Speculating About Speculators
By Pejman Yousefzadeh Posted in Economic Ignorance | Economy | Oil Prices | speculation — Comments (26) / Email this page » / Leave a comment »
There has been a lot of talk concerning the influence of speculative activity on the price of oil. All of the sudden, we are hearing that "speculators" are responsible for oil prices going up and for the fact that we have to pay more at the pump. Of course, this all fits in with the need of certain portions of the political class to find a narrative that identifies and excoriates certain human villains for the increase in the price of oil--thus making us feel better about having found and excoriated those villains and causing us to believe that if only we punish the villains, we will be able to solve the problem of high oil prices at the same time, or at least be well on the way towards solving the problem of high oil prices.
Well, it just ain't so. Read the whole thing, but here's the key passage:
. . . there's nothing about futures or options that makes it any more attractive to bet that commodity prices will go up than to bet they'll go down. Guess wrong on the direction, and you lose money.
And that's basically all you need to know about speculation. When you speculate on the price of a commodity, what you are doing is betting on whether that price will rise or whether it will fall. Not whether you wish it would rise or fall. Not whether you hope it would rise or fall. And your money will do nothing to cause the price of oil to rise or fall. It will do so based on--wait for it!--the laws of supply and demand.
Right now, we don't have that much in terms of supply. We have huge demand--especially from the Chinese and the Indians. We have precious little refining capacity as well. This raises the price of oil and causes us to pay more at the pump. Speculators understand this and that is why they are currently betting that the price of oil will go up. But their bets don't cause the price of oil to go up and if any speculator bet on oil prices to go up during the 1980s--back when oil prices were actually crashing through the floor--that speculator would have lost his or her shirt.
It's amazing how much you begin to understand about economics when you realize that economic forces are significantly beyond the control of human beings to influence and that they are significantly more under the influence of the laws of supply and demand. Once that knowledge becomes widespread, we won't waste our time blaming people like speculators for the fluctuations in the price of oil.
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... will do little to nothing to the price.
If it's not however, we'll see a drop in oil prices.
Personally I don't see any problem with a bit more regulation of speculation on the commodities markets. There is plenty of actual demand without the speculators there that we won't be impacting the markets ability to set an accurate price.
...with the idea that speculation isn't driving a lot of the increase in oil prices -- as well as the dollar's devaluation, which is an important factor whenever commodity futures go up -- I fail to see a form that anti-speculation legislation could possibly take that would keep any semblance of our investment economy intact.
How would one limit the legislation to oil prices? Why not every single thing people speculate on? Why not?
If someone has such a way to word the law, I'm open to it. Gas is costing me...
the idiot politicians pushing this regulation plan to punish the evil overseas speculators. They are throwing up a smoke screen. MORE OIL and LESS DEMAND will lower the price. Both need long term commitments. Lets get started NOW. Forget about making stupid laws.
Check this article out... We don't need to bar 'speculators' and large investment firms from the market, just increase the margin needed to make large investment moves. I think there's some speculation but it's not A DRIVER! of the problem; it's just capitalizing on the market.
Here it is: http://www.greenfaucet.com/economy/who-is-an-oil-speculator
And it will probably increase it by a huge amount. Speculation is a fundamental part of any commodities market. Curtail it and you'll destabilize the market.
And energy is a $4 trillion (with a T) global market. If the government wants to see what happens if it destabilizes, all I can say is, pass the popcorn. And the warm mittens and sweaters.
Someone please correct me if I am wrong, but I had thought there were multiple markets for oil, all based on the American Dollar, in which speculation takes place.
legislation to remove speculation HERE will do nothing to stop it elsewhere, and may instead show a sign of fear that can cause a jump in the price.
how about this..... let's use Supply and Demand to our advantage.
Since reducing demand by a sufficient amount requires everyone to spend quite a bit of money (buy a hybrid car, install solar panels, etc), how about if we just.... well.... increase supply?
Drill. Drill Drill Drill. If there isn't oil there, what a great place for a nuclear power plant.
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Dependence is Slavery.
I didn't know that Congress could, but I did know that if you use the new government-mandated flourescent lightbulb, you can.
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Dependence is Slavery.
MCCAIN: I believe there needs to be a thorough and complete investigation of speculators as to find out whether speculation has been going on, and if so, how much it has affected the price of a barrel of oil. I also think that the whole international global financial system, the world financial system that we are in that we need to understand that there's a lot of things out there that need a lot more transparency and consequently oversight.
RUSH: No.
--an excerpt from Rush's attempt at reeducating McCain on this issue.
I've heard both Obama and McCain rant against "speculators", with varying degrees of fire(and sincerity). Either way, it's all talk. The market is no more affected by campaign rhetoric than it is by speculation.
I'm as free market as the next guy, but why don't many ever mention the changes that allow the speculators to put down only 5% of their purchase versus 50% in other markets. This gives them much less risk, and the ability to drive the price higher looking for a bigger score. Also, I believe in the mid-90's the rules were changed allowing those not in the oil industry to begin speculating in it anyways, this has added more money to the market and more of an influence from outside the industry. Yes, I agree that outside investment is always good, but in this case, with a commodity, this outside influence is doing more harm than good.
I'm as free market as the next guy, but why don't many ever mention the changes that allow the speculators to put down only 5% of their purchase versus 50% in other markets. This gives them much less risk, and the ability to drive the price higher looking for a bigger score. Also, I believe in the mid-90's the rules were changed allowing those not in the oil industry to begin speculating in it anyways, this has added more money to the market and more of an influence from outside the industry. Yes, I agree that outside investment is always good, but in this case, with a commodity, this outside influence is doing more harm than good.
the Beta of the investment goes way up, allowing for larger gains and larger losses.
Instruments like derivatives, options, and margin accounts operate on similar principles.
that so many people who have no idea what they're talking about try to explain away the speculators in the commodities market.
The commodities market is NOT about pure supply and demand and anyone who tries to spin that is flat wrong.
Dirty Secret #1:
Total money in the commodities market at end 2005: $13billion
Total money in commodities market as of May 2008: $260billion
(That's not oil, that's ALL commodities)
Dirty Secret #2:
China's demand for oil in the past 5 years: 920mil brls
Index SPECULATORS demand for oil futures past 5 years: 848mil brls.
(Index Speculators have now stockpiled, via the futures market, the equivalent of 1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own stockpile as the United States has added to the Strategic Petroleum Reserve over the last five years.)
There is a crucial distinction between Traditional Speculators and Index Speculators: Traditional Speculators provide liquidity by both buying and selling futures. Index Speculators buy futures and then roll their positions by buying calendar spreads. They never sell. Therefore, they consume liquidity and provide zero benefit to the futures markets.
hey distribute their allocation of dollars across the 25 key commodities futures according to the popular indices – the Standard & Poors - Goldman Sachs Commodity Index and the Dow Jones - AIG Commodity Index.
I appreciate Pejman wanting to defend free-market principles, but you need to be RIGHT about it.
"Strength and Honor."
"What we do in life, echoes in eternity."
One thing to remember is that speculation only create temporary price pressure, they need to keep buying more of the market to push the price up, merely taking a future and rolling it every three month only impacts once. To keep an upward price pressure you need new money continuously coming into the market and thus this isn't the same as the china demand which is reasonably seen as long-term.
the commodity or otherwise owning the commodity?
If people are willing to compile surpluses of commodities in a time of sharply escalating prices without any intention of using the commodities, then we are by definition, experiencing a commodities bubble.
We all know that bubbles will inevitably burst. If what you say is true, then prices will come WAY down when that happens.
What can policy makers do to induce the popping of the bubble?
To decry to Index Speculators makes no sense whether such "speculation" occurs in stocks, commodiies, or any other asset.
Isn't the point of capitalism to give people the freedom to own things and do what they want with them? If I want to "hoard" gold, isn't that my business? If someone wants to start a collection of oil barrels and sit on them (taking the risk of the bubble bursting), then why not let them.
How is Index speculation worse than the .com tech stock speculation of the 90s?
...that speculators play a key role in market dynamics. In any futures marketplace, you have two main players:
1. Hedgers - those who make offsetting futures transactions to balance the books when they make cash sales/purchases
2. Speculators - the eeeeeeevil Gordon Geckos who manipulate the prices with their awful speculative ways
Or, to put it in less sarcastic terms, speculators are needed to offset the risk management transactions conducted by the hedgers. For example, if American Airlines purchases X quantity of fuel at a cash price, they (should) would then sell an equivalent number of futures contracts in order to mitigate the price risk they have assumed by purchasing a commodity in the open market. Who is going to take on that futures obligation by buying what AA just sold? In all likelihood, the specs will do that, thus preserving market liquidity. The speculators have a critical role.
Where things get hairy is when market standards are not standardized across the whole commodity spectrum. These gaps provide for temporary advantages in market trading activity, i.e. varying margin requirements that allow for specs to risk less money. Further, any bull run will eventually slow down, and a lot of those speculators growing their long position will lose their shirts. Specs are betting on the market going up, and eventually, it becomes a spec-fulfilling prophecy. Increasing margin requirements on the oil specs will bring them into line with other markets, and regulate the flow of money into long/increasing positions; but, we should not saddle them with an onerous burden, or the only specs in the market will be the moneyed hedge funds who can absorb the risk, and have the dollars to truly push the market around.
It's a bubble, people, and eventually the price will break, a bunch of people will be left holding the bag, and fundamental forces will again control the market.
If Mr. Yousefzadeh doesn't believe speculation causes prices to rise and fall, I have a $200,000 tulip bulb I am willing to name after him.
I am also nominating him for the "Pump and Dump Society" annual award for the person who does the most this year in the vital work of "Keeping the Suckers Ignorant".
Over time, speculation is just another word for liquidity. If Speculation is enhancing the upward movement in prices, it will be only a matter of time before it causes prices to go down.
Other recent bubbles:
US housing market
Tech stocks in the late 90s
Speculators can't make money indefinitely by trading oil contracts with priceses increasing continuously. This is true whether they are stockpiling them or just trading them.
Never underestimate the madness of crowds. In that vein, a big 5 to Joe Sixpack for this quote:
...I have a $200,000 tulip bulb I am willing to name after him."
Tulipomania, along with other mass-driven bubbles invariably deflate/explode. You can see Charles Ponzi, the big "multi-level marketing" craze from the 70's-80's, the Florida Land Boom, the South Sea Company, or any other bubble, and it will give you some comfort that this will sort itself out.
BTW, I was waiting for someone to reference Tulipomania.
The simple truth about bubbles is they create big winners and big losers. Create is the keyword, out of nothing.
If you believe the future cost of production is going to rise, that is speculation. If the PRESENT price is moved above the PRESENT cost of production, that is not speculation, that is a FACT that creates enormous pools of capital taken from the people who are forced to pay these current prices, left over after subtracting the current cost of production. As is the nature of money, it insists it belongs to someone.
There is a whole class of people who have happened to notice this and are willing to be the people this money belongs to. Yes, the market will sort it out, from your pocket to mine.
Sounds like what he's saying is that speculation isn't the root cause of high oil prices, only ever a contributing factor. The root causes appear to be limited supply, increased demand, and insufficient/reduced domestic refinery capacity.
And, hey, all of that's in the fourth paragraph.
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This too shall pass.
The only effect of legislation on Oil speculation will be to drive the marktet offshore.. Oil's an internationally traded commoddity and the only impact of any such legislation is to export some jobs for New York and Chicago to London.
It won't be the first tiem for this sort of thing and London will continue to gain as long a wishfull thinging is the major driver behind US legislation of financial markets.
When the bottom falls out it's going to be university endowments and those who have their government pensions stuck in this mess who will be shirtless.
My dad said, "the bulls always make a bunch of noise, the bears sit quietly and wait til the time is right. And when the bears hit, the bottom will fall out."
"Strength and Honor."
"What we do in life, echoes in eternity."
be the big losers, as will those whose appetite to profit grows expontentially and is not tempered by heding their bets. I.e. Someone who keeps doubling down will ultimately lose everything.
If university endowments are playing these types of games, then they deserve to go down.
"they deserve to go down".
Maybe. But they'll be carrying our money with them. The housing market is getting the current bailout, all in the name of the greater good, or to forestall catastrophe.
This bubble, caused in part by money in refuge from the housing market, will burst along with the foundations of many pension funds and endowments. And thus the insecurity continues, while another bailout bandage is pursued.
Speculators speculate on other speculators speculating. And whether that's on oil or seashells by the seashore, it will defeat supply and demand pricing of commodities. When the supply we're talking about is oil futures and not oil itself, then we're dealing with something different that production vs. consumption of petroleum.
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