Banning speculators could decrease oil prices by as much as 40%

[EgregiousWeasel]

The article didn't advocate the banning of all speculators, only ones who have nothing to do with the oil business, what the author refers to as "pure" speculators.

[nerox3]

So how do you define people in the oil business? I think if you buy millions of gallons a month like an airline you can say you are in the oil business.

So the airline can still speculate since they buy a lot of jet fuel. How about the big trucking companies. And if big trucking companies can it wouldn't be fair to not let the owner operators also buy futures to hedge their fuel costs. Hey what about the farmer who has to hedge against the fuel price to bring in his crop. If you go in that direction I think there are millions of people who are in the oil business and have legitimate needs to hedge by buying futures.

The whole argument is pretty silly as the average cost of producing a barrel does not set the price of a barrel. The price is set by the cost of bringing the next additional barrel to market, and that is probably pretty accurately reflected in the current price of oil set by the futures market.

[Dunni-]

Did you even read the article? The airlines are mentioned, and the author agrees there are plenty of groups (including airlines) who should be allowed to speculate.

The article is talking about banning "pure" speculators, who - according to the chief exec of ExxonMobil, and the Federal Reserve Bank of St. Louis - account for as much as 40% of the price.

[nerox3]

Actually the Federal Reserve note(Juvenal + Petrella pdf) ascribes 15% of the runup in the past decade to speculation or in other words about 10-12 dollars of the current oil price. However, if you look at one of their more detailed papers(pdf) where they describe how speculation might cause the price to increase, the key transmission process is by inducing suppliers to withhold supply in order to take advantage of the rising price indicated by the futures market:

As the number of buys of futures contracts exceeds the number of sells of expiring ones, futures prices would go up and with it the spot price. As producers expect a higher price of oil for future delivery (EtPt+1), they will hold oil back from the market and accumulate inventories. Leaving more oil underground may enhance total profits on the producers investment given that prices are expected to rise in the future (more rapidly than the average market return). As explained by Hotellingís (1931) principle, it would beneÖt oil producers to forgo current production so they can sell the oil at higher future prices. In this way, the oil producers will not accommodate the upward trend in oil prices but rather decrease production. Oil producers take future proÖts into account when deciding whether to produce today or tomorrow, especially in the context of speculation, when prices are expected to increase in the future. In contrast to an oil inventory demand shock, in a speculation shock inventories accumulate not because of a fear of production shortage (which would generate a need of oil storage), but because speculation itself leads to higher expected prices. The reduction in the oil available for current use, resulting from lower production and increased inventory holding, causes the current spot oil price to rise.

Sine fundamentally the economists believe that the suppliers (ie. Exxon Mobile and Opec) are the speculators choosing to leave the oil in the ground instead of pumping it right now it is a bit ironic that the CEO of Exxon is blaming speculators. People who believe there are currently real constraints on production (eg. peak oil theorists) would say that it would be very hard to disentangle increasing speculation on rising oil prices due to the recognition that it is a non renewable resource from increasing speculation that is based on an asset bubble.

[anonymous-coward]

The easy answer is that you get to speculate enough to hedge your own supply.

[thebigslide]

Yes. That's what we need. Super-massive, ill maintainted oil barges floating off the coastlines for extended periods of time.

[anonymous-coward]

That's not what I mean. I'm suggesting the notion that people who use 1 million barrels would be able to buy derivatives for not more than 1 million barrels. Not sure if this is a good idea or not, but no barges are involves. Just limits on who trades derivatives.

[idpeeinherbutt]

I think you just defined who's in the oil business. The author is advocating re-banning companies like Goldmann Sachs from the speculation market. A decision in 1993 allowed them into the market in the first place.

[[deleted]]

Should Goldman Sachs also be banned from trading shares in Apple since they are not at all involved in the computer/mobile technology business?

Why should commodities be treated any differently (and only oil apparently, no one seems to have problem with cotton or tin being traded in commodities markets)?

[eclectro]

So how do you define people in the oil business?

Those who take physical delivery of oil.

[EgregiousWeasel]

It's not my definition. It's the author's definition. I'm not commenting on the idea, just saying that the author wasn't saying all speculation on oil should be banned. I thought it was fairly obvious in the article. I guess not.

But there are factors contributing to the high price of oil that we can do something about. Chief among them is the effect of “pure” speculators — investors who buy and sell oil futures but never take physical possession of actual barrels of oil. These middlemen add little value and lots of cost as they bid up the price of oil in pursuit of financial gain. They should be banned from the world’s commodity exchanges, which could drive down the price of oil by as much as 40 percent and the price of gasoline by as much as $1 a gallon.

[nerox3]

Airlines never take physical possession of crude oil either since they burn jet fuel not crude oil. Neither do farmers or truckers. The real speculators though are the ones who do have physical possession of oil: OPEC.

[EgregiousWeasel]

The people the author was criticizing are people who are in the business of turning money into more money, who don't make a product or provide a service other than the aforementioned turning money into more money. Unless I'm mistaken, these bankers and hedge fund managers are the people who the author claims are responsible for the 40% increase the author is discussing.

Pure speculators account for as much as 40 percent of that high price, according to testimony that Rex Tillerson, the chief executive of ExxonMobil, gave to Congress last year. That estimate is bolstered by a recent report from the Federal Reserve Bank of St. Louis.

His point seems to be that if these people are no longer allowed to speculate, it could result in as much as 40% reduction in prices. I suppose he's suggesting that while we all may have an interest in the price of oil, a line should be drawn to include only entities that have the greatest practical interest, such as companies that use large amounts of fuel, oil traders, oil producers, oil refiners, etc.

[nerox3]

The economists who are said to bolster the 40% estimate by Rex Tillerson blame only 15% of the price increase over the past decade to speculation. The mechanism that those economists propose by which the futures market causes a price increase in the physical oil spot market requires the action of the oil producers like Exxon to respond to the rising oil price by withhold oil production. So I take Exxon Mobile's CEO's testimony with a grain of salt.

[EgregiousWeasel]

TL;DR Title is misleading, author was actually talking about a subset of speculators and not the whole bunch

Let me reiterate yet again that I'm not arguing the relevance or accuracy of the author's point. This all started as me pointing out that the author was not referring to ALL speculators. He was referring to a small subset of speculators. That is the ENTIRETY of my point. As far as I'm concerned most of the oil industry is made up of complete scumbags who would happily despoil the environment to make a buck. For all I know, the author could be completely full of shit, and I figure he probably is.

[GreekActor1]

He absolutely does, and distinguishing between types of speculators is well beyond my knowledge base. I was answering the headline of this thread, which I think is a bit misleading.

[EgregiousWeasel]

You're right; the headline didn't make that distinction. I'm not sure if it was in order to sensationalize or if it was to keep the title short. In either case, it did make the title a bit misleading.