Speculators / Rising prices

[KendallJ]

Inflation is a significant component but not the full answer.

This response puzzles me. Nobody said it was, nor is it necessary for it to be to explain the factors involved. You've given several that appear valid already. The issue becomes then, what do you think is missing, and for what quantitative reason do you think the existing factors do not expain it? Speculation as a contributing cause to the rise in oil prices does not exist. It's mechanism cannot be described (I'd invite you to attempt it). The factors already mentioned do a pretty good job of explaining the issue. To make a case for more you actually would need to bring it.

[softwareNerd]

The thing is Kendall, that congress (Bill Stupak, et al) does not merely want to stop short term trading by people they consider irrational. That does not appear to be their concept of "speculator". I don't base this on any document, but on the hearing I saw on C-Span. The way they use the term they mean: people who -- even rationally -- are buying oil-futures because they think they're worth it, without having anything to do with the actual production or use of oil themselves.

Edited June 28, 2008 by softwareNerd

[adrock3215]

How much investment in refining capacity have you seen? If the refining capacity is limited, then increasing the flow of crude does not help much.

ruveyn

You have a good point, and I am unable to answer off the top of my head. Since refiners are being pinched by high crude prices right now, my assumption is that refiners aren't really investing much of anything into increasing capacity at this moment. Once crack spreads widen a bit more (either crude prices come down, or demand for refined gasoline rises), and refiners are again able to make decent profits, I would expect investment in that particular sector to pick up.

Edited June 28, 2008 by adrock3215

[KendallJ]

The thing is Kendall, that congress (Bill Stupak, et al) does not merely want to stop short term trading by people they consider irrational. That does not appear to be their concept of "speculator". I don't base this on any document, but on the hearing I saw on C-Span. The way they use the term they mean: people who -- even rationally -- are buying oil-futures because they think they're worth it, without having anything to do with the actual production or use of oil themselves.

That's exactly the point. I think the term "speculator" is being used as an anti-concept, and an anticoncept blends two distinctly separate ideas, specifically to smear the good, rational concept. Many people who do not use or produce oil themselves still have exposure to it, and rational should hedge. But congress wants us to think that these are all people who are making profits off of the rise in oil prices, essentiall a pump and dump sort of mentality.

That's why I don't like the term speculator used for rational hedging, and or investing. Can you imaging the impact that woudl be taken away if you said that "investors are driving up the price oil". It would be a non-issue.

... and now, back to OCON packing.

Edited June 28, 2008 by KendallJ

[~Sophia~]

This response puzzles me. Nobody said it was, nor is it necessary for it to be to explain the factors involved.

I have responded in this way because it seems to me that to have brought it back again into focus as a way to minimize/dismiss the other factors we have been discussing. If that is not the case then I don't know why you would.

[~Sophia~]

The idea that you only need a little ante and so many people play is not right.

That is not what I had in mind. A big player can have a much bigger impact in terms of position (demand on paper) than his real money would otherwise allow.

Edited June 28, 2008 by ~Sophia~

[KendallJ]

That is not what I had in mind. A big player can have a much bigger impact in terms of position (demand on paper) than his real money would otherwise allow.

Does the big player not take the same risk? It is irrelevant whether your issue is a number of small players or one large player. The idea that they can have leverage because of the leverage their money brings runs up against the same issue. It is why the whole idea of "speculation" in futures markets is bogus. Anyone who tries will lose their shirt.

If one can't buy enough oil to affect the price in the commodity market, then one also cannot buy enough in the futures market as well without taking enourmous risk. The futures market does not give you magic leverage without commensurate risk. There are no free lunches. The large players are even more rational than the smaller players because of this.

I have responded in this way because it seems to me that to have brought it back again into focus as a way to minimize/dismiss the other factors we have been discussing. If that is not the case then I don't know why you would.

I'm not sure what your language is saying here. Are you saying that I brought it back to minimize the other factors? I never left it. You minimized the topic of it with your report. When you again asked how it is that price can be affected with a seeming lack of excess demand, I again answered that inflation explains that effect very well.

The other factors are all in play, except the concept of "speculation". It is unnecessary and there is no evidence of it.

[~Sophia~]

I found this report:

Assets allocated to commodity index trading strategies have risen from $13 billion at the end of

2003 to $260 billion as of March 2008, and the prices of the 25 commodities that

compose these indices have risen by an average of 183% in those five years.

Another one.

Edited June 28, 2008 by ~Sophia~

[Steve D'Ippolito]

Actually, it's worse, in the futures market, than "you could lose your entire dollar". You could lose far more than you ever put in if the commodity price goes in the wrong direction in a big way. E.g., if you buy an oil future for a specific price (say, $140/bbl) and oil plummets tio $90 a barrel, you've lost 50 bucks per barrel, which most likely is far more than your margin requirement.

[gags]

Another thing about futures is that you only need a small percentage of the money in order to be a player (which is not the case with stocks). Wouldn't that further inflate the demand?

Leverage is readily available to stock traders. You can buy stocks on margin (essentially a loan from the brokerage house) or you can buy options, which provide a substantial amount of leverage. The thing you have to remember about leverage is that it cuts both ways. It can magnify your losses the same way it magnifies your gains. As Kendall said, there is no free lunch. Raising the margin requirements for commodity traders would simply drive the business off shore to other markets.

It is important to remember that during an inflationary period, investors will increase their holdings of tangible assets like commodities as a hedge against inflation. Clearly that is a major part of what is currently happening in the oil markets.

[KendallJ]

I've read the Senate report that seems to be at the beginning of every discussion of this whole issue, and it is complete bunk. It does not require any sort of specialized knowledge to see the gaping holes in basic argumentation.

Since posting links seems to be the replacement for discussion and integration these days, I'll just do that and assert it is self-serving trash and maybe that'll be enough.

http://www.senate.gov/~levin/newsroom/supp...spec.062606.pdf

[softwareNerd]

The two different uses of the term "speculator" has caused this thread to remain as multiple strands. This post is an attempt to "reorient" it by dropping that term, and also by focusing on what is before focusing on what should be done.

One way to categorize traders: Many buyers and sellers in the commodity markets consume and produce the commodity as a business (farmers, miners, airlines). Many others do not. These others buy and sell the commodity even though they do not intend to deliver or take delivery of the commodity or anything similar.

The driver of prices: When facts of reality change (supply disruptions, more middle-class Asian drivers wanting gas, more US$ inflation, etc.), the various people trading the commodity change their assumptions and re-evaluate the value of the commodity. In that sense, those types of external facts drive prices. However, being economics, this is not automatic. People who trade the commodity, evaluate the facts, and these new evaluations are the proximate driver.

So, buyers and seller do drive prices, but not subjectively or whimsically. Rather, they observe facts, and apply theories and projections apply to those facts. In that sense, it is the facts and the processing of those facts that drives prices.

Therefore, to say that traders (no matter of what type) drive prices is to say nothing in particular. If they don't who will? The price of oil is not hooked up by some computer machine to the current inflation figures.

Economic function: The traders play the role of that non-existent computer. Their economic usefulness has been covered in some previous posts, and I don't think anyone here will disagree with the usefulness of traders in general.

Market opinion: There are always differing opinions in the market, and the price reflects the "intersection" of these. The more uncertainty ahead, the more that people will have differing opinions. Being wrong means: losing money. That implies: lessened inability to trade. In this type of market place, the profits and losses are easily reckoned. Over time, theories and evaluations that reflect reality, tend to win out in the marketplace.

Mistaken Traders: When one trader buys a commodity thinking it is undervalued, and another sells it (at the same price), one of them is going to be proven wrong over time. Over the short to medium-term, more money can be backing wrong evaluations than is backing the right ones. Of course, if this could be known with certainty at that point (omniscience would help here), then the person who knows this could make a lot of money picking the right side. Over time, this person would likely get a reputation as a great trader, and more people would ask him to invest their money.

Can we ask: "is oil price right today?" Of course, oil does not have an intrinsic price. An outsider to the oil-market really cannot ask whether oil is trading at the 'right' price. Definitely, the government may not legitimately decide that a particular price is right. The government may not legitimately decide that certain traders are being irrational. If they are, they will pay by losing money.

On the other hand, this is a question every trader has to ask himself every day. He has to evaluate the current price against his personal horizon of trading: whether that is a day, a week, or ten years. There's no other way for him to know whether to buy or sell. So, it is a legitimate question for a market participant to ask himself: maybe the question.

Edited July 1, 2008 by softwareNerd

[~Sophia~]

I've read the Senate report that seems to be at the beginning of every discussion...

You are the only one who has been mentioning it.

[~Sophia~]

The price of oil is not hooked up by some computer machine to the current inflation figures.

There is another indirect effect. The higher the price the less incentive oil producers have to convert their oil reserves underground which appreciate in value into dollar reserves which depreciate in value.

[agrippa1]

Can we ask: "is oil price right today?" Of course, oil does not have an intrinsic price. An outsider to the oil-market really cannot ask whether oil is trading at the 'right' price. Definitely, the government may not legitimately decide that a particular price is right. The government may not legitimately decide that certain traders are being irrational. If they are, they will pay by losing money.

On the other hand, this is a question every trader has to ask himself every day. He has to evaluate the current price against his personal horizon of trading: whether that is a day, a week, or ten years. There's no other way for him to know whether to buy or sell. So, it is a legitimate question for a market participant to ask himself: maybe the question.

Oil is always trading at the "right price." The question is whether today's right price is tomorrow's or next year's. A commodity trader's job is to predict the future relationship between supply and demand to try to understand in what direction prices will go. If he sees prices rising due to reduced supply (war in the Middle East), increased demand (rising industry and middle class in China and India), or devaluation of currency (Growing U.S. fed debt, huge credit bailouts, impending socialism) he will bet that future prices will rise, and buy futures. High futures prices "steal" from current supplies by inducing current oil holders to sell their holdings as futures, thus reducing current supply until current prices rise to a point where selling just makes economic sense.

A speculator who buys futures is betting that prices will rise. If he's right he makes money, if he's wrong he loses money. Buying futures pushes oil to the right to increase future supply, which will push prices lower at that future time. For the consumer, it's probably a wash, since the speculator's shift in supply left or right (on the time scale) simply lowers or raises prices in the future or present (but not both).

If Congress is blaming speculators for high prices now, then they should thank them for lower prices a year from now.

[softwareNerd]

agrippa1, I agree with everything you say except this formulation.

Oil is always trading at the "right price."

This depends on what one means by the "right price". If the "right price" is the price that best reflects the opinions of the various people buying and selling, then that's correct. If the "right price" is the one that the government should allow, that is true as well. Finally, the price is always "right" from the context a market-outsider , i.e. a person who is not making an independent judgement about the factors that go into that price.

"Right" is a pretty general term. A buyer or seller who is making an independent judgement about the factors in the market, figures out what he considers to be an appropriate (i.e. "right") price-range. He can then buy or sell, based on whether the opinions of other traders (aka the "right price" as reflected by market opinion) is different from what he considers to be the right price.

[ruveyn ben yosef]

agrippa1, I agree with everything you say except this formulation.This depends on what one means by the "right price". If the "right price" is the price that best reflects the opinions of the various people buying and selling, then that's correct. If the "right price" is the one that the government should allow, that is true as well. Finally, the price is always "right" from the context a market-outsider , i.e. a person who is not making an independent judgement about the factors that go into that price.

"Right" is a pretty general term. A buyer or seller who is making an independent judgement about the factors in the market, figures out what he considers to be an appropriate (i.e. "right") price-range. He can then buy or sell, based on whether the opinions of other traders (aka the "right price" as reflected by market opinion) is different from what he considers to be the right price.

This sounds like the good old Law of Supply and Demand.

Which is totally at opposition to the medieval notion of "just price" which the Catholic Church pushed in the Bad Old Days. Any prices other than the strike price that comes out of voluntary trade is whim and decree, or extortion.

I was a young during world war 2 and what we had was rationing. Everything from meat to gasoline and tires was rationed at prices set by the OPA (Office of Price Administration). Guess what. A lively "black market" flourished, where one could get the stuff one needed if he were willing to pay the price asked by the supplier. There is simply no way to keep the Law of Suppy and Demand from operating. Even in the late and unlamented Soviet Union, which was a police state, there was a vibrant market where prices were set by Supply and Demand. Even that son of bitch Vladimir Ilyich Lenin recognized this when he instituted the "New Economic Policy" in 1924, which grudgingly granted a free market in necessary goods such as food. Without this concession the Soviet Union would have starved.

Right now, the more or less free market price of gasoline in the U.S. is around $4.00 a gallon (and rising). If the government, God forbid, institutes price control what is going to happen (as sure as the sun rises and shit flows downhill) will be long lines to buy limited amounts of gasoline a regulated prices. Very long lines (just like in 1974). And there will be plenty of gasoline at say 7.00 a gallon bought from the back of fuel trucks during midnight fill ups. I guarantee it. Just wait.

ruveyn

[softwareNerd]

If the government, God forbid, institutes price control what is going to happen (as sure as the sun rises and shit flows downhill) will be long lines to buy limited amounts of gasoline a regulated prices. Very long lines (just like in 1974). And there will be plenty of gasoline at say 7.00 a gallon bought from the back of fuel trucks during midnight fill ups. I guarantee it. Just wait.

Let's hope poiliticians have some memory of those lines and the resulting mood of the voter. On the bright side, news reports indicate that China (the largest source of new demand over the last 5 years) is allowing its domestic prices to rise a bit.

[gags]

There is further evidence that commodity markets in countries other than the US are developing rapidly:

China's futures market witnessed a sharp increase in trade volume in the first half, led by an active trade in farm products, including sugar, soybeans, and corn.

Compared with the well-developed commodity market, the Chinese futures market is much weaker, with few types of contracts available. Futures trading of pork, steel, crude, silver and lead are expected to be introduced to the market, said Yu Junli, research director of Green Futures.

http://english.people.com.cn/90001/90776/90884/6440246.html

If the politicians persist in this crusade to regulate "speculators" out of the market, the business will simply move elsewhere.

[softwareNerd]

The recent spike in gas prices has inspired a new business, called "MyGallons.com", where one can buy gas, by pre-paying for it at some current price. Then, one can use one's MyGallons card at gas-stations anytime. So, one locks in a price in the form of a micro-mini futures contract.

This is not a recommendation. I don't know anything about this, other than seeing their web-site. (HT: ROFASix)

Edited July 3, 2008 by softwareNerd

[gags]

Yesterday I received the following e-mail from Northwest Airlines:

An Open letter to All Airline Customers:

Our country is facing a possible sharp economic downturn because of skyrocketing oil and fuel prices, but by pulling together, we can all do something to help now. Visit www.StopOilSpeculationNow.com.

For airlines, ultra-expensive fuel means thousands of lost jobs and severe reductions in air service to both large and small communities. To the broader economy, oil prices mean slower activity and widespread economic pain. This pain can be alleviated, and that is why we are taking the extraordinary step of writing this joint letter to our customers.

Since high oil prices are partly a response to normal market forces, the nation needs to focus on increased energy supplies and conservation. However, there is another side to this story because normal market forces are being dangerously amplified by poorly regulated market speculation.

Twenty years ago, 21 percent of oil contracts were purchased by speculators who trade oil on paper with no intention of ever taking delivery. Today, oil speculators purchase 66 percent of all oil futures contracts, and that reflects just the transactions that are known. Speculators buy up large amounts of oil and then sell it to each other again and again. A barrel of oil may trade 20-plus times before it is delivered and used; the price goes up with each trade and consumers pick up the final tab. Some market experts estimate that current prices reflect as much as $30 to $60 per barrel in unnecessary speculative costs.

Over seventy years ago, Congress established regulations to control excessive, largely unchecked market speculation and manipulation. However, over the past two decades, these regulatory limits have been weakened or removed. We believe that restoring and enforcing these limits, along with several other modest measures, will provide more disclosure, transparency and sound market oversight. Together, these reforms will help cool the over-heated oil market and permit the economy to prosper.

The nation needs to pull together to reform the oil markets and solve this growing problem. We need your help. Get more information and contact Congress by visiting www.StopOilSpeculationNow.com.

Robert Fornaro

Chairman, President and CEO

AirTran Airways

Bill Ayer

Chairman, President and CEO

Alaska Airlines, Inc.

Gerard J. Arpey

Chairman, President and CEO

American Airlines, Inc.

Lawrence W. Kellner

Chairman and CEO

Continental Airlines, Inc.

Richard Anderson

CEO

Delta Air Lines, Inc.

Mark B. Dunkerley

President and CEO

Hawaiian Airlines, Inc.

Dave Barger

CEO

JetBlue Airways Corporation

Timothy E. Hoeksema

Chairman, President and CEO

Midwest Airlines

Douglas M. Steenland

President and CEO

Northwest Airlines, Inc.

Gary Kelly

Chairman and CEO

Southwest Airlines Co.

Glenn F. Tilton

Chairman, President and CEO

United Airlines, Inc.

Douglas Parker

Chairman and CEO

US Airways Group, Inc.

http://capwiz.com/sosnow/issues/alert/?alertid=11571321

This is a great example of an instance where big business is happy to call for government intervention and regulation when they think it suits their purposes. Personally, I think it's very weak on the part of the airlines.

[KendallJ]

You are the only one who has been mentioning it.

OK, if you look up what I originally said about this report,

Every time I look up speculation in tehe oil market I come back to the 2006 congressional study which is where this rotten idea seems to have come from. I haven't had a chance to read it, but my suspicion is it's going to be very self-serving. Govt needs a scapegoat, and today it happens to be the "speculator."

Maybe I'm the only one who researched this far.

More importantly, Sophia, this comment is unlike you. Usually, you're intrested in an idea and research it and commet throughtfully. Today it seems you simply want to snipe at me. Why the sniping?

You gave me a link. I read it. My claim about this link is quite correct. Start googling an be willing to dig a layer or three and this report gets mentioned. The point that I'm the only one who has brought it up in this conversation could just as easily be explained by the fact that those who believe that "speculation" is a valid malfunction of the market don't want to look very deep for evidence that it is being misrepresented.

Edited July 12, 2008 by KendallJ

[adrock3215]

Not sure if anyone saw this editorial by a University of Houston finance professor titled "Restricting Speculators Will Not Reduce Oil Prices" from the WSJ yesterday. Some quotes:

For the most part, speculators do not demand physical oil the way thirsty Chinese refiners do. There is no evidence that speculators are accumulating large and rising inventories of physical oil. But to cause prices to be above their competitive level, speculators would have to take physical oil off the market -- the way that governments have done in the past with agricultural products, amassing mountains of grain and cheese to prop up their prices.

What some speculators do instead is trade futures contracts that entitle them to take delivery of physical oil at a future date (say next August) at a price negotiated in the marketplace. But they almost never exercise the right to take delivery when the contract matures.

A speculator who anticipates rising prices buys a futures contract at the prevailing market price. If he is right, and the futures price rises, he can sell the contract at the higher price before contract maturity and pocket a profit; if he is wrong, and prices fall, he sells the contract at a loss. Buyers and sellers of these futures contracts almost never take delivery of the oil to implement their trading strategies.

[Steve D'Ippolito]

There are times when a market (stock, commodity, etc.) gets into a "bubble" but those do not last forever. (I am thinking of gold and silver circa 1979-1980 just for one--a lot of the hyperbole about how gold "should" be over 2000 dollars an ounce right now to inflation-match the 850 it reached back then is ridiculous; that was a one-day spike in prices at the top of a market bubble.) Even if the oil market is in a "bubble" right now because the oil *futures* market is, it will eventually reverse itself. I personally don't think there is much of a bubble here; the problem is the dollar is in the toilet and someone is reaching for the handle. (Of course the dollar being so low *could* itself be a sort of reverse-bubble and it may be "too low" for conditions--but I doubt it.)

Sometimes though an "inexplicable" price hike (which may be granting too much to those who claim oil has no earthly reason to be at the prices it is at) really means the people in the market know something the rest of us do not. (Here's hoping they know we are about to pound the snot out of Iran. That would actually be worth a temporary jump in the price of gasoline. Again I ask, is it that hard to drill for oil through a layer of green glass?)

Bubble or not, though--it would be disastrous for the government to step in and regulate the market even more than it already has.

[softwareNerd]

There are times when a market (stock, commodity, etc.) gets into a "bubble" but those do not last forever.

The abstract question: "Can truly free markets have bubbles?" lies at the root of much of the disagreement here. Objectivists and many other free-economy advocates will definitely agree that government action explains much that we see in bubbles. The remaining argument then is whether it explains all of it, and -- if not -- how not so.

On the issue of oil-supply, higher prices sometimes cause governments to clamp down on oil companies, making supply less forthcoming than it would otherwise be. Consider the notion of the windfall tax on oil-company profits. When prices are high, oil-companies have an incentive to produce more. Then, the government imposes a windfall tax and remove that incentive. Then everyone complains that they aren't producing as much as they physically could.

Today, this windfalls profit approach is followed in both India and China. India is not as significant here, so let's consider China. One would think that China would be investing all it could into pumping its own oil. "In theory", this should be particularly the case in a country like China, where the government is so powerful. However, the actual way things are structured is not that simple. Chinese drillers are set up as separate entities, and the government takes a special tax on what they produce. The government uses the same reasoning as do U.S. politicians who want windfall profits: the extra profit is a windfall, so it won't hurt the producer if we take it away.

However, within the existing system -- whether a relatively free economy of the U.S., or the Chinese government's own management control systems -- the windfall tax acts as a disincentive. At some point, perhaps, China will demand that it's firms produce more oil, but meanwhile the tax is a dampener. Indeed, according to this IHT article, China is the one major producer bucking the trend toward declining oil production. Still, if the Chinese government removes their windfall tax, it is likely that they will speed up even more.

Edited July 12, 2008 by softwareNerd