Don’t Blame Oil Speculators for High Gas Prices

by Apr 14, 2012Liberty & Economy0 comments

Foreign Affairs has an article, “In Defense of Oil Speculators: Don’t Blame Wall Street for High Gas Prices”.

Foreign Affairs has an article, “In Defense of Oil Speculators: Don’t Blame Wall Street for High Gas Prices”. Some excerpts:

In the popular media, the term “speculation” tends to refer to several types of activity that occur in the oil market. The first is the buying and selling of futures contracts, which are financial securities that give their holders the right to buy or sell a certain quantity of oil at a later date. Airlines, oil producers, and refineries all use financial markets to hedge against wild price fluctuations. This is sensible: by securing the right to receive or offload oil in the future at a fixed price, these companies are able to protect their own balance sheets. But the needs of companies that consume oil and those that produce it often do not match up. Financial firms that trade in futures markets help bridge the gap between these companies, assuming risk that they are desperate to shed. Were speculators to stop trading, companies on Main Street, not Wall Street, would suffer the most.

A second common form of oil speculation is precautionary buying by companies that rely on access to oil and fear a future supply disruption. This type of speculation, which can cause gas prices to rise, acts as a form of insurance, both for the imperiled companies and for the economy more generally. It lowers the risk of an extreme spike in prices later on — or worse still, a dire shortage of gasoline — by tempering demand and calling forth more supplies. Facing uncertainty, companies are wise to rush to secure oil that they can use in the future. If businesses did not pad their inventories, a disruption could mean catastrophe for them and their customers. Moreover, the relatively gradual rise in prices that cautionary buying prompts is far easier on the economy than the alternative: prices flying through the roof in an oil market caught completely flatfooted by an unforeseen interruption to trade.

Speculative betting in futures markets can theoretically affect the flow of oil, but the market imposes its own form of discipline rather well. If traders think that Iran might shut down shipping in the Strait of Hormuz this summer, for example, they might accordingly place their bets on oil prices rising in August, thus pushing up the price of oil that month. In theory, the market’s expectations could lead oil companies to dial back production, store oil instead of releasing it onto the market, or order their tankers to dither en route to delivery while awaiting higher prices. Yet if an oil company were to decide, on speculative grounds, to hold back some oil in case of a future disruption and it turned out to be right, it could well turn out to be a good thing for consumers. The decision to wait would end up helping to relieve the shortage when it struck, which would lower prices in the time of need. On the other hand, if the company’s prediction were proved wrong and prices did not rise as anticipated, or even fell, the company would be forced to unload its oil for less than it otherwise would have, also lowering prices in the process. Because the company might well lose money from its incorrect prediction, the market discourages it from taking such a risk.

As for why oil prices are so high:

By the same token, extraordinarily high gasoline prices across the United States reflect a global oil market facing serious strain and historic uncertainty. Sanctions on Iran are biting into the country’s oil exports, while talk of military action has reached a fever pitch. Unrest from the Arab Spring continues to simmer. Unscheduled outages in production around the world, from South Sudan to Syria to the North Sea, are starving the market of crude oil. The buffer between how much oil the world is currently producing and how much it is capable of producing has worn painfully thin.

That seems to me to be another way of saying that the consequences of Peak Oil are upon us. Unmentioned is the role of the Federal Reserve system and its inflationary monetary policy, and the Bretton Woods arrangement, in which the U.S. dollar acts as the world’s reserve currency. We saw what happened to Iraq when it switched from the dollar to the euro for oil trades. We’re seeing a similar situation play out with Iran.

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About Jeremy R. Hammond

About Jeremy R. Hammond

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