11/11/2008

Where Are Those Damn Oil Speculators?

As the price of oil settles around $60/barrel, I'm wondering what happened to those calls to reign in the speculators that prevailed when oil was at $140/barrel. Somehow, without the benefit of any misguided legislation clamping down on speculators, or a windfall profits tax on oil companies, the price of oil has fallen more than 50% since its high in mid-July.

The main reason for the precipitous drop is demand destruction, first from a change in consumer behavior that finally occurred when oil made its blowoff top this summer, and second (and more importantly) from the US and world economies falling off a cliff in the last few months. A secondary cause was the announcement by the Bush administration in July that the executive ban on drilling offshore was being lifted.

The collapse in oil is an object lesson that the price of oil (and other commodities) is not determined by the nefarious actions of speculators, or oil companies acting in collusion. It is determined by good ole supply and demand. And not just current supply and demand, but expectations of future supply and demand. The blowoff top in oil this summer finally changed the behavior of consumers and caused a significant reduction in miles driven this summer. The lifting of the ban on offshore drilling signaled to the markets that the US might finally get serious about tapping its unutilized oil reserves. And most importantly, the US and world economies falling off a cliff in the last three months caused a great reduction in current and estimated future oil demand.

This issue will probably be off the front pages for the foreseeable future now that oil is back to $60/barrel. But the next time oil skyrockets, prepare yourself for the same misguided calls to punish oil companies and speculators. Once again, the age old laws of supply and demand will be ignored by our economically illiterate political leaders.

4 comments:

Anonymous said...

saginaw smart!

Anonymous said...

Sorry, to say but you have a misguided and niave (not to mention uneducated) perspective of oil. How many years have you been working in/with the oil industry? Well it shows!

I've been involved with energy and financial institutions for nearly 20 years so let me teach you something.

Oil has dropped exactly because of the speculators. The speculators, who were leveraged 10:1 (or more)were forced to close out their long (and speculative) positions as their leverage was reduced AND b/c banks required them to post larger margins. Exacerbating the problem was the fact that hedge funds have been facing huge redemption .... requiring them to liquidate even more positions (and remember, each position was leveraged). As these guys were forced to sell .... there were no buyers ... so oil dropped by 50%.

Howard M.

viachicago said...

Howard, I won't deny that speculators may have exacerbated the move in oil, but my point was that in the long run speculators aren't the driving force for the price level of oil or other financial assets. Speculators most likely contributed to the blow-off top in oil that we saw this summer, but their effect on the price was ephemeral. In fact, some might argue that, to the extent they contributed to the final spike in prices, they had a positive effect in that they finally stimulated a change in behavior by consumers and suppliers which contributed to the subsequent decline in prices. Oil was in a bull market for at least five years (and some might argue ten years since it bottomed in the high single digits in 1998) based on supply and demand dynamics, not on actions of speculators.

The overall point of my post was that politicians like to blame oil companies and evil speculators instead of addressing the true causes of the problem. Speculators are noise in the long run.

Lou said...

The problem is the politicians are idiots. In the long run, it would be to America’s advantage to have gasoline at $4 per gallon or higher.

The average joe of course would not agree with that statement, but if the goal is to reduce America’s dependence on foreign oil (a catch phrase that has been thrown around since the oil embargo days) then the government should tax gasoline in such away that the price per gallon stays relatively high.

For the last several decades the government has set CAFÉ standards for auto makers in a weak attempt get them to make more fuel efficient vehicles. Detroit has always pushed back that the market place doesn’t want fuel efficient vehicles, they wants Trucks, Mini-vans and SUVs. Yet, one summer of gas at $4 per gallon has fundamentally changed the market demand. In the 15+ years I’ve worked in the auto industry, I’ve never seen this sudden of a change in the market demand, nor have I seen the Big Three react so swiftly in response.

America has gotten spoiled with low gas prices. Trucks and SUVs are popular in part because of low gas price. The average commute to work has increased year over year. Heck I work with multiple people who drive over an hour to get to work. Only this summer when gas was high did they start carpooling.

Now gas is back in the $2 per gallon range, and it will be very easy for Americans to go back to their old habits. Gas at $4+ per gallons is good for America. It will shift the market from gas guzzling SUVs and trucks to more fuel efficient vehicles. Over the long term, it will eventually change the peoples commuting habits (live closer to your job, carpool, etc…). It will spur government to invest in better public transportation options. More importantly it will help alleviate our dependence on foreign oil.