DON'T BLAME THE SPECULATORS

July 10, 2008

Politicians around the world have fingered speculators for the feverish rise in the price of oil and other raw materials.  According to their theory, those speculators betting on higher prices have created a self-fulfilling prophecy: It is the tide of new investment, rather than inadequate supply or irrepressible demand, that is pushing the price of oil even higher.  However, there is little evidence to support this reasoning, says the Economist.

For one thing, the surge in investment in oil futures is not that large relative to the global trade in oil:

  • Barclay's Capital, an investment bank, calculates that "index funds," which have especially irritated politicians because they always bet on rising prices, account for only 12 percent of the outstanding contracts on NYMEX and have a value equivalent to just 2 percent of the world's yearly oil consumption.
  • Neither index funds nor other speculators ever buy any physical oil; they buy future and options, which they settle with a cash payment when they fall due.
  • In essence, these are bets on which way the oil price will move.
  • Since the real currency of such contracts is cash, not barrels of crude, there is no limit to the number of bets that can be made.
  • Since no oil is ever held back from the market, these bets do not affect the price of oil any more than bets on a football match affect the result.

What's more, says the Economist, the oil speculators actually provide vital services:

  • They help airlines and big oil consumers to hedge against rising prices, and therefore reduce risk.
  • They also provide oil producers with more predictable future revenues, which allow them to expand more confidently and borrow money more cheaply.

Source: "Don't Blame the Speculators," The Economist, July 5, 2008.

For text:

http://www.economist.com/opinion/displayStory.cfm?source=hptextfeature&story_id=11670357

 

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