But this doesn’t explain what happened to the “inventories” of excess oil that would have developed if the price was above the level determined by supply and demand.

We are in a market where supply and demand are both incredibly inelastic, and so the inventory accumulation would not be huge – however, inventories were consistently running BELOW forecasts over the past year.

Without inventory accumulation I find the “bubble” story of oil prices hard to swallow.

Of course the argument we have created in the post does allow for inventory accumulation – which is a function of price. In this case we only need slight changes in supply or demand conditions to cause a wild change in the equilibrium quantity and price of fuel. If anything this suggests to me that we may be in for a time of extreme volatility in prices – but not as a result of financial instruments.

Have you considered prices of crude oils may not be determined by supply and demand relations? Yes, I know such is hard to accept but does nevertheless rest in post-1986 changes in the oil price regime which was:
1. The use of formula pricing as the multiple different grades of crudes came to be priced +/- in relation to a small number of benchmark grades such as WTI and Brent, while
2. Price discovery of these benchmarks shifted into futures markets.

OK, the above worked well enough so long as production and trade in the physical benchmark oils was sufficient to avoid thin market conditions and send an adequate signal — but by the late 1990s and owing to the decline in production, thin market conditions with assorted manipulations had developed sufficiently that, in 2000-01, Saudi Arabia, Kuwait, Iran, began pricing in reference to futures’ markets determined prices, i.e. in reference to the trade in paper barrels on the NYMEX and IPE.

The price regime became financialized, less related to the real than the financial.

Even this may not have been a problem were it not, from roughly 2002, financial players near simultaneous search for high returns from uncorrelated asset classes such as commodities, and the progressively larger flow of funds into these classes until a self-fulfilling price dynamic took over driving far beyond fundamentals. When the overpricing and its causes are recognized it’s hardly surprising that crisis driven asset liquifications have taken prices down dramatically.

I attach the following less for content than internal links:
Futures Prices Determine…

Very much ^_^

http://www.mzuonqtr.com