Thursday, November 20, 2008

Oil $peculators $ave The Day

THE Evil oil speculators, who only months ago tried to bring the world to ruin by raising oil prices, have now shown mercy on us all and have lowered prices. And Big Media have been hailing their heroic efforts to save the world by bringing down the price of a barrel of oil. I mean headline after headline, the endless news cycle on TV, about how good and beneficent these speculators are now.

Left to its own devices, oil would have stayed sky high. Fortunately for us, the speculators decided to lower the price, arbitrarily.

And if you believe all that...

Look - when the price of something skyrockets or plummets there is no guarantee to anybody that the trend will continue. Speculators are putting their money at risk to try to correctly bet where the future price of oil will be. And you bet a lot of these folks lost their shirts when the price of oil collapsed - from about $150 to $50. Yes, it shrank to about 1/3 the price in a matter of months.

But why are we not now praising the speculators for bringing down the price of oil, if it was their fault for making it go up? Because it wasn't their fault to begin with.

Think of what would happen if these speculators didn't exist as such, and there were no formal oil trading markets. Years ago, operators in China would have bought up the entire current world's supply of oil, knowing that their country needed it for energy for the rapidly expanding economy and industry. So a select few would have gobbled up all the oil, creating panic in the world. And now, of course, those few would have been heavy laden with all those barrels sitting in warehouses, worth a fraction of what they paid.

This same thing has essentially happened in the oil markets, but in a more orderly way. One could probably make the argument that markets make commodities more easily traded, and thus more volatile in price. But this kind of crazy volatility comes from human nature, not merely oil speculators per se. Home prices, cabbage patch kid dolls, oil, tech stocks, gold, you name it, it's all subject to the whims of human activity, whether that be greed, desire, objective prediction, panic, or mild concern.

Check out this piece in IBD: Did Hated Speculators Lower Oil Prices?

In hindsight there is little mystery, just the latest affirmation that the most basic aspect of economic theory still prevails. Yet between oil's price ascent and descent, a very interesting morality play unfolded.

As economist Milton Friedman pointed out, it is human nature to ascribe to our own abilities the positive things that happen. It is equally so to attribute the negative things to others' faults. Enter the speculator. These unnamed actors were claimed to have participated in an action undefined beyond their own greed.

What is speculation? Is it simply presuming prices will move in one direction and seeking to make gains on this insight? What investor doesn't do this? Is it done in such a way that the market moves in a desired direction? If so, it apparently did not work.

• If speculation was a problem then, why is it not a problem now? If speculators were responsible for the price rise, why are they not liable for the price decline?

While it is human nature to take credit for the good and shift blame for the bad, neither is necessarily descriptive of reality. The laws of economics work, regardless of how we or government seek to constrain them or refute them. There is no mystery or conspiracy in them.

In the case of oil, they conspired to create a price we did not like. And it was a price that was the result of policymakers who had constrained supply and allowed it to be so outstripped by demand.

Another article if you're really that into this...
Speculators' Reprieve

Interesting factoid from this article: The US produces the same amount of oil domestically as it did in 1947, but our economy today is 8 times larger.


AuVox said...

Supply and demand dictate prices. Overall.

But speculators provide a valuable stabilizing effect to all markets; without them prices would spike and dive on daily whims. (Even more substantially than they do now.)

Although the demand for oil was certainly consistent and strong, speculators bid up the price artificially--every slight tick upwards meant huge profits--creating a bubble just waiting to be burst.

All the speculators needed was an indicator that increased supply would ease the demand.

President Bush supplied it. Surely you recall the MSM giving him the credit for bringing down the price of oil, don'tcha?

Me neither.

Read about what happened here:

Rob Baker said...

Thanks for the insights. Well said. So it seems then that events occurred on both sides of the supply/demand equation: more potential supply from off-shore, and less demand worldwide, especially China.