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Don't blame the speculators (There is no oil bubble)
The Economist ^ | Jul 3, 2008 | Economist

Posted on 07/09/2008 8:35:21 PM PDT by curiosity

ALTHOUGH the price of oil continues to hit new records, it has in one respect been a quiet week on the oil markets. America’s lawmakers are celebrating Independence Day by taking a few days off. That has led to a brief interruption in the torrent of proposals aimed at curbing speculation.

Ten different bills on the subject are in the works in Congress. Before the House of Representatives shut up shop, it approved one by a vote of 402-19. America’s politicians are not the only ones to have fingered speculators for the feverish rise in the price of oil and other raw materials. Italy’s finance minister believes that there is a “magnum of speculative champagne” included in the price of each barrel. Austria wants the European Union to impose a tax on speculation. Saudi Arabia and other big oil producers routinely blame the price on frothy markets, rather than idle wells.

The accusers point to the link between the volume of transactions on the futures markets and the price of oil. Since 2004 the near tripling of trading in oil on the New York Mercantile Exchange (NYMEX), the world’s biggest market for the stuff, has neatly coincided with a tripling in the price.

What is more, investing in oil has become something of a fad. Commodities traders and hedge funds with long experience have been joined by less expert sorts, including pension funds and individuals. All this, the theory runs, is contributing to a bubble in commodities. The rush of punters betting on higher prices is begetting a self-fulfilling prophecy: it is the tide of new investment, rather than inadequate supply or irrepressible demand, that is pushing the price of oil ever higher.

Follow the oil, not the futures

This reasoning holds obvious appeal for those looking for a scapegoat. But there is little evidence to support it. For one thing, the surge in investment in oil futures is not that large relative to the global trade in oil. Barclays Capital, an investment bank, calculates that “index funds”, which have especially exercised the politicians because they always bet on rising prices, account for only 12% of the outstanding contracts on NYMEX and have a value equivalent to just 2% of the world’s yearly oil consumption.

More importantly, neither index funds nor other speculators ever buy any physical oil. Instead, they buy futures and options which they settle with a cash payment when they fall due. In essence, these are bets on which way the oil price will move. Since the real currency of such contracts is cash, rather than barrels of crude, there is no limit to the number of bets that can be made. And since no oil is ever held back from the market, these bets do not affect the price of oil any more than bets on a football match affect the result.

The market for nickel provides a good illustration of this. Speculative investment in the metal has been growing steadily over the past year, yet its price has fallen by half. By the same token, the prices of several commodities that are not traded on any exchanges, such as iron ore and rice, have been rising almost as fast as that of oil.

Speculators do play an important role in setting the price of oil and other raw materials. But they do so based on their expectations of future trends in supply and demand, not on whims. If they had somehow managed to push prices to unjustified heights, then demand would contract, leaving unsold pools of oil.

The futures market does sometimes signal that prices are likely to rise, which might prompt speculators to hoard oil in anticipation. But it is not signalling that at the moment, and there is no sign of hoarding. In the absence of rising stocks, it is hard to argue that the oil markets have lost their grip on reality.

Some claim that oil producers are in effect hoarding oil below the ground. But there is also little sign of that, either among companies or countries: all big exporters bar Saudi Arabia are pumping as fast as they can.

It takes two to contango

Despite their dismal reputation, the oil speculators provide a vital service. They help airlines and other big oil consumers to hedge against rising prices, and so to reduce risk—a massive boon amid the economic turmoil. By the same token, they provide oil producers with more predictable future revenues, and so allow them to expand more confidently and borrow more cheaply. That, in turn, should help to lower the price of oil in the long run. Any attempt to curtail speculation, by contrast, is likely to make life harder for firms and oil more expensive.


TOPICS: Business/Economy; Government; News/Current Events
KEYWORDS: bubble; contango; energy; energyprices; oil; oilbubble; speculators
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1 posted on 07/09/2008 8:35:22 PM PDT by curiosity
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To: rurgan; dirtboy; jveritas; RegulatorCountry; Prokopton; HamiltonJay; colorado tanker
There is no bubble, people. High oil prices are here to stay. Get used to it.
2 posted on 07/09/2008 8:37:31 PM PDT by curiosity
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To: curiosity
Follow the oil, not the futures

Bull Excrement

3 posted on 07/09/2008 8:41:48 PM PDT by ATOMIC_PUNK (Read the Constitution to your children make them understand what Freedom is all about !)
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To: curiosity
You are walking on dangerous ground here at FR but you are 100% Correct.

High Oil Prices Are Here to Stay.

It is likely that we never see $100.00 oil but rather $175.00 to $200.00 oil within the next 24 months.

4 posted on 07/09/2008 8:45:39 PM PDT by trumandogz ("He is erratic. He is hotheaded. He loses his temper and it worries me." Sen Cochran on McCain)
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To: curiosity

A lot of people like to promulgate the “Peak Oil” myth to justify current oil prices.

I am certain that we reached “Peak Real Estate” more than a few years back, and do recall a lot people saying real estate was not a bubble.


5 posted on 07/09/2008 8:48:08 PM PDT by bluefish (NoBama! Because Commies Suck)
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To: ATOMIC_PUNK
Read the Constitution to your children make them understand what Freedom is all about

I read my children Animal Farm when they were pre-schoolers and then talked about it through out their lives. They learned about Freedom and politics that way.

6 posted on 07/09/2008 8:52:31 PM PDT by Zevonismymuse
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To: bluefish

My doctorate is not in economics, but I do have a couple of degrees in that field and the argument that futures speculation was driving the recent price increases was never coherent to me. I have not heard anything on the side of those who want to claim that it is speculators ginning this which amounts to much more than wishful thinking and hand waving. Granted this is the standard for politicians and they are in desperate need of a scapegoat - but that still doesn’t make the case.


7 posted on 07/09/2008 8:52:49 PM PDT by Wally_Kalbacken
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To: curiosity

Maria Cantwell, unfortunately my senator from Washington state, is now pushing some bill trying to scapegoat speculators.
She has been one of the biggest opponents to new drilling in the US for years. She is also one of the biggest receivers of campaign contributions by the Sierra Club.
She was even quoted saying something along the lines that that any overshore drilling in Washington state would be done over her dead body. She’s constantly butting into Alaska’s politics as well trying to block any new drilling there as well.


8 posted on 07/09/2008 8:54:16 PM PDT by Proud_USA_Republican (We're going to take things away from you on behalf of the common good. - Hillary Clinton)
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To: curiosity
We will agree to disagree on this topic, professor, that high energy prices are here to stay. You have taken the affirmative, I shall take the negative, quite cheerfully.

And, a bit later on, we will have a conversation about the workings of mkts, whether manipulated -- as they obviously are just now -- or not.

May I commend to your attention the study of the ''open interest'' in the various futures exchanges: NYMEX, SIMEX, and DUBEX (ICE/IPE can't be studied right now -- they don't present OI figures)? Just a thought. Look it up, professor, over the past 3 days...you might just learn something.

FReegards!

9 posted on 07/09/2008 8:54:45 PM PDT by SAJ
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To: curiosity
And since no oil is ever held back from the market, these bets do not affect the price of oil

Despite their dismal reputation, the oil speculators provide a vital service. They help airlines and other big oil consumers to hedge against rising prices, and so to reduce risk—a massive boon amid the economic turmoil. By the same token, they provide oil producers with more predictable future revenues, and so allow them to expand more confidently and borrow more cheaply. That, in turn, should help to lower the price of oil in the long run.

First oil speculators have no effect on oil prices, then oil speculators do have an effect on oil prices; before I buy "The Economist" theory they need to determine which position they are taking.

10 posted on 07/09/2008 8:55:00 PM PDT by Libertarianize the GOP (Make all taxes truly voluntary)
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To: Wally_Kalbacken
...this is the standard for politicians and they are in desperate need of a scapegoat...

My doctorate is in economics and I agree with you 100%. Others on this forum have stated that $175/bb is here to stay. I think that may be true in the long run, but I think that long run is only as far away as Congress's willingness to make new supplies available now. There is no reason that we have to accept $175/bb oil now and into the forseeable future. At current prices, remote drilling (ANWR), deep water drilling (OCS), and shale oil and tar sands (most of which is federal land holdings) are all economically viable and we will see those sources tapped. However, there will be no movement to ease the problem until after Nov. In the meantime, the public needs to beat on Congress for a real explanation of why we aren't drilling when we know there's oil to be had. This bullsh@# about not coming on line for 10 years and even if it did, it wouldn't make a difference is simply political nonsense. With a 9% approval rating, you'd think they'd try to do something good for the American consumer...but, no. They have their political agenda and you and I will pay the price. Their behavior is disgusting.

11 posted on 07/09/2008 9:06:36 PM PDT by econjack (Some people are as dumb as soup.)
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To: ATOMIC_PUNK
Bull Excrement

BS is right...

12 posted on 07/09/2008 9:13:25 PM PDT by Niteflyr ("If you’re drawing flak, you know you're over the target".)
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To: trumandogz
Only because types like you wish it. There is plenty of supply - both long and short term. You and others like you who are pushing peak oil theory will kill the economy and break the back of this nation. I am sure you are more than tickled.
13 posted on 07/09/2008 9:18:29 PM PDT by BoBToMatoE
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To: BoBToMatoE
There is plenty of supply - both long and short term

That is a fact...and just now the headline is: "In open letter, 12 U.S. airlines call on Congress to curb excessive speculation that they say drives up oil and fuel prices, slamming the airline industry."

more here>

14 posted on 07/09/2008 9:40:48 PM PDT by Niteflyr ("If you’re drawing flak, you know you're over the target".)
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To: Niteflyr
oooppppsss.....

http://money.cnn.com/2008/07/09/news/companies/airlines_speculation_letter/index.htm

15 posted on 07/09/2008 9:41:53 PM PDT by Niteflyr ("If you’re drawing flak, you know you're over the target".)
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To: curiosity

...agreed. We can do better without clinging to wishful thinking about cheap freight fuel and continuation of the recent trade paradigm.


16 posted on 07/09/2008 9:48:43 PM PDT by familyop (cbt. engr. (cbt), NG, '89-'96, Duncan Hunter or no-vote)
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To: BoBToMatoE

There are even idiots that claim we have already peaked...inspite of the fact that production (as shown here by the IEA) is still increasing! Kind of like the global warming crowd that ignores global temperatures showing that the earth is actually cooling. Insanity....

http://bp2.blogger.com/_fl4GqRfOC9Q/SGnDq54csLI/AAAAAAAAAOY/NmEcpoODaJI/s1600-h/IEASupply.jpg


17 posted on 07/09/2008 9:50:45 PM PDT by tatown (How to piss off a liberal: Work hard and be happy!)
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To: trumandogz
High Oil Prices Are Here to Stay.

Maybe, maybe not.

The problem with all of this prediction stuff is that it is impossible to predict the future.

The price of oil is a perfect example. The problem is that we have too many variables. The other problem is that oil is a fungible commodity whose price direction is largely driven by the last units sold. Demand, supply, distribution (refineries), taxes, speculation, depreciation of the dollar, etc. all play a major role in determining the price and many of them are completely independent variables.

Merely increasing domestic production will do nothing to affect the price of gas if world wide demand keeps increasing. What it will do though is help maintain the value of the dollar. The problem is that we are shelling out more than 700 billion a year for oil, it is the trade deficit coming back to bite us.

For what it is worth (nothing) I think that the price of oil has peaked for at least the next year or so. I fully expect the price to fall below $100 as the Chinese end their oil subsidies and as demand falls in response to the high prices. The main problem I have with that prediction though is that the Fed seems determined to continue manufacturing money to keep the financial institutions solvent. If the Fed doesn't keep pumping out the money we would in all likely hood be facing the prospect of deflation and a depression.

18 posted on 07/09/2008 9:57:22 PM PDT by LeGrande
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To: curiosity
These aren't the droids you're looking for.
19 posted on 07/09/2008 10:11:17 PM PDT by PeaceBeWithYou (De Oppresso Liber! (50 million and counting in Afganistan and Iraq))
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To: curiosity

This was previously posted here:
http://www.freerepublic.com/focus/f-news/2040579/posts

It was worth posting again. Anyone interested in this topic would likely find the comments on the earlier version interesting and even enlightening.


20 posted on 07/09/2008 10:19:26 PM PDT by USFRIENDINVICTORIA
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