In contrast, if the price of oil is not expected to rise as fast as the rate of interest, the owners will extract more and invest the proceeds.

The relationship between future and current oil prices implies that an expected change in the future price of oil will have an immediate impact on the current price of oil.

Thus, when oil producers concluded that the demand for oil in China and some other countries will grow more rapidly in future years than they had previously expected, they inferred that the future price of oil would be higher than they had previously believed. They responded by reducing supply and raising the spot price enough to bring the expected price rise back to its initial rate.

Hence, with no change in the current demand for oil, the expectation of a greater future demand and a higher future price caused the current price to rise. Similarly, credible reports about the future decline of oil production in Russia and in Mexico implied a higher future global price of oil – and that also required an increase in the current oil price to maintain the initial expected rate of increase in the price of oil.

Once this relation is understood, it is easy to see how news stories, rumors and industry reports can cause substantial fluctuations in current prices – all without anything happening to current demand or supply.

Of course, a rise in the spot price of oil triggered by a change in expectations about future prices will cause a decline in the current quantity of oil that consumers demand. If current supply and demand were initially in balance, the OPEC countries and other oil producers would respond by reducing sales to bring supply into line with the temporary reduction in demand. A rise in the expected future demand for oil thus causes a current decline in the amount of oil being supplied. This is what happened as the Saudis and others cut supply in 2007.

Now here is the good news. Any policy that causes the expected future oil price to fall can cause the current price to fall, or to rise less than it would otherwise do. In other words, it is possible to bring down today's price of oil with policies that will have their physical impact on oil demand or supply only in the future.

For example, increases in government subsidies to develop technology that will make future cars more efficient, or tighter standards that gradually improve the gas mileage of the stock of cars, would lower the future demand for oil and therefore the price of oil today.

Similarly, increasing the expected future supply of oil would also reduce today's price. That fall in the current price would induce an immediate rise in oil consumption that would be matched by an increase in supply from the OPEC producers and others with some current excess capacity or available inventories.

Any steps that can be taken now to increase the future supply of oil, or reduce the future demand for oil in the U.S. or elsewhere, can therefore lead both to lower prices and increased consumption today.

Mr. Feldstein, chairman of the Council of Economic Advisers under President Reagan, is a professor at Harvard and a member of The Wall Street Journal's board of contributors.