In a CNBC interview this afternoon, when asked by Maria Bartiromo about how much of the blame for the recent oil price rise should be put on speculators, Treasury Secretary Hank Paulson said, "This is not about blame, this is about supply and demand," he said in an interview on CNBC television. "All the research we have done shows that speculators and investors have had very little impact on this." Traders and longer-term investors tend to take positions on both sides of oil market transactions, long and short, thus being essentially price receivers rather than price setters.
What research was he talking about? Here are a few possibilities.
Yesterday, the Bank of England's minutes of May 7-8 stated:
11 The price of oil had been extremely volatile. But over the month, the sterling price of Brent crude had risen by 13%. According to the Bank’s market contacts, speculative purchases did not seem to be the prime cause of the recent increases in the oil price. More fundamental demand and supply
factors had probably been at the root of its steep rise during recent months, and there remained considerable uncertainty about the oil price outlook. There was little prospect of a significant increase in supply over the next two or three years. So although it was likely that the oil price would fall back
at some point, that might not happen within the time horizon relevant for current monetary policy decisions.
In October, 2002, the Department of Energy conducted an exhaustive review of the economic literature and concluded:
The bulk of the empirical studies find that the use of derivatives has either reduced or had no effect on the volatility of commodity prices; however, one of the two studies examining the effects of futures trading on crude oil markets found that in the short term the introduction of futures increased the volatility of crude oil prices. As just noted, this result is the “exception rather than the rule.” There have been no published academic studies examining whether derivative use increases the volatility of natural gas or electricity prices. Additionally, theoretical analyses on whether firms with market power can use derivatives to manipulate spots markets are inclusive.
However, there is plenty of research on the other side of this argument.
On May 8, The International Monetary Fund (See Box 7 on p.27.) concluded that speculation had indeed played a significant role in boosting the price of oil above $80 a barrel.
Tuesday, the Senate Permanent Subcommittee on Investigations heard conflicting testimony, but on June 27, 2006, it published a report which cited considerable evidence of oil and natural gas price increases resulting from speculation.
Federal Reserve Chair Ben Bernanke presented a very well researched and thoughtful analysis on October 21, 2004. He concluded:
Many people take a dim view of speculation in general, and in some instances this view is justified.7 In many situations, however, informed speculation is good for society. In the case of oil, speculative activity tends to ensure that a portion of the oil that is currently produced is put aside to guard against the possibility of disruptions or shortages in the future. True, speculation may raise the current price of oil, but that increase is useful in stimulating current production and reducing current demand, thereby freeing up more oil to be held in reserve against emergencies. Speculative traders have no altruistic motives, of course; their objective is only to buy low and sell high. But speculators' profits depend on their ability to induce a shift in oil use from periods when prices are relatively low (that is, when oil is relatively plentiful) to periods when prices are relatively high (when oil is scarce). Social welfare is likely increased by informed speculation in oil markets because speculative activities make oil relatively more available at the times when it is most needed.8
I doubt you will find any better synthesis than Mr. Bernanke's.
I would also note that vitriolic debate about speculators is as old as the United States itself. George Washington's Army was paid in "Continentals," if at all, and they quickly lost all their value. Those who supplied Washington's Army were usually paid with promisory notes. Speculators bought these notes and Continentals for pennies on the dollar and redeemed them at par for huge profits when Treasury Secretary Alexander Hamilton consolidated the debts of the United States. Howls of outrage met Hamilton's plan from those had bled for our country, but Hamilton realized rewarding speculators was a small price to pay to restore the credit of the United States. He prevailed and the United States was ultimately a lot stronger for it. However, those Revolutionary War veterans were left penniless.
Supply and Demand
Has there ever been an economic theory that postulated a 170% rise in price with a 2% rise in demand? We have just seen that in crude oil prices, yet all of the "knowlegable people" keep insisting that it is simply supply and demand. No speculation involved whatsoever. Does anybody inside the Beltline remember why margin requirements were invented after the 29 Crash. I think they were 10%. Crude oil futures margins are less than 10% and haven't been moved in the price runup. If this situation is all so open and above board, why restrict delivery on the NYMEX crude oil futures contract to Cushing Oklahoma where it is impossible to make delivery?
I think we all know the
I think we all know the answer to that. As long as there's money to be made whilst pointing in another direction, they have no problem screwing the world to make a little more.
Henry "Goldman Sachs"
Henry "Goldman Sachs" Paulson, says it's supply and demand?
"In the popular press the explanation given most often for rising oil prices is the
increased demand for oil from China. According to the DOE, annual Chinese demand
for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion
barrels, an increase of 920 million barrels.8 Over the same five-year period, Index
Speculatorsʼ demand for petroleum futures has increased by 848 million barrels.9 The
increase in demand from Index Speculators is almost equal to the increase in demand
from China!"
"Think about it this way: If Wall Street concocted a scheme whereby investors bought
large amounts of pharmaceutical drugs and medical devices in order to profit from the
resulting increase in prices, making these essential items unaffordable to sick and dying
people, society would be justly outraged.
Why is there not outrage over the fact that Americans must pay drastically more to feed
their families, fuel their cars, and heat their homes?
Index Speculators provide no benefit to the futures markets and they inflict a
tremendous cost upon society. Individually, these participants are not acting with
malicious intent; collectively, however, their impact reaches into the wallets of every
American consumer."
The fox is guarding the henhouse, the CFTC is another prime example:
Read more here:
http://hsgac.senate.gov/public/_files/052008Masters.pdf
Economic Rent
XOM is making far beyond a normal profit and the oil industry is far from perfectly competitive and market entry is near impossible. Even they know it, that's why they spent $80 billion in stock buybacks in the past 4 years. If they thought their profits were normal they would be paying dividends, not buying back stock. Tax the hell out of the rent. Either A the government will gain revenues and not stifle productive behavior and can fund alternative fuel research or implementation, or B the companies will come up with efficient ways to employ that excess capital. The build up of economic rent clearly demonstrates the market isn't operating efficiently. It's a simple and blatantly obvious concept that every other country in the world seems to have figured out.
Commodities Speculation Regime
Ed Wallace has a fascinating two-part article on the recent history of the ICE, the Commodities Futures Trading Commission and years-long effort in energy market deregulation, as epitomized by the Enron's manipulation of the California energy shortage scam. I've not heard anyone ever extol Enron's behaviour as a fine example of the value of speculation and market manipulation, but maybe I'm just missing something.
The Intercontinental Exchange (ICE) was, in part, the "brainchild" of Goldman Sachs while Paulson was at the helm. In 2001 ICE purchased the International Petroleum Exchange in London, renamed ICE Futures, it now operates as an "exempt commercial market," where previously the CFTC had oversight of oil markets, which was designed to prevent exactly the kind of market speculation we are seeing now.
For Paulson to claim that current pricing reflects supply/demand is true in one sense: it is the result of futures contract supply/demand, which is now almost completely decoupled from the materiel price curve. But that is not what he meant, of course, and his claim that current pricing is the result of actual supply and demand is risible.
Part I
ICE, ICE, Baby
and II
ICE, ICE, Baby, conclusion
Paulson/Goldman Sachs may be doing us a favor
By placing oil and other survival and strategic commodities into the pool of rabid speculation and total disconnect from reality (what Soros calls reflexivity) the price can be driven irrationally -- to the point where consumer behavior actually (finally) changes.
We live in bubble world. Learn how to play it and you will prosper.
Yes, it's supply and demand
Henry Jacobsen:
Yes, there is a simple economic theory that postulates a 170% rise in price with a 2% rise in demand.
You draw supply with an upward sloping curve and demand with a downward sloping curve, quantity on the horizontal axis and price on the vertical axis. The curves intersect at the market price and quantity.
Demand slopes down and is very steep (inelastic). This just means that with big changes in price people will change the quantity of oil they buy very little.
Supply slopes up and is also very steep (inelastic). This just means that even if prices increase a lot, it is hard for oil companies to profitably produce more.
If you make China a lot richer, and model this by shifting the demand curve to the right, you'll move a long way up that very steep supply curve. It isn't hard at all to get prices to double, triple, or more from a small shift in demand. Note that the quantity change in your graph will be smaller than the shift in demand.
I'm not sure where you got your numbers, but realized price and quantity changes of that magnitude are highly plausible.
-mike
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