Speculate On This

Why is it, that when something goes wrong a scapegoat must be found? Oil prices rising cannot be because of increased demand from other developing countries, nor can they be because of the increased usage of oil in the United States without a matched increase in supply. Didn’t you know? They’re because of the speculators! Those nasty, greasy people who soil the market with their grubby little paws and make it impossible for normal, clean-cut people to go about their business. But hey, it seems Western civilization has always had this problem:

Speculation has been a favorite target of politicians looking to mollify anxious voters since the time of ancient Greece, when the orator Lysias protested that wheat traders had reduced Athens to a “state of siege.” Even in market-friendly America, there is a long tradition of
denouncing speculators as dishonest, unproductive parasites; the
nineteenth-century preacher Henry Ward Beecher decried their “cool,
calculating, essential spirit of concentrated avaricious selfishness.” [link]

Far be it from me to defend speculators, but they definitely have their place to keep markets free-flowing. When a commodity’s expected to see an increase in demand, who but the speculators predict the increased demand and hasten the process of reflecting that in the price? They provide necessary liquidity, and do so in a reasonable way.

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. [link]

And, ok, once in a while things get a little out of hand, when speculators invest a little too much in futures contracts for a particular commodity (in this case, oil), but they don’t actually buy the oil (or sell it, for that matter). In fact, there are no drastic changes in oil inventories to reflect that.

Speculators, by contrast, mostly use futures contracts to gamble on oil
prices, and have no interest in buying or selling real barrels of oil.
These gambles can be tremendously lucrative, but they don’t directly
determine the real (or “spot”) price of oil. That’s set by the people
who are buying and selling actual barrels of petroleum. Although
speculators could directly distort oil prices by turning their futures
contracts into oil and then taking it off the market to drive up
prices, a look at oil inventories shows no sign that this is happening. [link]

At the end of the day, it’s easy to blame the speculators, but instead of doing that why don’t politicians call for real change and risk making life difficult for their constituents? Stop driving the SUV, start doing some real research into alternative energy, etc. etc.

This is not new, but it’s worth reminding one’s self about who the top seven oil-consuming countries are and how varied their usage is:

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5 comments for “Speculate On This

  1. July 12, 2008 at 1:36 pm

    Indeed, there is no single cause for the spike in oil and food prices, and thus it would be silly to blame these crises on any single factor. However, that does not absolve speculators of all culpability.

    The real lesson learned here is that speculators have their place. And though they may be important to our global economy, they should not be permitted to trade futures of items we need for baseline consumption: water, food. The idea of speculators as villainous stems from their practice of speculating on baseline goods required for our survival.

    It’s interesting to see that the Greek condemnation of speculation described also baseline consumer good of time: grain.

    Lysias was getting at a rather simple conclusion that still holds true for our time: when speculation leads to mass starvation, it’s time to limit the practice.

  2. Arnav
    July 22, 2008 at 1:36 pm

    But that’s just the point – it’s not speculation that’s causing the problem. If it were, we would see changes in inventories, which are the real determinants of prices. Speculators gamble on prices using futures, producers hedge with them. But the difference is that speculators don’t buy anything. They’re just betting. In addition to the quote above, here’s something else – from what I talked about in class today:

    After all, it is only when “speculators” actually buy produce on the spot market that they can drive up the price, and this would have to be reflected in growing stock levels – but stocks appear to have declined throughout the period of rising prices. [link]

  3. Calvin Tay
    July 23, 2008 at 10:38 pm

    On this topic, the company SemGroup (now declared bankrupt and had its main business in trading futures) had made a loss of $2.4 billion in crude oil futures. Apparently, it had taken up long positions to cover its short positions and since it had decided to sell its futures to Barclays, in the surrounding 3 days, oil prices fell 9%.

    Also the start of this decline was when Bernanke said that the US economic downturn would be more severe and longer than originally expected. Furthermore, there was a report shortly after this that there was a build up of crude oil stocks in the US, signalling that there is not enough demand at that price to consume the supply.

    With that, the speculator lost, realizing the risk that was taken on. Now we will have to see how many other speculators will be hit which will remove them from the market and also the upward forces that keep oil prices high.

  4. Calvin Tay
    July 24, 2008 at 9:14 pm

    From Wall Street Journal

    SemGroup Loses Bets on Oil
    Hedging Tactics
    Coincide With Ebb
    In Price of Crude
    July 24, 2008; Page C14

    The collapse this week of SemGroup LP, a little known private oil-marketing firm, may have played a role in crude oil’s 14% drop over the past 10 days.

    The Tulsa, Okla., company filed for Chapter 11 bankruptcy protection Tuesday, citing among other financial woes a loss of at least $2.4 billion in crude-oil futures. Changes in its hedging strategies coincided with big moves in oil recently.

    The company had taken out short positions, or bets that crude prices would fall, as a hedging strategy for oil it intended to move through a subsidiary’s pipelines and sell to refiners, according to an affidavit filed in Delaware bankruptcy court by Terrence Ronan, SemGroup’s senior vice president, finance.

    Then, when oil prices rose, SemGroup moved to “cover” its short positions by taking out equivalent long positions, or bets that oil prices would rise.

    Eventually, SemGroup was unable to put up collateral for its swelling bets and sold its futures account to Barclays Capital on July 16, according to the affidavit.

    SemGroup officials couldn’t be reached for comment. A spokesman for Barclays declined to comment.

    The firm had $14.7 billion in revenue as of 2006, the last year for which there are public records.

    Its publicly traded subsidiary, SemGroup Energy Partners LP, operates about 1,200 miles of oil pipelines and controls 15 million barrels of oil storage capacity, including seven million barrels at Cushing, Okla., a storage hub closely tracked by the oil market.

    One theory making the rounds in the market is that as SemGroup’s long positions snowballed, so did the oil rally. SemGroup’s rapid exit from the market removed a force for upward momentum when the market, under siege from negative U.S. economic indicators, needed it most.

    “In the three days surrounding that transfer” to Barclays, crude futures “plunged $15.89…thus, with SemGroup removed from the market, crude oil has been free to fall,” wrote Stephen Schork, editor of the Schork Report, a newsletter tracking the oil market.

    The linkage isn’t entirely clear. Some traders note that SemGroup’s activity dried up well before July 16, and there is no indication of what Barclays did with SemGroup’s positions once it took control.

    Oil prices have also continued to drop since last week, falling an additional 3.8% from the settlement price on July 17.

    SemGroup likely played a supporting role in oil’s fall, said Nauman Barakat, senior vice president at Macquarie Futures USA in New York.

    “They certainly contributed to it, but other factors were already in play,” Mr. Barakat said.

    The initial plunge came on July 15, as Federal Reserve Chairman Ben Bernanke told Congress that the U.S. economic downturn would prove more persistent, and potentially more severe, than initially thought.

    Oil prices fell again the following day, immediately after the Energy Department reported a surprise build in U.S. crude stocks, underscoring that demand is weakening.

    SemGroup’s contribution would have been to remove a steady source of upward momentum, wrote Edward Meir, with MF Global.

    “SemGroup is not helping the bullish cause, as with the firm now bankrupt, whatever short-covering that was done…is now behind us,” Mr. Meir wrote.

    The next question for the market is whether SemGroup’s failure was an isolated incident, said Mr. Schork in an interview.

    “We know SemGroup was in trouble, the only question is when another shoe drops,” he said.

    Separately, Reuters reported that a group of SemGroup LP creditors on Wednesday raised the prospect that unauthorized energy trading may have caused the $3.2 billion loss that sank the firm.

  5. Anny Chien
    August 10, 2008 at 8:54 pm

    Speculation is arguably not the cause of major oil price fluctuations but it seems politicians find it easier and faster to enact laws against speculation of futures rather than coming up with real solutions or alternatives to our dependence on foreign oil.

    A real alternative or solution can’t possibly be created in the space of this response, but likewise neither will enacting another law against speculators be the end of the story. However, the hint that drilling (offshore) may be allowed after years of opposition, as well as the fact that many believe alternatives will be pushed more fiercely in the near future as evidenced by a major electric car push by GM and Tesla, may have pushed the price of oil down in recent weeks

    As the New Yorker article states, the inability to produce enough oil to meet demand, the falling dollar, and threats of military action against Iran have all conspired to drive up the price of oil. “Although speculators could directly distort oil prices by turning their futures contracts into oil and then taking it off the market to drive up prices, a look at oil inventories shows no sign that this is happening.” The recent bantering between political parties obscures the obvious need to drill for more oil in the US, while increasing investment and development in and of alternative energy sources AT THE SAME TIME. 30 years ago politicians said it would take too long to invest in more domestic drilling and now here we are wishing we had started it long ago. Perhaps the wise thing to do is to plan for the worst case even when things are fine, but perhaps that is an impossibility for politicians.

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