BOONE PICKENS, the famous Texan oil investor, made a bold prediction three weeks ago. “I think oil’s going to back off,” the 79-year-old said in an interview with American television channel CNBC. “We’ll drop $10 or $15 a barrel in the second quarter.”

When it comes to oil, Pickens is not often wrong. He has pocketed more than $1 billion (£493m) in each of the past two years by making big bets on rising oil prices, say Wall Street sources.

In spite of his predictions, American crude prices last week rocketed to record highs of more than $111 a barrel. Pickens’s gamble that oil prices would fall has lost his $4 billion fund $560m.

He is not the only one to have been caught out by the relentless climb in crude prices, which is pushing up petrol prices and driving up global inflation.

With the world’s oil supplies in decline, everyone agrees that prices should be high. A new breed of speculators in hedge funds and investment banks, though, is being blamed in some quarters for pushing prices too high.

“If you talk strictly about the fundamentals of supply and demand, the oil price should be about $80 a barrel,” said Ruchir Kadakia from Cambridge Energy Research Associates (CERA).

Trading oil is big business. While there are only 87m barrels of oil produced each day by the world’s refineries, there are contracts over about 2 billion barrels changing hands in the financial markets. These bets on the future price of oil are worth more than $220 billion at today’s prices.

While BP and the other oil majors trade millions of barrels a day, the biggest oil dealers are Wall Street’s investment banks. Goldman Sachs and Morgan Stanley have bought and sold more oil than any other party in the market for more than 20 years.

A number of former Enron traders have set up on their own, just to trade oil, such as John Arnold at Centaurus Energy Advisors. Overall, hedge funds now account for almost 10% of the world’s oil trade, according to figures from the US Commodity Futures Trading Commission. Citadel, Tudor, Och-Ziff and Steve Cohen’s SAC Capital are all known to dabble in commodities.

The profits and losses can be huge. Andrew Serotta, a trader at Vitol, the secretive energy trading firm in Geneva, is estimated to have made a personal profit of $200m in a matter of days by simply placing bets on the future cost of a barrel of oil.

“That was the biggest oil trading heist we’ve seen for some time,” said one analyst.

Hedge funds are not the only ones driving the oil price higher. The fall in the value of the dollar against all major currencies has left investors with a headache. Oil is always priced in dollars. So when the dollar falls, the headline price of a barrel of oil increases. CERA estimates that the ratio is three to one – a 1% fall in the dollar leads to a 3% rise in the price of oil.

“I would estimate that about 70% of the new money that has come into oil trading has come from big, passive, old-fashioned investors who are just looking to diversify away from equities and have ended up crowding out the oil price,” said Philippe Bonnefoy at Cedar Partners, a hedge fund in Geneva.

Longer-term there are clear reasons for oil prices to remain high. Production from ageing oil provinces like the North Sea is declining quicker than expected, while new projects are taking longer to come on stream. The 500,000 barrel per day Khursaniyah field in Saudi Arabia, for example, was due to begin pumping oil at the start of this year but has been hit by repeated delays.

“We are very happy with fundamental explanations of why crude is high and going higher,” said Paul Horsnell at Barclays Capital. “Seven years ago people would say that if the long-term price went above $20 then demand would start falling. Here we are at $110 and demand is not falling.”

Not everyone is so sure. A relatively mild winter has allowed America’s fuel stockpiles to replenish. Inventories are at a 15-year high. Figures last week from the International Energy Agency showed a similar picture across Organisation of Economic Cooperation and Development countries.

“The numbers that came out of the US this week were the most bearish we’ve seen yet this year,” said Michael Waldron, analyst at Lehman Brothers. “But it didn’t really move the market.”

It was this logic that encouraged Pickens. It seems that most oil traders think he should have been right.

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