Posted on 07/03/2008 7:32:43 PM PDT by USFRIENDINVICTORIA
Politicians who try to make oil cheaper by restraining speculation will just make things worse
ALTHOUGH the price of oil continues to hit new records, it has in one respect been a quiet week on the oil markets. America’s lawmakers are celebrating Independence Day by taking a few days off. That has led to a brief interruption in the torrent of proposals aimed at curbing speculation.
Ten different bills on the subject are in the works in Congress. Before the House of Representatives shut up shop, it approved one by a vote of 402-19. America’s politicians are not the only ones to have fingered speculators for the feverish rise in the price of oil and other raw materials. Italy’s finance minister believes that there is a “magnum of speculative champagne” included in the price of each barrel. Austria wants the European Union to impose a tax on speculation. Saudi Arabia and other big oil producers routinely blame the price on frothy markets, rather than idle wells.
The accusers point to the link between the volume of transactions on the futures markets and the price of oil. Since 2004 the near tripling of trading in oil on the New York Mercantile Exchange (NYMEX), the world’s biggest market for the stuff, has neatly coincided with a tripling in the price.
What is more, investing in oil has become something of a fad. Commodities traders and hedge funds with long experience have been joined by less expert sorts, including pension funds and individuals. All this, the theory runs, is contributing to a bubble in commodities. The rush of punters betting on higher prices is begetting a self-fulfilling prophecy: it is the tide of new investment, rather than inadequate supply or irrepressible demand, that is pushing the price of oil ever higher.
Follow the oil, not the futures This reasoning holds obvious appeal for those looking for a scapegoat. But there is little evidence to support it. For one thing, the surge in investment in oil futures is not that large relative to the global trade in oil. Barclays Capital, an investment bank, calculates that “index funds”, which have especially exercised the politicians because they always bet on rising prices, account for only 12% of the outstanding contracts on NYMEX and have a value equivalent to just 2% of the world’s yearly oil consumption.
More importantly, neither index funds nor other speculators ever buy any physical oil. Instead, they buy futures and options which they settle with a cash payment when they fall due. In essence, these are bets on which way the oil price will move. Since the real currency of such contracts is cash, rather than barrels of crude, there is no limit to the number of bets that can be made. And since no oil is ever held back from the market, these bets do not affect the price of oil any more than bets on a football match affect the result.
The market for nickel provides a good illustration of this. Speculative investment in the metal has been growing steadily over the past year, yet its price has fallen by half. By the same token, the prices of several commodities that are not traded on any exchanges, such as iron ore and rice, have been rising almost as fast as that of oil.
Speculators do play an important role in setting the price of oil and other raw materials. But they do so based on their expectations of future trends in supply and demand, not on whims. If they had somehow managed to push prices to unjustified heights, then demand would contract, leaving unsold pools of oil.
The futures market does sometimes signal that prices are likely to rise, which might prompt speculators to hoard oil in anticipation. But it is not signalling that at the moment, and there is no sign of hoarding. In the absence of rising stocks, it is hard to argue that the oil markets have lost their grip on reality.
Some claim that oil producers are in effect hoarding oil below the ground. But there is also little sign of that, either among companies or countries: all big exporters bar Saudi Arabia are pumping as fast as they can.
It takes two to contango Despite their dismal reputation, the oil speculators provide a vital service. They help airlines and other big oil consumers to hedge against rising prices, and so to reduce risk—a massive boon amid the economic turmoil. By the same token, they provide oil producers with more predictable future revenues, and so allow them to expand more confidently and borrow more cheaply. That, in turn, should help to lower the price of oil in the long run. Any attempt to curtail speculation, by contrast, is likely to make life harder for firms and oil more expensive.
Master's shows a correlation between oil prices and levels of speculator interest — but, he does not provide solid evidence of causation (IMHO). The “Goldman Sachs Loophole” is only a loophole if there is indeed a need to regulate index speculation — and there is no need to do so, unless speculation in futures markets actually causes price increases in the cash market. Master hasn't proven that the increased speculation isn't caused by rising prices, which have attracted investors & traders to the market.
I've read plenty of economic history, & taken graduate-level economics courses. I've also lived through some bubbles and crashes — so I know that they can happen. I haven't read anything by Soros — though I suppose I should force myself to; because, despite his politics, he does appear to know about market manipulation.
IMHO, there is a bubble in the oil market — but it isn't caused by speculators. The root cause is a shift in the fundamentals of the market — supply is lagging behind demand.
Just when a huge pent-up demand for energy has been unleashed in China and India (amongst other rapidly developing nations) — western governments are doing what they can to restrict new supply. These governments are motivated by the “global warming” panic to drastically reduce the consumption of oil. To them, high oil prices are not a problem — they are part of the solution.
In the U.S., you continue to lock up tremendous supplies of oil — to say nothing of coal and nuclear power.
The result is a very sticky market, on the supply side. The demand side is being tasked to make all the adjustments — by reducing demand. If it were just a matter of the U.S. reducing demand — that might be relatively painless. With the new demand-side pressures coming from the developing world — finding a new market equilibrium point will be very painful indeed.
In the medium to long term, the world will leave the oil age behind. During the transitional period fewer restrictions on the supply side are necessary — or consumers will be burdened with making all the adjustments at the demand side.
The role of speculators in this mess is to provide the markets with the liquidity necessary to discover new equilibrium prices. Government interference in the market has been a large part of the problem — more interference isn't the solution.
Please see my post #41. I meant to include you in the address line.
The long side only index speculator is is a different breed of speculator. He is not providing liquidity to match supply and demand. He is taking current supply off the table.
The reason that spot and futures prices are virtually identical is that crude suppliers can sell their product on the spot market or on the futures market, whichever is higher.
Unless you take delivery and store the oil, you are not taking supply off the table.
If you buy it and tell the seller to leave it in the ground, you have taken supply off the table.
There are two problems. First is that index speculators don't have position limits because they are trading swaps with investment banks which through a loophole in the rules don't have position limits because they are classed as commercials rather than speculators.
Second, the problem that Masters specifically discusses are the very large long side only positions being taken by pension funds, university endowments, etc. encouraged by what they see has high inflation and low interest rates.
They don't see themselves as long and short speculators, but as accumulators of a net long term commodities position as a bet on inflation and growing demand.
Sorry, the seller isn't going to do that because he only gets paid for the oil he delivers.
you have taken supply off the table.
Wrong.
If so, then they are betting on the market fundamentals. You put a lot of faith in what Masters has to say — yet the pension funds and endowments you refer to employ many investment managers, who are at least as qualified and sophisticated as Masters. If they thought that the price rises were just due to the piling on of speculators; then they would not think oil futures were a suitable investment vehicle. They would have to be very careful to avoid being caught in a speculative bubble; because all of those funds have very strict rules about the levels of portfolio risk allowed.
Someone in a previous post made the comment that there are only so many futures contracts and therefore it is easy to run prices up. That is not true. Initially, there are zero futures contracts, until someone takes a position, either long or short. Then a contract is created. The person on the other side of the contract could be a hedger, a speculator, or could even be looking to add a leg to a spread or a straddle, or whatever. When that position is closed out prior to expiration, that contract ceases to exist. It disappears. This is part of the reason that the analogy to the housing market doesn't work. The actual speculators in futures contracts have no interest in either taking delivery nor in delivering. They take a position in the hope that the market moves in their direction. If the market moves against them, they can have a stop to immediately close their position at whatever amount of loss they are willing to take. This is another reason the real estate analogy doesn't work.
“sellers in most cases have the choice of selling in the cash or futures markets”. Sellers in the cash market would have to have product to deliver, so I don't think would work for arbitrageurs, who are generally speculators, not producers.
“if you don't think speculators cannot drive prices, explain the real estate market.”
1. Speculators in futures trade in contracts, not physical products. Those contracts are created and destroyed at will as positions are entered and exited.
2. Speculators in real estate trade in actual, physical properties, of which they must take possession.
3. The term “Speculator” in futures markets and in real estate are two different things, with completely different meanings and sets of rules. The risks are not the same. The transactions are not the same.
4. The real estate market is analogous to the “cash” commodities markets. I think people misunderstand this, since most people buy real estate with a mortgage, but it is still a physical, cash market.
5. The correct analogy is between real estate buyers (of all types) and the buyers in the oil cash market. That is where the real price increases occur. Demand exceeds supply and prices are bid up. The futures traders simply make their best guess as to whether prices will continue up, or will reverse. They could be right and they could be wrong. But they don't drive the cash price (which is what effects the price we pay at the pump). Supply and demand (and some fear and greed) drive the cash price.
6. Real estate prices were driven up by people buying actual houses, not futures contracts. The big drop in RE prices is because those houses actually exist and the actual owners can't afford them, especially the housing “speculators” who hoped to flip them at a profit. They weren't able to put in a sell stop to liquidate their position if the price of the house dropped by $1,000. Again, no analogy to the commodity futures markets.
Bottom line; there is no correlation between speculating in futures and speculating in real estate. I've done both. I drive the house prices in a neighborhood either up or down, short-term by paying either too much or too little for a house. I can't drive the price of gas at the pump in either direction by taking a long or a short oil futures position. The word “speculating”, or “speculator” may look the same, but they have nothing to do with each other.
You have missed two things. First is the peculiar role of the long side only index speculator, and second that for these guys there is no position limit, unlike for any other kind of speculator. Because of the size of their positions, speculator in markets where they operate are no longer limited to a certain size of the total market. They are becuase of the Goldman Sachs loophole, treated as commercials and can take arbitrarily large positions, though I doubt that the Yale University endowment fund is ready to take delivery of 100 box cars of corn anytime soom.
There are three theories that enter into the overall problem. First is free market theory. For there to be free market in a product or service three things must hold: 1. no monopolies 2. no information asymmetries and 3. no externalities
Second is bargaining theory, and third is the theory of economic rents [see Ricardo], which is the use of price to allocate a fixed commodity.
The problem in both housing and energy is that there are enormous externalities. People have to have housing and they have to have energy.
Let us start with a simple exchange where free market rules do apply, say, potato chips or soft white tasteless sponge "bread" (why is there a market for this crap? But I digress). In either of these there are a variety of choices and numerous producers. Therefore, price is pretty much fixed by cost of production, delivery and retailing (including reasonable returns on capital), and no one complains about the manipulation of bread prices or potato chip prices. There is plenty of competition, unless you are a potato chip addict (I am not an addict. I am not an addict.) you can easily decide not to buy potato chips, so market exit and entry are voluntary dependent upon price). There is no great secret to making either (would someone lose that bread recipe, PLEASE), and no particular information asymmetries between buyers and sellers. These are as close to theoretical free market transactions as you are going to get.
Energy and housing are very different. Because you have to have them the issue is not sale, but price, and the price ranges anywhere from the cost of production to a large multiple thereof. This is where theory of rents and bargaining theory enter in. This wide bargaining range exists because, these being necessities, the question is not what you can "afford" but what else you can give up in order to afford it.
This is where what are called "locals" in futures exchanges come in, which are a particular kind of speculator or dealer. Brokers play the same role in real estate, where in any given market there is probably one predominant broker (here in DC it is Long and Foster. In some places it is Caldwell Banker). The role of these guys is to ensure that market prices stay at the high end of the bargaining range, by quickly acquiring anything that comes on the market at slightly less than what they have established to be the going price. [Every real estate broker is also a speculator or works closely with flippers to keep market prices up]
The interlocking process of brokers, mortgage brokers, flippers, wall street, publicly traded property developers (talk about an information asymmetry - how is there a stock market for these things), well connected privately held developers (Bechtel, the Rockefellers), and Alan Greenspan, has pushed the bargain so far, that a lot of people have borrowed what they cannot pay at anytime, and it is going to be a decade before all of that is worked out. There is nothing "free market" about that whatsoever. No free market equilibrium allows someone in California to pyramid real estate debt until he has 10 or 20 million dollar properties, off of which he lives very comfortably by extracting the run up in equity through loans every year. Yet this has been a not uncommon practice since well before 1980 when I first visited the place.
Let us turn to oil. What you pay for oil is an economic rent. You are paying a very large multiple of the cost of production because it is a fixed resource (about 85 mmbpd world wide).
And here is where bargaining theory enters in, and the role of a specific kind of speculator, the long side only index speculator, who is acting very much like the brokers in real estate who ensure that all transaction take place at the top end of the bargaining range.
What people don't understand is that for any particular oil well, owned by an individual, company or country, the well represents a fixed quantity of wealth, and the owners interest is to get the most revenue possible for it, while providing current revenue to keep him in palaces, girl friends and yachts on the Riviera (not all oil sheikhs are good muslims). If you start to offer him more for a barrel of oil what happens to his rate of production? His income needs go down, and so he decreases the rate of exploitation, because he can, and saves his excess wealth for a future day. After all, if one thing is safe from the ravages of time and inflation, it is oil in the ground.
While certainly some additional oil comes on line because of rising prices some goes off the market for exactly the above reason (pay me $1,000,000 an hour, and my total productivity will drop like a rock. After a week or two my labor will be off the market), and overall you get a vertical if not backwards sloping supply vs price curve.
What long side only commodities speculators, the size of whose positions have been increasing at an exponential rate over several years now, do is to provide a market whereby producers can sell oil that is in the ground, and just leave it there. So they take supply off the market, run up the prices causing additional supply not to come on the market (through hording by producers), and it is all legal, right now, because they are "index" speculators as opposed to real speculators with real market limits.
The obvious solution is horizontal substitution, i.e. synfuels, thermal solar where it makes sense, and nuclear, big time. All of these are influenced by substantial regulations. Nuclear needs to be. A lot of the problem with nuclear is caused by the behavior of utilities back in the heyday of nuclear, when they each tried to build their own one of a kind plant to cut corners on costs. There are lots of Navy nukes on this forum, and I doubt a single one of them would tell you that a free market free for all in nuclear safety is what we want. We should feel absolute shame, disgust and self-loathing that the French got this right and we Americans can't.
You can’t debate logically and without emotion or defend your Democrat talking points including that the “speculators are causing rising oil prices” so you resort to name calling and personal attacks, typical liberal/Marxist.
That’s why reasoning and talk is not possible with you and your liberal ilk. You liberals seem to have the emotional and mental IQ of a child.
Like I said, your Mommy is calling you. Randians are childish dolts who don't live in the real world. There I insulted you again.
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