Economics
Free exchange
Oil
Reining in the speculators
Mar 8th 2011, 17:52 by R.A. | WASHINGTON
FEW relationships in life are as tight as that between rising oil prices and increasing complaints about commodity speculators. Nation reporter Chris Hayes sees the cost of oil going up and unholsters his anti-speculation column:
In the wake of the price explosion in the summer of 2008, a bubble that extended to all kinds of commodities, including copper and wheat, a number of observers from George Soros to Hedge Fund manager Michael Masters to former Commodities Future Trading Commission staffer and derivatives expert Michael Greenberg concluded that the underlying supply-and-demand fundamentals couldn't account for sharp rise in prices. In the first six months of 2008, US economic output as declining while global supply was increasing. And even if supply and demand were, over the long run, pushing the price of oil up, that alone couldn't explain the massive volatility in the market. Oil cost $65 per barrel in June 2007, $147 a year later, down to $30 in December 2008 and back up to $72 in June 2009.
The culprit, they concluded, was Wall Street speculators.
First, it's not true that American output was falling in the first half of 2008; GDP declined in the first quarter but rose in the second. Second, the oil market is global. While American output stagnated in early 2008, growth in places like China continued to soar and demand for commodities followed. Indeed, the fundamental trend in commodity prices, including oil, over the past decade has been a general upward movement as demand growth outstrips supply growth. Third, the fact that price increases span commodities undermines the argument that speculation has played a major role, because prices for commodities that don't trade on these markets have risen alongside those that do.
Fourth, the wild swings in price after July of 2008 aren't evidence for speculation either. As prices rose supply ramped up on a lag. Not all of the world's marginal supply can be turned on at the flick of a switch. But in the fall of 2008, the global economy fell off a cliff. Demand plummeted in the face of rising supply and prices tumbled. But by 2009, supply and demand were more closely aligned, and the global economy was recovering. There's no mystery here. And fifth, the easiest and most effective way to speculate on the price of oil is to leave the stuff in the ground, and there's not a thing the American government can do about that.
It's not impossible that financial market shenanigans have added a bit to the tops and bottoms of market swings. But America's vulnerability results directly from the fact that it uses a massive amount of a scarce resource that other people also want to use. As convenient as it is to blame the nasty bankers for causing this particular economic pain, the fact is that the problem isn't financial markets, it's American consumption.
About Free exchange
In this blog, our correspondents consider the fluctuations in the world economy and the policies intended to produce more booms than busts.
Advertisement
Economist blogs
- Americas view
- Asia view
- Babbage
- Bagehot's notebook
- Banyan
- Baobab
- Blighty
- Buttonwood's notebook
- Charlemagne's notebook
- Clausewitz
- Daily chart
- Democracy in America
- Eastern approaches
- Free exchange
- Global Leadership
- Gulliver
- Johnson
- Leviathan
- Lexington's notebook
- Multimedia
- Newsbook
- Prospero
- Schumpeter's notebook
- The World in 2011: Cassandra
Most commented
- Charlemagne: No time for doubters
- This week's caption competition: Caption competition 7
- Turkey and Europe: Mr Erdoğan goes to Germany
- America’s security commitment to Taiwan: From keystone to millstone?
- China's foreign policy: Setting sail for Libya
- America's budget: The elephant in the room
- Mormons in politics: When the saints come marching in
- A special report on property: Building excitement
- Trains again: All countries with passenger trains also have highways
- The Republicans: Who dares take him on?
Over the past five days
Most recommended
- Oil and the economy: The 2011 oil shock
- Turkey and Europe: Mr Erdoğan goes to Germany
- China's foreign policy: Setting sail for Libya
- Mormons in politics: When the saints come marching in
- Psychiatry: Therapist-free therapy
- China's pre-emptive crackdown: The people doth not protest
- KAL's cartoon
- Libya: The limpet's legions
- The Tata group: Out of India
- Insider trading: A tip too far?
Over the past seven days
Advertisement
Subscribe to The Economist's free e-mail newsletters and alerts.
Subscribe to The Economist's latest article postings on Twitter
See a selection of The Economist's articles, events, topical videos and debates on Facebook.
Advertisement
Readers' comments
The Economist welcomes your views. Please stay on topic and be respectful of other readers. Review our comments policy.
Sort:
Do you really believe that the fad for alternative investments has not caused an increase in magnitude and speed of commodities price changes ?
I've yet to see any evidence that speculators are actually having a serious impact. It's really a question of demand; demand for easy explanations and villains in the story besides ourselves.
@bampbs:
Do you really believe that the evolution of return-seeking investment into 'alternative' spaces to stocks and bonds is a 'fad'?
It's easy to see why people blame speculation. Libya represents 1% of global oil production (an amount that Saudi Arabia can easily make up in spare capacity anyways), yet my gas prices have gone up something like 20% since the protests started there. Simple supply/demand dynamics don't see, to explain this short-term swing (there is, after all, no actual contraction in supply). What does?
msgkings, I think that trustees need to have their chains put back on, and attend to preservation of capital above all. They ought not be free to run with the sheep over the next financial cliff.
There is always a problem with trying to increase diversification. Once everyone is in the new pasture, the sheep all flock together. So diversification-seeking that is emulated destroys the benefits of diversification. The end result has been greater extremes and faster changes in prices for commodities that the world economy depends on.
So, no, I don't consider direct investment in commodities a good idea. There are the securities of companies and nations that depend upon them that can provide sufficient exposure. I'd like to see commodities markets limited to real producers, real consumers, and speculators who take the other sides of their trades. No completely naked trades, except for hedging by market-makers.
The main cause of rising commodity prices is the credit expansion of the US, Europe and Japan which feeds inflation in every country in which they trade.
Speculators have a bad name because of the ignorant press. But speculators are nothing but pure entrepreneurs: they take the risks that no one else wants.
What would the world look like without speculators? There would be no insurance and no investors in businesses. No one could raise funds from strangers to start a business; they would have to rely exclusively on their own savings.
Speculators in the oil market perform a valuable service: they dampen the swings in prices. It doesn't seem that way because people assume, without reason, that oil prices wouldn't change much without speculators. But without speculators changes in demand or supply would shock and frighten everyone. Volatility would be much greater.
Oil is an emotional issue, so let's examine other speculative markets. Take grain for example. Speculators buy contracts in grain when real prices are low, thereby raising them. Then the speculators sell when prices are high, thereby reducing prices. The same thing happens in the oil market but few people are willing to open their eyes to what is really happening.
On Tuesday March 8, 2011, 1:29 pm EST
NEW YORK (AP) -- Pump prices will average $3.70 per gallon this spring and summer with a barrel of oil averaging $102 this year, the U.S. Department of Energy said Tuesday.
EIA sees pump prices peaking at $3.75 a gallon in June. But its report says there is "significant uncertainty surrounding the forecast" and pump prices could spike above $4 this summer, which would threaten the all-time high of $4.11 a gallon reached in July 2008.
This is no different than a Wall Street analyst's projection/prediction of a stock price, which leads to "herd mentality".
Regards
Wow, if spectators dampened the swings so much and we still got oil going from $65 > $147 > $30, I can only imagine how volatile they would have been without them! They must truly be doing god's work.
Check out the price swings in the early 1970's, from $3 to $30.
It is somewhat unnerving that most contributors here and other forums like Marketwatch, etc, have NOT done ANY homework...and support their arguments by the seat of their pants. It is a fact that the abolision of the CFTC regulations through the Gramm Ammendment of 2001 UNLEASHED a cascade of trading money from banks to pension managers to hedge funds, directly into the commodities futures. It is a fact that UNDENIABLE testimonies from Greenberg to Masters to Soros testified under oath in Congressional hearings that as of Feb-May 2008 $240 Billion was pumped into TRADING and Speculating in the futures markets which were never designed to handle a TENTH of that. Derivatives used by many of these participants have many times obscured the preponderance of MANIPULATION, but could not hide it !
Finally, and this is very seldom mentioned in these conversations,the MAIN attraction to this out-of-control casino is its unencumbered Leverage. Our now powerless and asleep at the wheel "regulators" have not been YET forced to raise margin requirements to 100% to all non-user traders, to break a runaway bubble, as it was the practice BEFORE the Gramm Deregulation, thus the Financial-Trading bunch STILL enjoys 25 to 1 and 30 to 1 leverage until this day ! This is pure and simple LEGAl robbery of all of us ! Let us see The Fed or The Treasury declare a national "vital commodities emergency" and demand ALL MONEY DOWN (100% margins)to traders, for three months and you'll all see how oil and all other commodities will collapse to a THIRD of current levels. The writer of the Speculation Denial has no clue as to the extent of this MASSIVE manipulation ! If anyone wants to be helpfull,go check the carefully kept figures at our own government's EIA website, for example, to compare supplies of fuels on hand in 2003 and today's. You'll simply find that Cushing Oklahoma supplies were LOWER than today, as were the supplies of gasoline. April 2003 average closing price? $19.70 a barrel! You can write any dream and fantasy stories,about China demand, Nigeria rebels,drilling rights, but the bottom line is 500% spiral in prices in 7 years WITHOUT fundamental facts ! And the same cowboys brought all of us the rest of the commodity bubble.Are we mad enough yet to DEMAND that our government curtail this casino ? Probably not yet...
fundamentalist, you are right about the traditional commodities trader, but I think that the "alternative investor" is much more likely to be a trend follower than a contrarian.
Simple way to rein in speculators:
Global cap on leverage at the inverse of Basel limit (currently 8%), hence 12.5:1, or 1 million dollars per PERSON, whichever is larger.
Banks should be prohibited from making any speculative lending (that is effectively what leverage is).
This way, only way for banks to earn greater returns is by concentrating on small businesses with starting capital of less than 80,000 dollars....
Thanks for this. This is one topic I see the need to keep writing about. I know there are speculators and I'm sure some are shady but I'm fairly sure speculators cannot be responsible for anything of the magnitude that provokes their accusations.
For example, we have notoriously inelastic markets in oil and we know that. We should expect small disruptions to cause major price changes.