Do You Still Believe it Wasn't Speculation?
With crude oil prices now twenty percent below their levels of just a month ago, and other commodities down as much or more, it's time for the countless economists who told us the rapid prices increases had little to do with speculation to stand up and explain themselves.
Now, anyone writing about or discussing economics is going to make mistakes. But this claim was a whopper. More to the point, and the reason it brings out this writer's passionate anger, is that the rapid rise in prices has caused so much pain for the world's poor.
The simple fact is that prices for any commodity can be moved by speculation about the future. When they are financialized, as is crude oil, it means non-users can make easy bets on future prices that require only a small down payment.
It's just like the stock market. Do stock prices reflect only rational projections of corporate earnings and dividends? We've had enough of irrational exuberance and its opposite to know better now. Then why should oil futures prices reflect only genuine shifts in supply and demand?
The fascinating question is why all these economists were so anxious to deny speculation an important role.
There are two answers. One is the persistence of a view that financial markets are efficient and mostly rational. Many economists, not only Friedmanite conservatives, like to believe that. It makes doing economics a lot easier to assume most of the time that prices accurately reflect the real world supplies and demands of goods and services, including financial assets, and that market participants always have their wits about them.
The second answer is that if the financial community admitted oil price speculation was a major problem, regulation of trading might likely follow. Many economists work for Wall Street firms, or might someday like to, even those staffers at the Fed.
What is really galling is when economists make such claims implying that anyone who disagrees is simply ignorant of the basic laws of economics or just not bright enough to understand all the nuances.
Oil is a financial asset now. It attracts hundreds of billions of dollars of institutional investment. It is a hedge against inflation and against a falling dollar. And like all financial assets throughout time, it is given to fashion and fad.
Demand for oil in the US is down only a couple of percentage points, crude down twenty percent. Quite a swing, Try to explain it rationally.
Then tell us how the Federal Reserve and other central banks can dare make monetary policy based on assumptions that such prices have genuine roots in supply and demand. Not to say that there may not be a long-term shortage over time in oil. Fortunately, Ben Bernanke has thus far resisted. But tough guys at central banks were wiling to cause people to lose jobs without sufficient sensitivity to the wobbly foundation of these oil prices.
Why do so many smart people believe such things?
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No matter how recent price fluctuations have appeared to you, the supply-demand fundamentals for oil are still terrible. We will see some respite in prices with the wearing off of the fiscal stimulus and economic weakness in Europe, Japan, and elsewhere across the globe, but once the economy strengthens again prices may go up much higher than even the $147 we saw this summer. The fact is that we're seeing declining oil production from nearly all major producing countries and until more supply comes on-line, we have a serious problem. Right now global spare capacity is barely over global demand. We can talk about speculation until we're blue in the fact, but supplies just aren't there and we need to find them.
"but supplies just aren't there and we need to find them."
If oil and gasoline were in short supply there would be SHORTAGES! See any long lines at the gas stations? Are gas stations closing for lack of product? Why do the weekly reports on petroleum stockpiles continue to be in the normal range, the same range they were in when gas was $1 a gallon? Why did the April 2008 report show gasoline stockpiles at their highest levels in 15 years? Do you remember the "electricity crisis" that increased spot prices by 1000%? Did you notice that after an investigation and conviction of trading companies like ENRON that the prices returned to normal without increasing supply? Does the word PROPAGANDA ring a familiar bell? What about the term "Sheeple". Finally, if oil, gasoline and diesel are in such short supply, how can we be exporting 185,000 barrels of these products every day?
Oil is a global commodity. There are currently no shortages, however, spare capacity is so tight relative to demand that a continuation of strong global growth or even a minor disruption in supply will result in shortages. Currently in the US gasoline supplies are nowhere near even five year highs and US oil supplies are near five year lows. The real demand driver for oil products has been in a massive increase in demand for diesel fuel.
"If oil and gasoline were in short supply there would be SHORTAGES! See any long lines at the gas stations?" This is incorrect. These types of shortages occur when the government puts an artificial ceiling on prices. If oil is in short supply relative to demand, price will react until equilibrium is reached. I haven't noticed any gas lines, but I've sure noticed gasoline prices going up.
Here's a great link from dd that you should read and think about:
http://www.star-telegram.com/ed_wallace/story/659081.html
"that financial markets are efficient and mostly rational."
In many ways they are. Take the current financial meltdown. Wall Street was trading bogus securities that were fraudulently rated. When it blew up no one would buy their dirty paper and they were quite rightly faced with bankruptcy. The rational thing was to cleanse the system by allowing the efficient demise of the criminals and their crooked enterprises. When the Federal Government interceded they lent their support to the irrational course of allowing fraud, misrepresentation and conspiracy to remain embedded in our financial system. Likewise, Congress in pandering for votes has initiated a "bailout" for the unwise that have made irrational housing decisions.
"that if the financial community admitted oil price speculation was a major problem"
They are protected by the Fifth Amendment against self incrimination. They cannot therefore be expected to answer that question. Many of the large Brokerages ARE the speculators!
I have been posting for months that the run up in oil prices were the result of unbridled speculation. The reason that the laws against this have not been enforced is:
Many were rescinded by frugal Phil Gramm, friend of the common millionaire.
The present Administration is on the same side as the criminals.
The Corporate News Media has abrogated its Constitutionally protected responsibilities.
The federal reserve and federal government providing liquidity to banks and investment banks is extremely important in continuing the normal functioning of the economy. Without access to liquidity, companies can't expand, can't accumulate inventory, and sometimes can't pay employees or debt service. Even if providing liquidity to these concerns seems "irrational" to the average American, it is absolutely necessary and not having access to liquidity can affect the economy much more negatively than $147 oil can.
Excuse me dugie, but the "excess" access to "liquidity" was THE cause of the financial crisis that is about to implode.
Excess access to liquidity is responsible for and defines the tremendous growth in the national debt, both public and private.
I am not sure what American taxpayers have done to more than double their tax liabilities for the sake of funding either the Iraq war or the housing bubble-credit crisis.
So, to some of us, the idea of using "more of the same" as that which caused the problem as the solution to the problem is one of the definitions of insanity - this time of a monetary policy nature.
Today's "SCREW THE AMERICAN TAXPAYER" monetary strategy is born in the private debt-money system, that forces the GOVERNMENT of these TAXPAYERS to borrow non-existent money from private bankers who collect interest on each iteration of both debt-issue and money creation.
This strategy does not make sense, and is not providing liquidity to companies wanting to expand inventory or increase jobs. It is staying at the top of the financial food chain.
This strategy is providing "liquidity" to the commercial banks and to the investment banks to keep them from failing, and thus to prevent the whole house of cards from tumbling down.
Which it should.
So we can replace the private cabal at the FED with a government-issue, debt-free monetary system, and put the bankers to work lending their own money.
There is a difference between criminal activity and poor investing. Criminal activity, like fraud, should be investigated and punished by the government. Poor investors should be set "free" to suffer the consequences of their poor investments.
"The rational thing was to cleanse the system by allowing the efficient demise of the criminals and their crooked enterprises. " I guess I'd have to agree with this statement if "criminals and their crooked enterprises" was changed to "poor decision makers". If criminal activity is taking place, that is exactly where the government should intercede.
Bif brokerages get out before the peak, and respond by getting out and let the market drop destroying the naive investors who take the loss
Great article--great insights. It is also an historical fact that every recession and or depression had its root in speculation. I think it is time to end speculation by getting rid of leveraging with 5% and making it 100%.
The US hasn't had a notable recession since 1982. The recessions in 1990 and 2001 were short and minor, mostly because economic weakness in some sectors was mostly off-set by economic strength in others. In 2001, for example, there was weakness in commercial construction, exports, business spending, and manufacturing but strength in consumer spending, residential construction. and autos. Currently there is weakness in consumer spending, residential construction, financial services and autos but strength in commercial construction, exports, and many areas of manufacturing.
Oh please, the 2001 recession has never disappeared. If Bush would not have loosened the money in the housing market, Clinton deregulated the banks and now
we saw what they have caused. Bush bragged about the many new homeowners
yet people did not make any more money, only they let us cash in on home equity
and gave us more credit on credit cards, and that spurred on the economy for a while,
and now we see, it was a house of cards.
Oh, thanks for the news.
This explains the Futures Traders game.
http://www.rsi-ireland.com/documents/DarkPoolsVol2.pdf
Remember Graham of Texas who SNEAKED the Enron Electronic Trading DEREGULATION into a bill that passed Congress is on the Borad of the Swiss Bank that has the computer program that keeps these electronic investor dark pools hidden from regulation !
dad,
That's Gramm of Texas.
Graham's from South Carolina.
A real pair of winners.
It's insane allowing such a vital and essential asset as Oil or energy to be subject to such frivolous manipulation as now occurs on the Commodities and Futures Market...!
if America had listened to Professor Michael Greenberger months ago price would be cut by now from 30-50%..!
Our Media is allowing the Republican party all those Republican Congressman and women and Bush and McCain to lie to our entire nation every day over and over repeatedly..so as to sustain this huge swindle..!
Here's a great explanation of the biggest swindle in history.. by Ed Wallace..
http://www.star-telegram.com/ed_wallace/story/659081.html
Great link, dd, thanks!
Oil shouldn't be in the futues market it's low risk and the only risk is drilling and not striking oil, which is pocket change for the oil guys.
The price on the barrel is determined by OPEC (monopoly), even Canadian tarsand oil has to follow OPEC, re: NAFTA agreements, as so to not destabilze the futures market., (no competition)
Since the Saudi';s and their ilk play the futures market in oil. all they have to do is to reduce supply, viola barrel price increases and futures markets jump up, then they sell at high end, leaving ma/pop investors coming late to the party holding a lower value.....
So for stability in prices remove oil from the future markets.
You mean take it under ground ? into the dark ? Well the ENRON GUYS have already done that by moving thier operation odd shore and using Swiss computer programs to stay hidden by swaping Futures Contracts around before selling them thru that computer program.
To regulate them the SEC must find them but Bush cut the SEC budget so they have little money to look for them or regulate them if they find them.
To date the only time they find the Oil Furtures Electronic Traders who are controlling the market is when one goes bankrupt!
Sooooooooooooooooooo simple.
Yet, soooooooooooooooooooooooo TRUE !
"Oil shouldn't be in the futues market it's low risk" This is in your opinion. But obviously those that have to put their money on the line disagree. Are you suggesting that they not be free to participate in this market because of your evaluation of their risk?
When supply is a monopoly (opec) futures don't work
futures only work when there is competition
Actually, FBD, yes, oil and all energy futures trading should be abolished forthwith, via the elimination of what is known as the Enron Loophole.
By the way - nobody has to put their money on the line, it's their choice.
I am sure you are aware that prior to the creation of the Enron-enabled energy commodity market, IT WAS ILLEGAL for ANYONE, ANYWHERE in the world to trade anything except real oil products for real money.
No FUTURES.
No HEDGE FUNDS.
No DERIVATIVES.
Once the legalized crime of robbing the American people through the CFTC, as well as the international markets, was created, we began one of the biggest financial scams the world has ever seen. And we're still paying for it today.
Ken Lay would be proud of the legalized thievery that he has spawned.
But the rest of us would like to restore the free enterprise market in energy pricing, so that we don't have to participate in bizpage drivel on whether the price of oil and gas is related to speculation or not.
Restore free enterprise to energy products.
Re-illegalize commodity trading in the same.
NOW.
all those experts who are saying all this oil prices are speculation from futures markets here is my simple question ?
who is winning money and who is losing money? Futures markets and equity markets are different in ways they work.
Futures market is a zero sum game. 1$ won by party A equals 1$ lost by counterparty B.
So saying that all these traders are making money from oil futures, who is the counter party to the same future contract that is losing money?
You will never get a logical answer because none of the people who badmouth traders as the source of all evil actually understands the technicalities of futures trading.
People are mad about the fact that supply and demand (which is their own fault) and dollar devaluation (which is also their own fault) are making their lives harder. Somebody has to be at fault and it can never be the person who feels victimized. And that's when we start a good old fashioned witch hunt. Takes are being erected and straw men are burning. The stench of anti-intellect is filling the air.
But I am looking forward to the answers you'll get, anyway. Let's see how "creative" some will be to defend their losing proposition.
Have you forgotten already how the traders made money in the California energy Crisis?
I heard the same lame BS about supply and demand back then too.
And as i recall the crisis involved Natural Gas as well.
Supplied by the same damn folks who deliver our oil.
Yeah, cause the fact that demand wasn't all that high since the oilcos had VAST reserves of both oil and gas has NOTHING to do with prices!
Here this explains it
http://www.rsi-ireland.com/documents/DarkPoolsVol2.pdf
American run Hedge Funds are the ones where the MEGA Rich have put thier money for these ENRON Excutives to run their Electronic Futures Trading.
Ahh, the producers and speculators have been too smart this time by half. Funny how a year and a half of rising gas prices leaves me wit a bad taste in my mouth and my bank account. Did this in '74, and didn't have the choice of a more sensible form of transport then. Don't now either, ... but the lifestyle can change, and has. Eat, and drive differently.
Sorry guys, ... you made us third world, ... now we'll spend third world. Take your oil and shove it up your pumps!
So if speculators drove prices up, they must be driving them down, too, right? Now, can anybody show me evidence that lowering prices on oil and other commodities actually makes money for those speculators? If you can's show evidence, then what, in your opinion, is the reason that they are manipulating prices down?
I am looking forward to creative answers.
:-)
Actually, since the only thing that an investor needs to make money in the market is CHANGE, yes, they ARE making money on this drop! Maybe not everyone that's in the market, but the big guys are almost certainly making money!
However... the "speculators" were driving the market up a month ago, or so (look at historic futures prices!). So the people who bought those futures for today who were driving the market up just lost their bets and lost big time money...
"Maybe not everyone..."
I see... somebody, somewhere is making money while somebody else, somewhere is losing. That's a tautology for any investment at all times because money is a zero sum game.
"...but the big guys are almost certainly..."
Cool. Now prove it. With numbers.
Perhaps you have never heard of the invisible hand.
It is invisible.
Yet it makes the markets do things.
The futures market is not transparent, thus it is not visible.
Were it, we would know the answer to your question, and to iambusto's above.
It is because it is invisible that we cannot answer your question.
And you know that.
Making you the smart guy that nobody has the answer to.
And killing the message that manipulation and speculation are responsible for a large share of the price of oil today.
Very much more importantly - a truism.
It was not always legal to free-marketeer in oil futures or other energy products.
Re-illegalize those Bush-Enron robberies that made energy products into "commodities", and we will have a supply-demand market in oil.
Free enterprise.
Which is exactly what we all need and want.
In case you haven't noticed.
I'm currently making money as the price of oil goes down by "shorting" the oil ETF (USO) and the gasoline ETF (UGA). I'm currently not using my futures account. You could sign up for a trading account in about ten minutes, transfer money into the account, and could be shorting oil and making money yourself within three or so days. The issue with speculators pushing up the price is that if you believed oil was overpriced at $120, $130, $140, or $147, you could have just went into your account and shorted the ETFs or futures -- it's that simple, that's how a free market works.
This is easy. Congress did address this here recently and passed a law, it is not perfect but it
is better than what we had and immediately the price of oil was sinking. For $113 barrel of oil the
price should be $ 2.89. I don't see them going down as fast as they went up. Wondering why LOL.
One of the Republicans' chief causes for decades has been to present the oil companies with more tax breaks and drilling opportunities.
Ironically now that they have their "shock doctrine excuse" (the rapid increase in oil prices), the oil companies are making so much the way things are that they really don't want to go to the expense and take the risks involved in drilling where there might not be any oil. But the Republicans will continue to advance the cause anyway.
So even if laws against offshore drilling are relaxed, it is unlikely they will drill for a while. There are absolutely no proven reserves on the Atlantic coast, so that would be an unnecessary investment for oil executives, whose pockets are already bulging.
Still the Republicans will exploit this issue and any others for political reasons only.
Of course they would never concede the increase could be from speculation and Republican policy visa vis the "Enron loophole", not to mention Republican opposition to alternative sources of energy and fuel emission standards for decades.
As long as this kind of ignorance remains the prevailing view, speculators will have a field day.
Never mind that in 7 years demand for oil has increased by only 10%, but the price of a barrel of oil has risen 6-7 times, the media and electorate will continue to ignore the obvious.
I'm in the wrong line of business...
No, you aren't. If you were in the futures trading business, chances are that you would have gone bankrupt a dozen times by now. This stuff requires actual economics and math skills.
Richard Dennis
Last year when the oil dropped they all lost their pants and then came the very high
prices so they could recoup their money.
As far as I know (I'm 95% sure), there is no law requiring the producers of commodities to sell their products via a futures market. That means they are doing it voluntarily. One has to ask, why? What is the purpose? What is the consequence if this is no longer an option?
What is a speculator? A purchaser of futures contracts is certainly speculating. They speculate that the price they pay for the contract will be lower than the price they'll be able to sell the product for. What about the producer of a commodity? They are speculating as well. They speculate that they'll be able to sell their product for more than it cost to produce. Both are assuming an acceptable profit. Both are assuming risk. In fact, the way the producer reduces their risk is by selling the futures contract. The purchaser of the contract is selling their assumption of that risk.
Just because there is no such law does not mean that producers and consumers won't take advantage of the futures markets.
What the futures market does is to provide security for both the seller and the buyer of a commodity because they can sell that commodity at a known, guaranteed price without having to expose themselves to daily price fluctuations. The futures market therefor provides the financial risk management for the producers as well as the consumers (which are the refiners, ultimately). For that, like for every other financial service, the guarantor expects a certain financial upside (nobody secures your risk without taking your money for it).
If you don't understand this function of the market, you understand absolutely nothing about what is going on right now.
I must have been too vague in my post because you are basically making my point. My point being that those who purchase future contracts are performing a service that those who sell them desire.
If the seller is OPEC, Saudi Arabia, Nigeria, Iran, Venezula.
And the buyers is one of the few remaining oil giants, Shell, BP, Exxon who are vertically integrated.
Why buy or sell on the futures markets?
The producer sells on the market because they want to be "guaranteed" a price for their product once produced. They shift the risk from prices will be too low for a satisfactory profit to the purchaser of the contract will not pay.
You buy the contract because you are willing to assume the risk that prices will be at a certain level to make a satisfactory profit when you sell your newly acquired product.
Part of the problem is that most economists are not qualified to opine on this. This is a financial/capital markets phenomena, so financial analysts are the ones we should be listening to. Michael Masters testimony is a fine example of how a finance guy picks apart this problem.
Here's my thought: if you create a system that rewards sellers by increasing their profits when prices rise then hey presto, prices magically rise. This is because there is no punishment of the open market - the contract is sealed, the buyer will pay when the future sale time comes no matter the amount of increase.
What these traders want is this protection of futures trading - price goes up, big profit, no losses. The buyers are locked into the deal.
If prices fall, traders profits do too.
I wish to point out that only prior to the "Drill Here, Drill Now" chants was the increase in oil prices said to not be a result of speculation. Oddly, reducing the allure of oil speculation then became a supporting argument for why we must open up new areas for oil exploration.
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