Oil Speculation

The news is full of (no, not that!) stories about Congress investigating the role of oil speculation today.  A CNN story says “Near-record oil prices could quickly fall by half if Congress were to rein in speculators“. 

Sounds good – so what’s the hold up?  If Congress could simply pass a law that would drop oil prices by half, why don’t they? 

After all (the story goes on to say) “The testimony came as Congress, reflecting some sentiment among the public, blamed Wall Street traders for record oil and gasoline prices.”

let’s make sure we have this straight – Congress (and the public at large) are blaming “Wall Street traders” for the record oil and gas prices, and Congress could drop the price by 50% if they wanted to.  Am I missing anything?

Oh yeah, I forgot to mention one little bitty item: OIL IS A GLOBALLY TRADED COMMODITY!

In other words, disregard everything above, because (as the story eventually gets to) if it’s not traded on Wall Street, it’ll be traded in London, or Toyko, or Hong Kong.  The last time I checked, Congress can’t do a damn thing regarding regulating markets in other countries.  Oops…..

If you read to the end of the story, you eventually get to these two paragraphs:

Though many Democratic and some Republican politicians have furiously blamed speculation for driving up the price of oil, many analysts argue that the market fundamentals of supply and demand are the cause of record prices.

“If it is a bubble, then where is the evidence in the actual physical market?” asked Kevin Norrish, a commodities analyst with Barclays Capital in London. “There is an endless list of reasons why this argument is a very, very poor one – it will only make things worse.”

One thing that the idiots in Congress (and elsewhere) have forgotten is that “speculators” are only trading in the futures market – no physical oil changes hands. 

Here’s a quick example if you don’t understand.  Let’s say I buy a futures contract at $135/barrel for July delivery.  What do I do when the producer I bought it from drops off a tank truck full of oil at my front door?  Have you seen any oil tankers on Wall Street?   That’s what I thought.

In other words, if I buy up a bunch of futures contracts, I have to sell them before the contract date – I have no use for the oil!  Remember supply and demand?  If I bought oil for July delivery, I have to sell it before July – what happens to the price of oil if there’s no demand for what I bought? 

It’ll drop, big time.  So “speculators” must sell their oil before it’s delivered – if there’s no demand for it, they’ll have to sell at a loss.  If the demand has gone up, they make a profit. 

So what happens if Saudi Arabia pumps 5 million barrels of oil more in July than they did in June?  Supply has gone up so (assuming that demand has remained constant) the price will drop.  Supply and demand controls the price of oil.

Side note: There’s no way Saudi Arabia can pump that much more oil – I personally think we’re at “peak oil” right now at around 86 million barrels per day.  So with a constant or falling supply, and steady or increasing demand, the price must go up.  It doesn’t matter if we’re talking about oil or eggs or plywood or SUV’s – supply and demand rule.  As they should.

Any questions?

gk

 

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