much to price changes in the short run, the recent unexpected rise in oil consumption together with disruptions to supply can plausibly account for much of the increase in prices. however, the sharp increases and extreme volatility of oil prices have led observers to suggest that some part of the rise in prices reflects a speculative component arising from the activities of traders in the oil markets. how might speculation raise the price of oil? simplifying greatly, speculative traders who expect oil to be in increasingly short supply and oil prices to rise in the future can back their hunches with their money by purchasing oil futures contracts on the commodity exchange. oil futures contracts represent claims to oil to be delivered at a specified price and at a specified date and location in the future. if the price of oil rises as the traders expect - more precisely, if the future oil price rises above the price specified in the contract - they will be able to re - sell their claims to oil at a profit. if many speculators share the view that oil shortages will worsen and prices will rise, then their demand for oil futures will be high and, consequently, the price of oil for future delivery will rise. higher oil futures prices in turn affect the incentives faced by oil producers. seeing the high price of oil for future delivery, oil producers will hold oil back from today ’ s market, adding it to inventory for anticipated future sale. this reduction in the amount of oil available for current use will in turn cause today ’ s price of oil to rise, an increase that can be interpreted as the speculative premium in the oil price. many people take a dim view of speculation in general, and in some instances this view is justified. 7 in many situations, however, informed speculation is good for society. in the case of oil, speculative activity tends to ensure that a portion of the oil that is currently produced is put aside to guard against the possibility of disruptions or shortages in the future. true, speculation may raise the current price of oil, but that increase is useful in stimulating current production and reducing current demand, thereby freeing up more oil to be held in reserve against emergencies. speculative traders have no altruistic motives, of course ; their objective is only to buy low and sell high. but speculators ’ profits depend on their ability to induce a shift in oil use from periods when prices are relatively low ( that is, when oil is relatively plentiful ) to periods when prices are relatively high (

data, is now estimated to have been about 3. 7 million barrels per day higher than the iea projected in july 2003. 6 ( for reference, total global oil consumption this year has averaged about 81 million barrels per day ). a significant part of this unexpected increase in oil consumption, about 2. 2 million barrels per day, reflected quickly growing oil demands in east asia, notably china. however, an ongoing economic expansion across both the industrialized and the emerging - market economies has also contributed to the world ’ s growing appetite for oil. on the supply side, the production of oil has been constrained by the available capacity and by geopolitical developments. with oil consumption and prices rising briskly, saudi arabia and other members of the organization of petroleum exporting countries ( opec ) have promised to pump more oil. however, the relatively limited increases in production delivered so far by opec members, together with non - opec production that has fallen a bit below projections, have raised concerns that the spare production capacity available in the near term may be severely limited, perhaps below 1 million barrels per day. interacting with the limits on capacity, and contributing to the exceptional volatility in oil prices of recent months, are uncertainties about the reliability and security of oil supplies. of course, the oil - rich middle east remains especially volatile. but political risks to the oil supply have emerged in nations outside oil futures and other oil - related derivatives are traded on the new york mercantile exchange ( nymex ) and the international petroleum exchange ( ipe ) as well as over the counter. i should acknowledge that oil futures prices have a less - than - stellar record in forecasting oil price developments, but they are probably the best guide that we have. chinn, leblanc, and coibion ( 2001 ) find that futures quotes are unbiased predictors of future spot prices, though not very accurate ones. saudi arabia and other opec members, like the iea and most participants in the oil markets, did not anticipate the surge in consumption we have seen this year either. opec actually reduced its production targets in 2003 and again in early 2004 out of concern that weak oil demand would cause price declines. the middle east as well, including russia, venezuela, and nigeria. weather also has taken a toll, as recent hurricanes affected the production and distribution of oil on the u. s. gulf coast. because neither the demand for nor the supply of oil responds very