Sunday, May 15, 2011

Speculators and oil prices

In my local Sunday paper today, there was a pretty poor article about the effect of speculators on oil prices.  The article was a McClatchey piece and so probably appeared in numerous other papers.  The article's basic premise was that oil prices are high because the proportion of speculative traders relative to commercial traders is high.  Therefore speculators are causing high oil prices.

I've blogged on this before.   The argument is flawed for several reasons.

  1. The assumption that the relationship runs from speculators to oil prices is a classic case of confusing correlation with causality.  
  2. It makes little sense that highly informed traders would bid the price of oil up way beyond its fundamental value.  If they did, they would expose themselves to monumental risk of the price collapsing.
  3. Most oil speculators are trading futures contracts.  As a result they never actually take delivery of the oil.  It is hard to manipulate a market if you don't actually take possession of the commodity.
  4. The presence of more speculative traders makes it far more likely that a bubble in oil prices would burst sooner rather than later for the simple reason that bursting the bubble would make a lot of traders who bet against high oil prices very rich.
  5. The argument that shows that US refineries are not running at peak output and that US demand is down completely ignores the global demand for oil which is increasing steadily.
  6. The biggest "speculators" are the oil companies themselves who choose not to refine more oil and instead keep it in their reserves.  They just understand that real options have value.
Both Forbes and The Economist have excellent articles on this topic.  Notably these articles were written last time Congress went looking for a scape goat to explain supply and demand.