Monday, July 7, 2008

Some thoughts about oil prices

An article in Fortune says that it is unlikely that higher oil prices are due to futures trading. There are two basic reasons for this. First, these futures traders are not building inventories of oil, in fact oil inventories are down. Second, for every futures contract, there has to be a long and a short. If the longs are paying too much - the shorts should stand to make a killing. As usual, congress is blaming speculators for high oil prices and proposing legislation to reign in these "speculators". A similar article is in the Economist

On a related note, Newmark's door has an article about how the onion market is more volatile than the oil market, perhaps because there is not a futures market for onions. This finding is supported by my own work that shows that Single Stock Futures reduce volatility in the spot market for stocks. In fact most evidence shows that futures markets have a stabilizing effect on the underlying spot asset.

Finally, on NPR this weekend I heard a story about people trying to trade in their SUVs for more fuel efficient vehicles. In the story, one person brought a 2007 Escalade to a CarMax dealership. The truck was a year old, and cost over $70K. The owner was making $1400 a month payments on it. The CarMax buyer offered him about $30K for it. Here's what I don't get. You buy a 70 grand SUV a year ago when gas prices are $3 a gallon, but when gas prices hit $4 a gallon, you can't afford to run it? What's more, the owner said he would have sold it for $40,000 to the dealer - basically taking a $30,000 loss to save the pain of an extra $1 per gallon of gas. In behavioral finance this is called "mental accounting".