Monday, April 18, 2011

The Speculator Myth

Oil and gas prices are on the rise once again, and once again fingers are being pointed at those nasty speculators. What's a speculator? A gambler, really.

It's someone who buys contracts to buy oil or other commodities at a certain price within a certain period of time (i.e. oil futures contracts), in the hopes that they can resell them at a higher price. Two important things to keep in mind: The speculator has no intention of ever taking delivery and the contracts expire. If you can't get the price you're looking for by expiration time, you take delivery or take the loss. In the speculator's case, you take the loss. They have nowhere to put all that oil and they don't have the cash to actually buy all the oil they bought options on.

The refrain is that speculators "drive up the prices". How would one drive up prices? By paying increasingly higher prices for the contracts. Intentionally paying above market prices for anything is a good way to go broke fast. Speculators take advantage of short term fears, supply interruptions, knee jerk reactions, by trying to get in the market before prices rise, or at least well before they peak. Speculators also make bets that the price of oil will fall, but that doesn't seem to bother anyone.

The role of the speculator in the marketplace is to provide liquidity. That is, if you want to buy or sell a contract, you don't have to wait until an end user wants to buy or a producer wants to sell. There's always a speculator ready to buy or sell at most any point in the trading day. Speculation is risky, by definition and can only affect prices over a very short term. Ultimately prices are determined by supply and demand.

So why is oil soaring when supply is plentiful? Because we import most of our oil from producers who aren't terribly interested in our financial well being. They decide how much to pull out of the ground and make available for sale on any given day. We curtail production in the U.S. and then complain that we're being gouged by the Saudi's, the Iranians, the Venezuelans, the Libyans and all the other folks we've handed control of the market over to. We don't want to drill for oil, use coal, nobody wants a windmill farm in their neighborhood, or solar panels, or a nuclear plant. We seem to subsidize only alternatives that have no chance of viability in the marketplace and penalize or criminalize energy sources that are proven to work. Nobody can make the case that ethanol laden gas is a better product than non-ethanol laden gas or that the ethanol program is a success, or that it even makes sense. Yet it continues. Enabling more drilling is shunned because it can "take years" to develop a field. We'll still need oil in "years" and we're not getting any closer to it by continuing to put it off.

If the price of oil and gas is causing you grief, Washington D.C. is your problem, not the speculators or even the Saudi's. Then again, as one reader helped point out, politicians and bureaucrats do what the polls tell them to do. So I guess we're the real culprits.

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