Tuesday, June 24, 2008

Don't Shoot The Price Messenger, aka Speculator

The futures market may be a convenient scapegoat, but it's simply a price discovery mechanism. Major energy consumers – refiners, airlines – buy and sell these contracts to lock in goods at a future price, as a hedge against volatility. Essentially, they're guesses about coming oil supply and demand, as well as the rate of inflation. The political theory is that such futures trading is creating a bubble in the spot market (i.e., oil purchased for immediate delivery) beyond oil fundamentals. Thus, $4 gas.

But there's no inherent reason to "bet" that commodities will go up rather than down. Bet wrong – place all your chips on red, say – and you lose. If a company purchases the future right to buy oil at $140 a barrel and it instead sells for $130, the option is worthless. Besides, somebody has to take the other side of any futures contract: Some are trying to predict where the price will go in the future, while the other side is attempting to sell its future price risk. But no one knows how things will end up.

Mr. McCain calls such exchanges "reckless wagering." But speculators – normally known as "traders" – are really managing the exposure risks of American businesses to higher oil prices. Traders not affiliated with major producers or consumers provide liquidity to the market. Without the second group, futures markets would be determined exclusively by commercial participants. Another word for this is a cartel.

On the other hand, inflation does lead to a misallocation of resources, so it's not surprising that the Federal Reserve's weak dollar policy has driven investors to commodities to protect themselves. Loose monetary policy has caused price jumps across nearly all commodities, including surges in grains and precious and base metals. The Fed's rate-cut bender is the most important reason oil is up so sharply since last August.

The other major factor is supply and demand, as prosaic as that might seem amid today's political agitation. Energy consumption is surging in China and India, and global supply is not growing fast enough to keep up (see chart above). Congress could do something useful if it opened up America's vast natural resources, which are blocked by environmentalist romanticism. But then, it's so much easier to shoot the price messengers.

~Wall Street Journal editorial "
Political Speculators"

5 Comments:

At 6/24/2008 12:11 PM, Blogger Sophist said...

You said it; futures markets are price discovery mechanisms.

Too bad, because this is the inherent property of futures markets that can be exploited by orchestrated speculation to manipulate prices in a given direction.

Crude oil futures started trading during 1983. So, I'm asking you MP, the speculator defender, as it seems:

Do you have a quantitative model to show what price level would have been reached had crude oil futures been around in 1973 and 1979?

Do you know the difference between speculation that provides needed liquidity and speculation that manipulates price direction?

 
At 6/24/2008 12:58 PM, Blogger juandos said...

What's the next target?

Intrade?

 
At 6/24/2008 2:38 PM, Anonymous Anonymous said...

Juandos,

There's always a target. That is the nature of politics...passing the blame out and taking as little responsibility as possible.

How can one overlook the following decisions:

1. decision to ban drilling in ANWR
2. decision to ban offshore drilling on both coasts
3. decisions made at the state level to require different grades which vary from state to state and the lack of any attempt to work across statelines to streamline regulations
4. present inflationary policies of the fed which have caused the dollar to plummet over the last year

While the world will eventually run out of oil, we know that won't be tomorrow but probably about 90 - 100 years from now. Can anyone doubt that we got here because politicians failed to plan for sufficient capacity based on forecasting of demand that would have been presented years ago. The decisions were not made by speculators but legislators.

We know it takes considerable investment and time to bring supply online. Is there anyone who believes that decisions to expand for growth in capacity were made in a timely and pro-active fashion in the U.S.?

To be fair, one must also acknowledge that there are problems outside the U.S. which adversely impact the global oil supply such as state run oil companies that are driven into the ground by governments, terrorism and civic war.

 
At 6/25/2008 2:09 PM, Blogger OBloodyHell said...

> While the world will eventually run out of oil, we know that won't be tomorrow but probably about 90 - 100 years from now.

Only if we mark oil shales and tar sands off limits. There is a buttload of oil there, and I personally suspect that the pressure is going to result in a switch to a hydrogen economy (assuming some impressive breakthrough does not occur in energy storage techs), which will alter the whole system to allow usage of nuclear power -- if not here, then certainly in places like China and India. Bringing 2 billion people into the 21st century isn't going to be done with oil technologies. C&I cannot deal with the pollution issues, to say nothing of the oil-expenses (with limited resources of their own in that regard) if they truly ramp up their economies to compete with the likes of USA and Japan. Oil and coal are quick-fixes for immediate needs. Once they get to a minimum level, they'll have to switch to something more advanced.

.

 
At 6/25/2008 2:11 PM, Blogger OBloodyHell said...

> they'll have to switch to something more advanced.

... as well as cleaner and cheaper.

 

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