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Four Economic Mandates Examined: Oil Speculation

16 May

This is a continuation of Four Economic Mandates Examined:  Mortgage Modification.  This series focuces on four economic mandates proposed by Robert Reich.

Mr. Reich has recommended to the President, as his second of four mandates that he should

“…condemn oil speculators for keeping gas prices high – demanding that the oil companies allow the Commodity Futures Trading Corporation to set limits on such speculation and instructing the Justice Department to investigate and prosecute oil price manipulation.”

What the hell is a speculator and why are they keeping gas prices high?

An oil speculator is someone who purchases oil today at today’s prices, stores the oil in hopes that the future price of oil will be higher and then sells the oil at some future date in hopes of making a profit.  This is simplified but the principles are the same.  The speculator may pay someone else to store the oil or the speculator may buy a futures contract.  For more details on how speculation works, see “The Social Function of Futures Markets” and “The Social Function of Call and Put Options”.

So if the oil speculator buys oil today and stockpiles that oil, then we would expect to see immediate results:  1) Current oil prices will rise and 2) Oil inventories should increase.  These are easy assumptions to make.  Since the speculators are creating “artificial” demand by buying today what they will sell in the future, they have driven up the price.  As a result, we would expect oil inventories to increase.

“The data do not support this theory.  If speculators raise the price of oil above the level that balances supply with (commercial) demand, then there will be a glut of oil on the market that must be hoarded for future sales.”  —Speculators Fixing Oil Prices? , Robert Murphy

According to Robert Murphy’s research, crude inventories have remained relatively stable from 1998 to 2008 even as the spot price has increased during the same decade.  If our assumptions that speculation will raise oil prices and create an oil stockpile then we should expect to see a positive correlation, i.e. an increase in oil inventories as prices increase.  However, the data does not reflect this and calls into question our assumptions.  Robert Murphy concludes that “It appears that speculative activity has had little to do with the sharp increase in oil prices.”  For more reading on why speculation is not raising oil prices and why speculation is actually a good thing, read here, here, here, and here.

Mr. Reich has made a serious error and based his entire second mandate proposal on a factually incorrect assumption.  Do public policy “experts”, like Mr. Reich, even do the hard research and discover how commodity futures markets really work before proposing to condemn speculators and demanding oil companies to comply with what politicians have deemed the correct limitations on speculation?  Mr. Reich even goes so far as to recommend prosecution of “oil price manipulation”, most certainly referring to speculation as “price manipulation.”  By my estimation, Mr. Reich is zero for two.

Mr. Reich’s third proposal is a doozy.

3. “Third, he should stand ready to make further job-creating investments in the nation’s crumbling infrastructure, and renew his call for an infastructure bank. And while he understands the need to reduce the nation’s long-term budget deficit, he won’t allow austerity economics to take precedence over job creation. He’ll veto budget cuts until unemployment is down to 5 percent.”

This one will take some serious discussion and is best left to the follow-up post, Four Economic Mandates Examined:  Infrastructure.

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1 Comment

Posted by on May 16, 2012 in Uncategorized

 

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One response to “Four Economic Mandates Examined: Oil Speculation

  1. Michael Johnson

    May 16, 2012 at 4:53 pm

    Most speculators don’t take physical delivery of oil, that would be too expensive. Instead, they make money trading futures contracts. Non-commercial (speculators) purchases of futures contracts have exploded in the last 10 years.

    http://www.nrcan.gc.ca/energy/publications/sources/crude/issues-prices/1553

     

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