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Thursday, June 26, 2008

Hold oil speculators accountable while driving down the prices of crude oil and gasoline

This isn't rocket science. Instead, it's quite literally Economics 101.

Dems, including both Congressional leaders and their party's presidential candidate, Barack Obama, are all about "investigating" the role of "speculators" in the oil futures markets who, they claim, are responsible for driving up the cost of oil and, thus, the cost of gasoline at the pump.

Hearings are being scheduled and held. Legislation has been proposed.

This is worse than useless, because there is already in place a devastatingly efficient mechanism to punish any who've artificially inflated the current price of oil by reckless, collusive, or abusive trading in oil futures. It's a two-step mechanism:

(1) Start in a serious way to do what we can do to both reduce demand (i.e., conserve) and increase supply (i.e., drill and promote alternative energy sources).

(2) Let the market work.

The fundamentals of market economics will then cause the current price of oil to drop. Yes, it will drop today even if the oil whose production that Congress approves now from the outer continental shelf offshore and from the Arctic National Wildlife Preserves won't actually be produced for years yet. When the opportunities are opened up and the commitments are made, the market will indeed react based on its anticipation of future results. Only an economic idiot or a Democratic congressman can't understand that the market is reacting now to the absence of those future opportunities and commitments.

When the price drops, the wagers made by the speculators — who are heavily invested in the success of the do-nothing Democratic Congress — will come up snake-eyes. Those who've speculated will lose their shirts. Their leveraged purchases will bite them with a multi-fold and righteous vengeance. There's no need for hearings, no need for lawsuits, no need for citations or fines or newspaper exposes.

Just the brutal efficiency of the market, which — when permitted to function properly — punishes those who abuse its processes.

We don't know for sure how many market manipulators there are, or who they are, or how much of the current high prices are the result of their manipulation. Nor are we likely to track them down: Crooks hide their tracks, and the difference between a crook and an entrepreneur is often purely a matter of subjective judgment.

The market doesn't care; the market doesn't need tracks. The market passes its relentless judgments automatically, inexorably, and with the closest thing to perfect justice we're likely to see in our lifetimes — if, but only if, it's allowed by government to function normally, i.e., freed from government interference.

You want to purge the market of manipulative speculators? Let the markets work. Permit and encourage conservation to reduce demand; permit and encourage development (both drilling and alternative sources) to increase supply; and drive the price down using basic laws of economics that are more powerful than even Barack Obama on his best day when he's got a full gospel choir and both chambers of Congress singing with him in harmony.

Posted by Beldar at 12:13 AM in Current Affairs, Energy | Permalink


Other weblog posts, if any, whose authors have linked to Hold oil speculators accountable while driving down the prices of crude oil and gasoline and sent a trackback ping are listed here:

» Why committing now to begin drilling ASAP will indeed affect the oil price now from BeldarBlog

Tracked on Jul 2, 2008 4:16:04 AM


(1) stan made the following comment | Jun 26, 2008 12:43:23 PM | Permalink

Markets? Never! Oil is no different than Ted Kennedy and his hearings over whether banks discriminated in mortgage lending to black sections of certain cities. According to Kennedy, the govt specifically identified certain borrowers who were good quality credit risks that would have produced profitable business for the banks.

Most people would call this a great business opportunity!

Kennedy called it a travesty requiring extensive government regulation and enforcement.

(2) DRJ made the following comment | Jun 26, 2008 2:39:34 PM | Permalink

What a shame that few people will understand or care about the beautiful post you've written. With the possible exception of Texans and Alaskans, too many people view oil as a necessary evil and oil companies as greedy polluters.

(3) RWB made the following comment | Jun 26, 2008 5:31:20 PM | Permalink

I don't get your post. Let's say new oil from previously off-limits domestic sources starts pumping five years from now (for the sake of argument). So if I were a refiner, I could buy some in July 2013. And perhaps because I feel confident about the prospects of getting some in July 2013, I go ahead an buy futures contracts to lock in a price now that seems likely to give me a positive crack spread. Since people generally feel confident that they can get the oil they want after that date, contracts starting in that month get cheaper. OK, that's convenience yield in action. But why should that affect the value of contracts maturing before July 2013? And more important, why should it affect the spot price of oil today?

This is not to say that I don't think we should develop ANWR and the continental shelves (although I do believe based on current estimates of their reserves that the effect of this oil entering the world market will be significantly smaller than what people hope). I just don't see how it affects things now. It's not like we're seeing people buy up oil and hoard it. No one is trying to "corner the market" here like the Hunt brothers famously (and unsuccessfully) did with silver. Pretty much all the oil being produced now is being consumed. It's this supply (production)and this demand (consumption)that is setting the current price, is it not?

(4) nk made the following comment | Jun 26, 2008 8:00:34 PM | Permalink

I am not an expert on this but I know someone who does spot trading on oil. He loads his tankers and sends them sailing. Meanwhile, he's tracking the prices at reasonably near ports. He picks the ones paying the most and sends his ships there. Nothing speculative about it.

He also does paper trading. He tried to explain it to me and if I understood him correctly, that is pure speculation. Basically, an exchange of bets that oil will go up or down. It sets the price for the real market but there is no contract for delivery or acceptance of actual oil. I don't know how that's not price-fixing.

(5) Kent G. Budge made the following comment | Jun 26, 2008 11:37:49 PM | Permalink

Only an economic idiot or a Democratic congressman

... But you repeat yourself ...

(6) Beldar made the following comment | Jun 27, 2008 6:26:42 AM | Permalink

RWB: The current market price, and the current decisions being made on consumption and production, all factor in (in a macro sense) our current understanding of what's likely to happen in the future. And yes, there is "hoarding" going on, in the sense that some OPEC producers are indeed producing at less capacity than their current wells are capable of (and they're likewise deferring new drilling, secondary and tertiary recovery techniques, etc.) because they believe it's in their economic self-interest to keep some oil in the ground longer in the expectation of even higher prices as world-wide demand continues to soar. (I.e., they think they'll get a better rate of return by leaving some in the ground that they could, if they wanted, produce now and convert into other investments, e.g., T-bills or tourist hotels in Bahrain).

Suppose you're the King of Saudi Arabia. Your intelligence service tells you with 98% confidence that American research on the proverbial 1000 mpg carburetor (fuel injector, whatever) will succeed in four years; American research on fuel cells will have a major breakthrough in five years; American research on cheap, light-weight super-capacity batteries will succeed in seven years; and American research on safe cold nuclear fusion will succeed in ten years. Your economists tell you that as a result, the world-wide demand for both oil and natural gas will drop by 90% in ten years.

Your current production decisions were set before you got this intelligence. What do you do now?

I think you tell your oil field engineers to start pumping more ASAP. The net present value of your asset has just plummeted, and its value will continue to diminsh the closer you get to the world needing less of your product. Yeah, your increased production is going to cause a decrease in the current price, but you'd still rather sell now at a lower price than be stuck with almost worthless oil 20 years from now.

That hypothetical involves a future extreme suppression of demand, but it could as easily be an increase in supply, or better still (and more realistically) a combination of both. Instead of the research being into carburetors and cold fusion, it could be investment in infrastructure to drill in Alaska or offshore from California.

To change the current price, we have to change variables somewhere. We can't just snap our fingers and instantly create new supply or instantly depress demand, but we can instantly change the current assumptions about future supply and demand. Every day that goes by with Congress blocking real progress and instead blathering silliness about windfall profits taxes, producers can project another day into the future with no additional supply having come online. That affects their pricing decisions today. Similarly, futures traders are going long on oil in part because they can't imagine that the price will fall from current levels; give them a sound reason to think otherwise, and they'll stop bidding up.

(7) Rorschach made the following comment | Jun 27, 2008 9:03:36 AM | Permalink

Beldar it even goes beyond that, because since the price of oil just plummeted, the economic incentive to continue funding the R&D for those alternative energy sources goes out the window along with next year's research budget, thereby delaying the development of that technology.

We could punish the speculators further (and profit from it as well) by first dumping half the SPR onto the market to drive the spot market into the dirt, then announce the drilling program which will drive it even lower, then we can slowly start replenishing the SPR at the much lower spot price. the US government ends up profiting from the insider information. It is market manipulation writ large.

(8) hunter made the following comment | Jun 27, 2008 11:40:53 PM | Permalink

The cause of democrat whining about fuel prices is that they are not getting that kind of price action in the form of taxes on top of cheap gas.
They do not give a flip if it hurts the consumer. They just want more money to control. That the private sector is doing it is driving them wild.

(9) DRJ made the following comment | Jun 28, 2008 12:20:14 AM | Permalink

In addition to everything Beldar has so (and said well), I think it would help if the SEC rules that limit trading on margin were also applicable to commodity trades. Some of this is happening because it's so cheap and easy to speculate on commodities.

(10) hunter made the following comment | Jun 28, 2008 10:26:28 AM | Permalink

That one rule would do more to stabilize the commodity markets and protect investors. The oil bubble is going to burst- big time. Millions of naive investors are going to get creamed.
The Soros's of the world will, if they are not already, be long since gone when this happens.

(11) Neo made the following comment | Jun 28, 2008 10:45:55 PM | Permalink

And yet .. will none call this suicide ?

US halts solar energy projects over environment fears

Wow ! The Bureau of Land Management is putting a moratorium on new solar energy projects on public land for two years so it can study the environmental impact of sun-driven plants.

And then they came for nuclear energy,
And I didn’t speak up because we saw The Day After and feared the atom,
And then they came for offshore oil drilling,
And I didn’t speak up because we saw The Pelican Brief and feared "big oil",
And then they came for offshore wind,
And I didn’t speak up because Ted Kennedy was afraid his view would be obscured,
And then they came for solar energy,
And I didn’t speak up because I was too cold and in the dark to do anything

The New Politics of Fear

(12) hunter made the following comment | Jun 29, 2008 4:58:59 PM | Permalink

This confirms what a lot of people have been observing for a long time.
Wow. Just, wow.

(13) Jan made the following comment | Jul 11, 2008 6:37:13 PM | Permalink

Oil is the biggest industry in the world with dozens of major producers (both corporate and sovereign), billions of consumers and trillions of dollars involved annually. The speculators simply aren't big enough to effect the fundamentals very much or for very long.

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