Two Types of Speculation: One Harmful, One Not 26 comments
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Suppose you think that a hurricane might disrupt oil flows in the future. What should you do today? Tropical storm Edouardo gives an example. As the storm approached, people believed there was a chance that oil flows would be disrupted in the future, and the current price began rising as a consequence. If you expect a higher price in the future due to reduced supply or any other reason, you should begin purchasing and storing oil now to take advantage of the higher price in the future, and the increased demand for oil drives today's price
This is speculation - the storm may or may not actually hit and disrupt oil supplies - but it's not the kind of speculation we should worry about. We want this kind of speculation - which reflects underlying fundamentals - to occur. The expectation of a supply disruption in the future causes the market to take actions today and store oil for when it will be needed, and this provides insurance against the potential supply disruption, insurance that reflects the probability that the storm will cause problems (the larger the expected fall in future supply, the bigger the price change, and the more that will be stored for the future).
In this particular case, the insurance wasn't needed, but it's still good to have:
''It is pretty much expected the storm is going to slowly weaken now for the rest of the day and overnight,'' said Mike Pigott ... of ... AccuWeather... ''It wasn't anything unusual or spectacular; there wasn't any kind of massive intensification that we saw with Dolly.'' ...
Crude oil touched a three-month low of $118 a barrel on speculation Edouard wouldn't curtail production. Six rigs and 23 platforms were evacuated in advance of the storm, the U.S. Interior Department said yesterday.
Royal Dutch Shell Plc, Europe's largest oil company by market value, said the storm was no longer a threat and it would start regularly scheduled crew changes for its off-shore facilities, according to spokeswoman Darci Sinclair.
Noble Corp., the third-largest U.S. offshore oil driller, may have crews back on two submersible rigs by tomorrow.
The kind of speculation we should worry about is "bandwagon behavior." This is speculation that is disconnected from fundamentals. For example, suppose that people become convinced that offshore drilling will have a large impact on future prices. Even though this isn't true, suppose people become convinced that it is true through some sort of misleading information campaign, perhaps abetted by a media more interested in hyping controversy than in informing people of the facts.
This is the opposite of an expected supply disruption. It's an expected increase in future supply (based upon false information), so the expected future price would be lower. That would cause speculators to release stored oil - it's not as valuable in the future as it was before - driving the price down today, and this validates the markets anticipation that price would fall. Even if you know that the underlying basis for the fall in price is false, if you expect the price to fall further you may jump on the bandwagon and sell stored oil now before the price actually does falls further, and this will amplify the fall in price. To the extent that the fall in price then becomes self-validating, people afraid of a fall in price sell oil which causes the price to fall generating more sales and further price declines, the behavior can feed on itself and generate a large downward fall in prices.
None of this is based upon underlying fundamentals. It's all generated by people buying into the idea that drilling will have a substantial impact on future prices, and changing their behavior because of it. As a political strategy, I suppose it can work if you don't mind misleading people and sacrificing the environment for political gain - prices fall and you can point to the change as evidence that your policy has helped consumers at the gas pump. But eventually the (negative) bubble will pop (hopefully after you are elected), and prices will return where they started.
This type of speculative behavior - bets on price changes that are driven by something other than the underlying fundamentals - is harmful since it distorts both the intertemporal allocation of resources, and the allocation of resources at a point in time. I'm not saying that selling the false claim that drilling for oil will have a large downward impact on prices will create the kind of bubble that makes a bang heard round the world when it pops, or even necessarily affect prices noticeably. I think most of the price changes we've seen can be explained by changes in the underlying fundamentals.
But the attempt at a distortion is noteworthy in and of itself because if the attempt is successful, it can cause waste and inefficiencies. Because the fall in price is not based upon fundamentals, it's still a bubble, or perhaps more accurately in this case if there has been an impact, it's froth (since the price changes we've seen are relatively small compared to the base), and this sends false signals about where resources are needed the most. The people who are doing their best to reinforce the misperception that drilling will significantly impact prices are, to the extent that they are successful, imposing costs on the economy for political gain. This is not the type of speculation we want to see.
This makes another important point. Bubbles do not have to be price increases, they can also occur when price falls (think of a fall in the stock market that is based upon rumors that generate a self-feeding downward cycle that eventually ends, and the price goes back to its fundamental value). We often think of large price falls as the price returning to its fundamental value, and many people are making that claim about oil prices presently, but if there is a negative bubble at work, the fall in price can be taking you away from, not towards, the long-run stable price.
Finally, prices can also be distorted by false information about fundamentals, i.e. an information campaign that misinforms about true fundamentals. For example, a distortion on the merits of conservation versus drilling could cause us to misallocate resources. Tire gauges and regular tune-ups can do more to help with the energy problem than drilling, but Republicans are doing their best to distort that message and push resources into a suboptimal use:
The Tire-Gauge Solution: No Joke, by Michael Grunwald, Time: How out of touch is Barack Obama? He's so out of touch that he suggested that if all Americans inflated their tires properly and took their cars for regular tune-ups, they could save as much oil as new offshore drilling would produce. Gleeful Republicans have made this their daily talking point; Rush Limbaugh is having a field day; and the Republican National Committee is sending tire gauges labeled "Barack Obama's Energy Plan" to Washington reporters.
But who's really out of touch? The Bush Administration estimates that expanded offshore drilling could increase oil production by 200,000 bbl. per day by 2030. We use about 20 million bbl. per day, so that would meet about 1% of our demand two decades from now. Meanwhile, efficiency experts say that keeping tires inflated can improve gas mileage 3%, and regular maintenance can add another 4%. Many drivers already follow their advice, but if everyone did, we could immediately reduce demand several percentage points. In other words: Obama is right.
In fact, Obama's actual energy plan is much more than a tire gauge. But that's not what's so pernicious about the tire-gauge attacks. ... The real problem with the attacks on his tire-gauge plan is that efforts to improve conservation and efficiency happen to be the best approaches to dealing with the energy crisis — the cheapest, cleanest, quickest and easiest ways to ease our addiction to oil, reduce our pain at the pump and address global warming. It's a pretty simple concept: if our use of fossil fuels is increasing our reliance on Middle Eastern dictators while destroying the planet, maybe we ought to use less.
The RNC is trying to make the tire gauge a symbol of unseriousness, as if only the fatuous believed we could reduce our dependence on foreign oil without doing the bidding of Big Oil. But the tire gauge is really a symbol of a very serious piece of good news: we can use significantly less energy without significantly changing our lifestyle. The energy guru Amory Lovins has shown that investment in "nega-watts" — reduced electricity use through efficiency improvements — is much more cost-effective than investment in new megawatts, and the same is clearly true of nega-barrels. ...
Of course, in recent years, the Republican Party has been affiliated with the oil industry. ... John McCain has been a notable exception. He is not an oilman; he has pushed to regulate carbon emissions; and he opposed Bush's pork-stuffed energy bill, which Obama supported. He also opposed efforts to drill in the Arctic National Wildlife Refuge and until recently opposed new offshore drilling. But now that gas prices have spiked, McCain is running for President on a drill-first platform, and polls suggest that most Americans agree with him. It's sad to see his campaign adopting the politics of the tire gauge, promoting the fallacy that Americans are powerless to address their own energy problems. Because the truth is: Yes, we can. We already are.
[Update: hilzoy has more on how Obama's statement is being distorted for political gain. Too bad we can't count on the media to point out how McCain is misrepresenting what Obama actually said.]
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This article has 26 comments:
His thesis seems to be that because speculation based on incorrect information causes a misallocation of resources, it is bad. OK. Granted. So what? Did I miss his action step conclusion? Does he think this kind of speculation should be banned? Surely not. Who gets to decide what is good information and what is bad information? I hope he doesn’t think that people should be disallowed of an investment/speculation because they disagree with the accurate information police. Or maybe he simply prefers people should only be able to speculate on information that his wisdom deems accurate? This is nothing more than political hackery dressed up as economic analysis.
In reality, what author is talking about, is trend speculation (bad) vs countertrend speculation (good). In reality, both are quite legitimate.
Disclosure: short oil by holding DTO.
tks but no, tks
1. Drill, drill, drill (offshore, ANWR, NG shale etc), more nuclear plants....
or
2. hope..
"No ...We have a planet to save!"
Now that our government has waited for peak oil, or should I say peak conventional oil, to be knocking on our doorstep, our political parties still continue to fight amongst each other and cater to fanatical environmentalists. Nothing will get done; they should have been feverishly working on this energy problem 30 years ago. I read a great slap-in-the-face article recently that tells things as they are and was motivated to write the author and ask him some questions. Here is my last response from him:
On 8/4/08 12:48 PM
I read your piece called “Dependent on Foreign Oil? You Bet!“ I loved
it. I’ll start following your writings more now to see what you mean
when you say you want to talk about the “really big problems coming
our way.” I know we’re in no shortage of them. Can I bother you with
one more question? Can you clarify the following statement:
“The oil boys tell me that if they do everything right from this day
forward, we will hit a brick wall for oil around 2015. Oil at $250 and
gas at $8-10.”
What exactly do you mean when you say, “…if they do everything right
from this day forward…” ?
Thanks, Mike
Mike,
Meaning that every new oil field they work on has to hit. And
production rates can’t fall off at existing wells. Sadly, everyone
knew this day has been coming since early 2001. You can read
“Strategic Energy Challenges for the 21st Century” from the James A.
Baker Institution and it’s an eye opener.
Moreover, the oil guys were all in on that think tank paper and the
only thing on their lips was Iraq, Iraq, Iraq. Only because everyone
knows they have 115-240 billion barrels of oil, the world’s last great
major oil fields not exploited, and as the report said, “Like it or
not, Iraq remains our only option to enhanced oil recovery.”
The game changer is that by 2015 demand will exceed supply. (I’ve
wrote about that years ago in the ST) Which has been talked about now
as the reason for the high price of oil, but it hasn’t been true. Now
in 2004 it came close, maybe an 800K barrel daily buffer. But now you
know why I say I’m not against drilling or anything else that extends
our supplies.
Now, as of today at my website I put up a map of our offshore areas
and how much recoverable oil is believed to be there. It’s not that
encouraging with the exception of California and even if Washington
says to go after it, California has the right to say no. Which they
will. At least until the day they too are paying $10 a gallon. Then
they’ll put a bounty on surfers instead.
It’s at insideautomotive.com
I also know we’ve got to come up with an energy plan now to mitigate
this situation and our government, whether run by Republicans or
Democrats, love to work on things after the disaster hits and pounds
all of us.
You know Mike, I don’t always write things that people like, but I do
my best to write the truth and let time sort it out.
And thanks for the kind words
Ed
As I've said before, the politicians are too busy hunting for the oil-price-pumping bogeyman to cover up for their own failures. All they have to do is look in the mirror to find the real bogeyman.
if civil penalties and damages could be levied on people who originate or propagate information which is false or information clearly arranged to deceive or mislead - this would be good. but this will never happen, and i am not in favor this as the practical consequences could be enormous.
i will just settle for keeping my tires inflated.
So, there can be many views regarding whether speculation is done under the correct or incorrect technical fundaments on any issue, even if it is socially good or bad, but it is difficult to think that for the "speculator" the speculative operation has a negative implication.
I really don't see speculation about offshoring drilling a problem really. It shouldn't have too much impact on the price of oil in the short term. Any correlation is probably a coincidence.
What concerns me is the greedy speculation that spiked oil up at $147 which really damaged the economy more than any campaign statement. This is the harmful speculation that should be a concern.
The best solution for high oil price is high oil price. With the gloabl demand destruction from the high oil price, oil prices will eventually fall.
One thing I do agree with you is this, many news media reporters and writers are retards, they fabricate some news that's completely false.
High oil prices in the last few years are a reflection of strong global growth, and in many ways led by the global housing bubble. But now, gloabl housing and commodity bubbles start to unwind, That's very healthy for the US economy in the long run
Strangely, despite your misguided premise, your conclusion is sound. If the US were to become as efficient as the Germans, it would cut its consumption by 4 mbpd! And the Germans are considered the energy hogs in Europe. If that sounds like a lot consider the fact that if every vehicle on the road was 1mpg more efficient that would save 350,000 bpd. Imagine what would happen if the big 3 (OK, sounds like such a joke now), hadn't found the fuel standards so hard? Not only would the US's energy needs be much less, they would probably be much better off.
As they say, Karma's a --- you get the point.
I was stating that I agree with your conclusion about the fact that conservation is very beneficial - although you need to start utilizing your own resources. I think the politics was totally unnecessary.
Socialism is the Democratic system. One and the same and it has failed for 6,000 years it has been tried. Every. Single. Time. What does Ted Kennedy say? The difference this time is that he will be running it. That is a quote Mark, not a slam. Same as him saying he would never allow windmills in front of his home. But do you know what? I respect Ted Kennedy for his honesty out of all the deluded Democrats, because I can at least debate him, fact for fact.
But you shilling for Dems or any investor for that matter is strange to me. Wealth restribution is like Robin Hood. Was Robin Hood a villain or a hero? No need to answer, I already know what your answer is.
Moreover, your 'good' speculation wasn't caused by prudent saving of energy, we have the SPR for that. It was caused by the incessant pumping of the shills like GS, JPM, and the 'peak oil' dogs who just could wait to have their day. You're 'good' speculation doubled oil prices in a year, and just about took the world economy under its heel just so some a$$holes who run hedge funds could make their million dollar bonuses.
If you submitted this as a paper this would be my remarks to you;
Your paper looks like it was written at 3am in the morning after you were drinking. You could have put no more than 5 minutes of thought into your hypothesis, and even less into writing it. You're example of 'good' speculation is so contrived that it would take less than a nanosecond to rebut, and only slightly longer to come up with the counter of SPR. You have also not properly defined a 'negative' bubble, nor even shown any source to show that it is an excepted term.
In short, please don't waste my time with this useless drivel.
F-.
Mark Thoma thinks he's smart, and thinks Obama is right. Obama is a socialist. Your inflating tires analysis is simply wrong. Here's why
We consume 20.4 million barrels of oil per day, out of that amount, 9.3 million is gasoline. Oils are used for heating and other industrial uses. Now, many driver, including me, properly inflating tires, we rotate tirew every 5000 miles, let's say 65% of us properly inflate our tires, and 35% don't. Those don't use 35% of 9.3 Million = 3.26%, let's say 3% savings from tire inflation = less than 100,000 barrels per day saving. 100,000/20,400,000= .5%, very little impact on energy consumption.
Mark, do you see the holes in your argument?
Bad speculation occurs on the two extremes of possibility: almost complete certainty and almost complete impossibility.
Since most of life is a gamble, we are all speculators, of necessity.
Band wagon behavior isn't speculation, it's an attempt to avoid speculation through conformity.
“Whoso would be a man (a speculator,) must be a nonconformist” RWE
The real question for speculators is "What is the intrinsic value of oil?" Is it really "too valuable to burn" as some suggest? Is it replaceble? BUT in the meanwhile, we've sold off our inheritence at a discount price for uncertain gains, possibly a civilization that can't exist as we know it when it's gone.
My problem with the thesis of good and bad speculation is that it's virtually impossible to tell the difference with certainty until after the fact. And what you call a bandwagon effect is the psychology of all markets. One of the main contributors to volatility.
The concept of purposely disseminating false information to impact market prices is part of human behavior. If it's done by a principal, it's illegal. If not, then it's just another pump and dump and probably protected by the Bill of Rights. Buyer beware, etc. I agree that it's probably detrimental to market efficiency.
One person's opinion of accurate fundamental data is another's propaganda, look at global warming and peak oil.
Momentum investing and trading are principle drivers of markets. So are you and your DDE (Democrat Driven Economists) buddies proposing that Obama add yet another myopic law counter-market law that would prohibit this practice?
Maybe you should take a lesson from fellow Democratic supporter, George Soros who is more experienced in markets than you. Here is what he said a few years ago that clearly demonstrates that he understands how markets work.
“Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited.”
It is clear from what you have written that you are a believer in the efficient market myth and not a trader or investor.
Oh and one more thing. You say above, "Tire gauges and regular tune-ups can do more to help with the energy problem than drilling."
You really are living in a dream aren't you? The US now imports more than 70% of its oil and ships $700 billion overseas each year. There is an estimated 72 billion barrels of oil off the east and west coast of the US but you think regular tuneups and checking tire pressure is a better solution? I'm all for finding alternative energy solutions but it will take time. Currently alternative energy vehicles represent 1% of automobiles on the road today. It will take time to get this figure up significantly so we can either continue importing foreign oil or look for solutions here at home.
You have demonstrated that to me that you have zero credibility when it comes to an understanding of both markets and the energy challenge.