Oil Speculation The Cause Of High Gas Prices?

Stop Oil Speculation Now“, a front group for the Airline Transport Association of America (their news release is here), is charging that the high price of gasoline is due to speculators driving up the oil market.  They’ve released the results of a poll that says 70% of the population (based on a random sample population of 800 people) polled think that oil speculators are driving up the price of oil.  The actual questions asked are not listed, but the way the answers are presented leads me to believe that the poll could qualify as a “push poll“.  When asked to choose who was responsible for the current price of gasoline (presumably from a list of potential “bad guys”), the poll results are (1st choice only):

  • Oil speculators: 23%
  • Oil companies:  20%
  • President Bush:  20%
  • Oil producing countries:  11%
  • Congress:  10%
  • High consumer demand in the U.S.:  10%

The sample margin of error is +/- 3.5%.  So, despite the ATA propaganda, oil speculators, oil companies, and President Bush are statistically in a three-way tie for being to blame for gasoline prices.  Consumer demand is tied for a distant second.  Maybe people have a hard time equating their SUV with the 9 billion barrels of gasoline we consume daily (compared to roughly 8 billion barrels/day ten years ago) and the fact that, both nationally and world-wide, consumption is growing almost twice as fast as production.  It’s easier to blame somebody else (the classic scapegoat response of addicts).

Advertising Age has the best response to the ATA that I’ve seen yet:

When we first received word of airline CEOs asking their customers for help against those rapacious oil speculators, we couldn’t help but think of Jack Nicholson’s line in “As Good As It Gets”: “Go sell crazy someplace else. We’re all full up here.”

Big Oil might not be anyone’s idea of the good guy, but perhaps the airlines should try to figure out what exactly the oil industry does right when it comes to turning a profit. Or maybe the airlines can take a cue from the movie “Airplane” and realize this actually might be the right week to quit sniffing glue.

I would also recommend reading the Capitalism Magazine op-ed on this subject.

The reason speculators are buying oil is that they want to lock in today’s price because they forecast that prices will be even higher in the future. If they are wrong about that, they will lose a lot of money.

The airlines also buy oil futures, because they too want to lock in today’s price to avoid the impact of  prices getting higher in the future. What the airlines are saying is that they should be allowed to benefit from locking in today’s price, but that other people shouldn’t be allowed to. Why not? Because those other people are “greedy speculators,” whereas the airlines are supposedly altruistic servants of the consumer.

And that’s what the whole sorry thing boils down to. There isn’t any valid evidence that speculation is what’s causing the price of oil to rise. But since “everybody knows” that greed is the source of all the world’s problems, then it must be the source of this problem too, and the easiest scapegoat there is “those greedy speculators.”

The idea that speculation is causing higher prices just boils down to the idea that prices are going up because certain greedy people want them to go up. But if people could raise prices just by wishing, why weren’t prices already skyrocketing ten years ago? Why aren’t they always skyrocketing in every market? Why don’t the speculative short sellers greedily lower the prices simply by wishing them to go lower?

Petroleum News notes that politicians, being politicians, have made a lot of hay out of the ATA poll and have produced several bills to protect us from amorphous oil speculator bogeymen, and have gotten plenty of advice.

“The large purchases of crude oil futures contracts by speculators have, in effect, created an additional demand for oil, driving up the price of oil to be delivered in the future in the same manner that additional demand for the immediate delivery of a physical barrel of oil drives up the price on the spot market,” said the U.S. Senate Permanent Subcommittee on Investigations in a June 2006 report.

In June 2008 legendary hedge fund manager George Soros, testifying before the U.S. Senate Commerce Committee, described the escalating oil price as a bubble that would burst when the U.S. economy goes into recession. The bubble results from institutional investment organizations such as pension funds fueling prices that are already rising as a result of high oil demand, tight oil supplies and a weak dollar, he said.

Proponents of the speculative bubble theory say that, encouraged by low margin limits, institutional investors have been riding the back of the climbing oil prices by pouring money into oil futures contracts. And just as in the recent Internet and house price bubbles, the rush to put money into these contracts has created a self-fulfilling increase in contract prices.

Not so, said Professor Craig Pirrong, expert on market manipulation and director of the Global Energy Management Institute, Bauer College of Business at the University of Houston, in testimony before the U.S. House Committee on Agriculture on July 7.

“Speculation is not the cause of high prices for energy products; the arguments advanced in support of this view are logically defective and at odds with an understanding of how the markets work,” Pirrong said. “Most importantly, there is no evidence to support claims that speculation — or manipulation for that matter — is responsible for high energy prices.”

Almost without exception, trading by financial institutions has made no contribution to the demand or supply of physical oil and, as a consequence, trading by these institutions does not distort the physical market in oil. In addition, a speculative distortion in prices would result in the accumulation of excess oil inventories. No such oil inventory accumulation has been observed, Pirrong said.

So we have a he said/she said scenario.  Who is right, if anyone?

A graph of the steeply rising oil price over the past year certainly resembles the price graphs of the upswing sides of historical asset price bubbles. And there are data indicating the operation of large numbers of speculators in oil futures, with oil futures prices tracking oil prices on the spot market.

On the other hand, the futures market provides an essential means for companies who sell or use oil to hedge the risk of future price changes. For example, by locking in a future price, an airline can gain some level of certainty around its future fuel costs. And futures trading tends to smooth out price fluctuations by anticipating impending price increases and decreases — essentially the futures encapsulate the cost of future uncertainty.

But there are two types of futures trader — hedgers and speculators. Hedgers consist of businesses that own oil to sell or that actually use oil. These businesses buy and sell futures to hedge risk. Speculators on the other hand buy and sell futures contracts to try to make money out of future price changes. Speculators “lubricate” the futures market by providing high levels of liquidity for futures trading.

BP has argued that worldwide supply and demand, particularly increasing demand in China, India, and other developing countries, have a much greater impact on oil prices than futures trading.

That report [BP 2008 Statistical Review of World Energy] concluded that escalating oil demand in developing countries such as India and China, coupled with worldwide supply constraints, lies behind the current oil prices. On the other hand, some economists have questioned whether the current exceptionally high prices truly reflect the relationship between oil prices and the levels of demand and supply — perhaps excessive speculator trading accounts for at least some component of the price?

And the Air Transportation Association of America, with its strong interest in fuel prices and in the importance of the oil futures market, certainly blames the speculators in a big way — ATA has launched a “stop oil speculation now” campaign.

However, before anyone starts tinkering with the futures market, they might want to pay attention to the law of unintended consequences.

“While certain targeted controls on speculation are appropriate, speculators … provide the market liquidity to allow hedgers to manage various commercial risks,” Harris [Jeffrey Harris, chief economist of the Commodity Futures Trading Commission] said. “Unnecessary limitations on the amount of speculation that an individual or entity may engage in could limit the amount of liquidity in the marketplace, the ability of hedgers to manage the risks and the information flow into the marketplace, which could in turn negatively affect the price discovery process and the hedging function of the marketplace.”

Confused yet?  Additional information at Daily Kos or the Center for Media and Democracy.

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