I’m here to defend the oil speculators.
And now, while the Kevlar-vested cleaning crew scrapes rotten eggs from the wall behind me, let’s calmly investigate claims that these shadowy saboteurs are the driving force behind $4 gas, $7 corn and, for all I know, the $777 lobster burger.
After all, the charges aren’t coming from populist crackpots unfamiliar with the workings of the futures markets. President Obama recently launched a task force to probe the possibility that traders are “manipulating” prices. Jim Cramer, the mad prophet of CNBC, rails daily about how oil futures are a “joke,” demanding that the government do more to rein in the speculators who’d been driving them up. Our own Howard Gold argues that “Blame for $4 Gas Begins at Home,” namely with the “speculators [who] have run wild in the energy pits.”
Oddly, no one nominated speculators for humanitarian awards when the price of oil collapsed in 2008, and no one cried for them last week when it fell a jaw-clenching $13 a barrel in a day. We seem to endow these types with unlimited and malevolent powers only when prices move in an undesirable direction.
In fact, as last week proves, speculators are perfectly capable of losing a ton of money when the market moves against them, and perfectly willing to short whatever commodity they were long the day before if shorting looks like the better bet. They’re simply people with capital expressing an opinion — thereby providing essential liquidity for our capital markets.
Blaming traders for the prices they discover in these markets is a lot like blaming the weatherman for rain.
Speculators have been lining up to buy crude-oil futures in record numbers because:
- As of March, with Libya shut down, global demand was already edging past global supply, according to the International Energy Agency.
- Global crude inventories have been declining, and have recently fallen below the five-year average, according to J.P. Morgan (NYSE:JPM), which boosted its price targets for crude to what it fetched before last week’s correction.
- The secular trend in the face of rising global demand and finite supplies is for more expensive fuel, as we steadily replace old and shallow reserves with costlier ones in riskier and more remote places. Technological innovations like hydraulic fracking and horizontal drilling have not removed the need for oil from oceanic depths and northern wastes -- oil that can only be extracted at great cost and considerable risk, notably environmental.
- And, yes, interest rates are low, fueling expectations that commodities will benefit from cheap money chasing easy pickings.
The thing to keep in mind is that for every futures buyer, there’s a futures seller, and for every dollar long crude there’s a dollar short it. Without speculators, producers would have no way to hedge their risk and lock in prices they consider favorable.
As for the “speculative premium” some claim to see embedded in the price of oil, here’s the truth: No one knows or can reliably calculate how big it is, even if they could define it. Often, it’s just shorthand for “I don’t like the price.”
Many of the wells coming online today were developed five or more years ago, when oil trading at $60 to $70 was already deemed by some to be a bubble. Where would we be in the physical market today without the discoveries assisted by the “speculative premium” of those days? Nowhere warm, that’s for sure.
People speculating on higher oil prices are sending a valuable — and perfectly legitimate — market signal about expectations for future prices. Their exertions can make sure that today's feared shortages don’t turn into tomorrow’s front-page news.
The trading of futures contracts goes back to the founding of the Chicago Board of Trade in 1848, and before that to the 17th-century trading of rice contracts in Japan, then 16th-century Amsterdam, 12th-century European fairs, and so forth, back to classical times. Wherever and whenever people trade, it seems, they eventually figure out a way to trade risk.
The premise that such risk transfers should take place in well-regulated but otherwise free markets, open to all comers, is one of the bedrock principles of modern finance. So when people start talking about reining in the speculators, they are not targeting Exxon Mobil (NYSE:XOM) or even the commodity traders at Glencore. They are generally after the smaller fry such as, for example, investors in exchange-traded funds increasingly subject to limits on their positions.
Yet it’s not clear why it’s okay for Exxon to hedge its production, and for Glencore to make billions trading commodities, but not okay for you and me to hedge our significant future energy costs with an investment in a commodity fund.
The big boys can’t see the future any better than the little guys. Speculators aren’t any worse — or any better — at guessing future prices than the rest of us. The markets should decide who’s wrong and who’s right.