Oil Speculation

I’ve seen some arguments that the current spike in the price of oil is being driven by speculators. The general argument seems to be that people are betting that the price of oil will rise in the future, and are locking in prices now via futures contracts. They plan to sell those contracts in the future for a higher price.

This argument doesn’t make a lot of sense to me because it would be a very risky move. People are clearly starting to cut back on oil purchases. We can expect the price to fall again. That would mean that the speculators would lose their bet. I’m sure that some people would bet that way, but enough to make the price spike the way it has? I doubt it.

Another way that speculators might affect the price would if people are buying oil, or rather are receiving oil which they already paid for, and are holding on it until prices go higher. This is restricting the supply and thus driving up the price. That strategy would be more sensible. However, it would also be visible. Any interested government–and there are plenty of interested governments–should be able to track where most of the oil is going. The oil market is very visible, and oil tankers are easy to spot. If somebody were stockpiling significant amounts of oil, enough to affect the price, I think somebody would notice.

I expect that the oil price is spiking for the traditional reason: demand is growing faster than supply. Since demand is starting to drop, we can expect the price to start to drop too. In fact, oil companies expect that to happen; that’s why they are returning their windfall profits to their shareholders and executives rather than investing them in developing new sources.

For the sake of our sea levels, I hope the price doesn’t drop too far. If it plateaus at a reasonably high level, that should be an even bigger spur to investment in alternate energy sources, both from investors and from governments. We need that now.

3 Comments »

  1. jldugger said,

    May 28, 2008 @ 8:00 pm

    You can always sell commodity futures the moment you think prices are leveling off soon (perhaps when indicators say demand is slowing). Sure it’s risky business, but keep in mind the amount of money available for investment is quite large, and devoting only a small percentage of that to high risk investments is both common and enough to move the prices. After the subprime crisis nearly froze the bond market and hit stocks as collateral damage, commodities may look like an attractive place to seek “alpha”.

    A friend of mine who lives in Coffeevile KS has said the local refinery has been stockpiling oil, which leads credence to your second theory. It might make sense to find what government numbers are published on the subject.

    But there’s another group out there who’s got oil — the producers themselves. They’ve got oil in the ground, and their willingness to pull it out and sell it is related to both the current price and the price it will fetch in the future. One interesting argument I’ve heard regarding producers investing in new oil fields is that lead times run longer than the furthest oil future contract available. If it takes 20 years to get oil out of the ground and ship it, you can’t finance it through futures. That was the argument held last time windfall profits were suggested, and I don’t believe anything’s changed.

    Not that I believe their story — I’m sure it has far more to do with the average CEO tenure and compensation structure than futures markets.

  2. etbe said,

    May 28, 2008 @ 8:51 pm

    Cutting back oil purchases to any large degree can not be done easily or cheaply. Anyone who has purchased a car in the last few years is unlikely to sell it and buy a more fuel efficient model. If someone drives 12,000Km/year and their car uses 10L/100Km then that’s 1,200L of petrol per year. At current Australian prices that’s $1,800 per year which is less than 10% of the price of any new car which is desirable (a Prius will cost about $35,000).

    Reducing driving is not an option for all the people who’s travel to work does not match the routes of public transport. Getting another job, moving house, and spending an extra hour a day travelling are all bad solutions to the problem of increasing oil prices (which might cost a typical driver $600 a year).

    I read a news article saying that the US government has been decreasing it’s national oil reserve. Nothing that refineries or other organisations can do in terms of stocking up on oil can compare to national reserves…

    Note that to give lower prices to the consumer we not only need to control the growth of demand, but have demand decrease for a while until the prices drop. A recent survey suggested that at a petrol price of $1.75/L a significant portion of Australians would drive less, prices are currently around $1.50/L. So in terms of the Australian market prices MIGHT stabilise at ~15% higher than what they are now – but it seems unlikely that they will stabilise any lower than that.

    As for the producers, there is no hard evidence, but speculation is that they are simply unable to increase production. Some of the largest oil fields (including the big one in Saudi Arabia) are apparently starting to run low.

  3. Ian Lance Taylor said,

    June 3, 2008 @ 9:29 pm

    I’ve also seen various reports that Saudi Arabia is pumping at capacity. If they could pump more now, I expect that they would. The price of oil is too high for them–it is going to encourage people to get off it.

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