For over 100 years up to 1970, the price of a barrel of oil was remarkably stable at between about $us21 and $us25 (adjusted for inflation). Contrary to general belief, the formation of OPEC in 1960 did not lead to an immediate increase in oil prices – in fact, prices declined throughout the sixties. What actually changed things was peak oil in Texas which occurred in about 1970.
Up to that time, the Railroad Commission of Texas, which (despite its name) regulates the Texas oil and gas industry, had limited the amount of oil that was produced in order to control prices. In March, 1971, it stopped controlling supply because there was no longer any surplus which could be held back. The effect of this was to give control to OPEC, which did have a surplus – and, in reality, to Saudi Arabia whose supplies dominated OPEC.
In October 1973, the Yom Kippur war broke out and several Arab countries embargoed oil exports to countries seen as supporting Israel. Some non-OPEC countries were able to increase production and the net effect was a decrease of only about 7% in oil supply to the West – but prices quadrupled within six months. Prices remained high, fluctuating with the various Middle East conflicts, through seventies and early eighties – when they reached a point at which North Sea oil became competitive. The Saudis lost their controlling position and, in August 1985, linked their oil price to the world spot market. Prices dropped back to the historical level of around $us25 – $us30 a barrel.
North Sea oil peaked in 1999 and control of prices once again moved to the Middle East. As always at such times, the price of oil fluctuated with the conflicts in the area. When the US coalition invaded Iraq in 2003, prices started to climb – at about 30% per annum until 2006.
In January 2006, the way in which oil prices were determined changed radically. Up until that time, US oil futures were traded exclusively on exchanges in the United States which were regulated by the Commodity Futures Trading Trading Commission. The CFTC was mandated by Congress to ensure that prices on the futures market reflect the laws of supply and demand rather than manipulative practices or excessive speculation.
Then, in January 2006, ICE Futures in London began trading a futures contract for West Texas Intermediate (WTI) crude oil, a type of crude oil that is produced and delivered in the United States. ICE Futures permitted traders in the United States to trade its new WTI contract on the ICE Futures London exchange. The CFTC has no jurisdiction over the trading of these contracts. This means that nobody is controlling "manipulative practices or excessive speculation". ICE Futures is not even required to report large daily trades of its "paper oil". The development was condoned by the US Government because it saw that it would result in taking control of oil prices put of the hands the Middle Eastern producers.
The main players in the oil futures market, who are now controlling oil prices, are large US-based trading banks, like Goldman Sachs and Morgan Stanley and investment funds, like Citigroup and JP Morgan Chase.
In June 2006, a US Senate stated that $25 of the then $60 price of a barrel of oil was pure speculation. Since then, the price has increased to over $135 a barrel. While the demand for oil is increasing and supply is becoming more difficult, nothing has changed that dramatically in just two years – implying that around $100 of this is pure speculation.