Saturday, July 12, 2008

The New Yorker: Speculators not causing high oil prices

The New Yorker defends financial speculators from politicians' attacks, saying they are not responsible for the high price of oil:
When bad things happen, it’s always nice to have a scapegoat. So, with Americans furious about soaring oil prices, Congress has gone in search of someone to blame. There are a number of usual suspects to choose from, depending on your politics—OPEC, greedy oil companies, lily-livered environmentalists opposed to oil drilling—but now Congress has seized on another set of villains: commodity speculators. ...

Congress is not, though, just attacking illegal market manipulation; it’s also taking aim at perfectly legal speculation, namely the buying and selling of futures contracts, which are effectively bets that oil prices will go up (or down). Futures contracts can be used by oil sellers (like OPEC) or oil buyers (like the airlines) to hedge their risks by agreeing to sell or buy oil in the future at a set price. Speculators, by contrast, mostly use futures contracts to gamble on oil prices, and have no interest in buying or selling real barrels of oil. These gambles can be tremendously lucrative, but they don’t directly determine the real (or “spot”) price of oil. That’s set by the people who are buying and selling actual barrels of petroleum. Although speculators could directly distort oil prices by turning their futures contracts into oil and then taking it off the market to drive up prices, a look at oil inventories shows no sign that this is happening.

If speculators aren’t at fault, why have oil prices spiked so high? Fundamental reasons aren’t hard to find. Between 2000 and 2007, world demand for petroleum rose by nearly nine million barrels a day, but OPEC has been consistently unable, or unwilling, to significantly increase supply, and production by non-OPEC members has risen by just four million barrels a day. The prospect of military action against Iran, which would disrupt global supply, seems greater than it did a few years ago. And the plunging value of the dollar has meant that the cost of oil has jumped more in the U.S. in the past year than it has in countries with healthier currencies. ...

But there’s also something else at work, which the oil guru Daniel Yergin calls a “shortage psychology.” The price of oil—more than that of many other commodities—isn’t based solely on current supply and demand. It’s also based on people’s expectations about future supply and demand, because those expectations determine whether it makes sense for oil producers to sell their oil now or leave it in the ground and sell it later. ...

The difficulty for Congress, of course, is that none of the problems that have driven up the price of oil lend themselves to a quick fix, and most, like the boom in global demand and the inaccessibility of certain oil fields, aren’t under our control at all. That’s what makes speculators a perfect target: by going after them, Congress can demonstrate to voters that it understands their pain, and at the same time avoid doing anything that might require real sacrifice from Americans.
Hat tip to Greg Mankiw.

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