How many times do you hear someone blame the oil speculators for high oil prices? Our family and friends have told us, in no uncertain terms, that the hedge fund speculators are to blame. This opinion has become the 'general consensus' and 'accepted wisdom'. Our opinion is that the general consensus is generally wrong and 'accepted wisdom' is frequently an oxymoron.
Are speculators to blame?
One of the greatest investment managers of all time, John Templeton, told us to begin with common sense. Common sense suggests that speculators must be right about the longer term fundamental direction of supply and demand. Speculators lose their money if they are wrong. This is an important concept that the mass media & the general consensus seem to ignore. Most recently, oil & gas prices have been falling. Do Hedge Fund speculators get credit for making prices fall? Or, did the speculators somehow get out at the top of the market? Who did they leave 'holding the bag'? Have the mass media & the general consensus thought this through?
In free enterprise capitalism, the fear of loss is an incorruptible regulator. Speculators need to be right about the direction that supply & demand is moving, otherwise they lose.
Another important aspect to this concept is to understand that there are participants in the economy who do not lose their money when they are wrong. It isn’t the Speculators. It is the managers of our ‘fiat money system’: the Federal Reserve & its partners. ‘Fiat’ means that the controlling authority can issue more money when they want. The Speculators do not have this power. Speculators must be right about the direction of fundamental supply & demand. To blame them makes no sense. They are not managing the economy.
One more appeal to common sense before focusing on specifics. Markets have no end of "players" that can buy or sell. Industry, as well as Speculators, can push the price back down. Selective hedgers experience fear and greed too, and may get caught up in the moment. There were airlines who bought at the top in a panic, afraid oil might go even higher. There were producers who were making oodles of money and should have hedged future production, but they held off hedging hoping to make even more. The producers and consumers of petroleum knew the same fundamentals as speculators and were equally "complicit" in creating the high prices of the 2008 blowoff.
Now, let’s delve into the facts and the evidence, looking to see if speculators drive oil prices higher or not. We will review the rise in oil prices during the last decade, with particular emphasis on the rapid run-up period from 2007 to mid 2008. Oil prices reached a record $145/barrel. We will call this the 'run-up time period'. There has been a lot of research and study on this 'run-up time period'. Most studies indicate that oil speculators did not drive oil prices higher than what their fundamentals would otherwise justify. Of course, if oil speculators were to buy lots of oil and physically store it in tankers in the fjords of Norway, this would definitely cause higher oil prices and the rise in prices could then be blamed on the oil speculators. Oil speculators have yet to take this approach during the last decade.
Much of the material we have reviewed is referenced at the end of this article. You are encouraged to read these studies in more detail.
Here is the conclusion from one study by the University of Michigan and the Oxford Institute:
“A popular view is that the surge in the price of oil during 2003-08 cannot be explained by economic fundamentals, but was caused by the increased financialization of oil futures markets, which in turn allowed speculation to become a major determinant of the spot price of oil. This interpretation has been driving policy efforts to regulate oil futures markets. This survey reviews the evidence supporting this view. We identify six strands in the literature corresponding to different empirical methodologies and discuss to what extent each approach sheds light on the role of speculation. We find that the existing evidence is not supportive of an important role of speculation in driving the spot price of oil after 2003. Instead, there is strong evidence that the co-movement between spot and futures prices reflects common economic fundamentals rather than the financialization of oil futures markets.”
Another study was done by the Federal Reserve Bank of Dallas. A key finding from this study was that energy consumption increases as a country’s economic GDP rises, but energy consumption in developing countries like China increases almost 2x as fast as in developed countries like the U.S. During the last decade, demand for oil, especially by developing countries, has been rising rapidly. In fact, the rise in demand is rising faster than supply – see the chart below from the industry’s respected BP Statistical Review. The left hand side is production (supply) by region, the right hand is consumption (demand) by region. Note that in the last decade, demand increased faster than supply. Oil was indeed in tight supply. This would cause a rise in prices. Was the rise in prices all due to real world demand and supply, or was it possible the rise was mostly due to oil speculators artificially driving prices higher? The evidence presented below refutes those who would blame speculators.
Evidence #1 – No fall in consumption in reponse to the higher prices during the run-up time period. There was almost no consumption decline during the period. This implies that oil prices were driven by global growth & demand. In addition, analysis performed by the Federal Reserve Bank of Dallas indicated that oil prices during the period were fully consistent with the sensitivity of consumer demand relative to prices (called elasticity).
Evidence #2 – OPEC had insufficient excess capacity to meet tight oil market shocks. Shocks to a tight oil market can increase oil price volatility because OPEC lacks the ability to offset these shocks, even if it wants to. As oil prices rose into the 'run-up time period', OPEC excess capacity was very low, down to only 1 million barrels per day. With such a tight world oil market and insufficient excess capacity by OPEC to generate sufficient supply, oil prices rose and volatility resulted. See the chart below.
Evidence #3 – No increase in inventories. The cash spot market is where transactions are settled with actual physical oil changing hands, not futures contracts. Inventories would naturally rise as oil speculators would be holding oil. However during the 'run-up time period', oil inventories did not go up; they went down! Furthermore, oil speculators did not use floating storage, as in renting oil tankers and keeping the oil out on the high seas and off the market. See the chart below that indicates how floating storage was relatively stable during the 'run-up time period', and actually declined in June 2008 and continued to fall throughout the summer as prices skyrocketed. The floating storage did increase in late 2008, 2009 but that was concurrent with the global recession.
Evidence #4 – Comparable increase in prices for other energy commodities, many of them not even trading on futures markets. There are many energy commodities, such as different types of coal, other non-oil commodities, and other oil commodities that are not traded on futures commodity exchanges. The prices of these commodities had similar price increases during the run-up time period. If oil speculators were driving up the oil market in the futures commodity exchanges, these other markets would not have experienced comparable rises in prices.
Now, let’s look at some findings in the oil futures markets.
Evidence #5 – Zero Sum Game. Realize that the futures market is a zero sum game, meaning that for every winner there is a corresponding loser. The stock market is not zero sum; you can have the stock market going up and have everyone get 'richer' (nominally). The futures market is different. For every person, company or fund buying one or more contracts of oil, there must be another person, company or fund selling an equal number of contracts of oil. So the net is 0. One side buys, the other side sells. It is not like everyone is buying and no one is selling. There must be an equal number of sellers. One side makes an amount of profit equal to the loss of the other side.
Evidence #6 – Very small amount of physical commodity delivered; no evidence of hoarding. The person, company or fund who buys must eventually sell or hoard. It is estimated that only 2% of futures contracts in all futures markets (not just oil) are kept for physical delivery. This represents only a very small amount of actual physical commodity. If the vast majority of speculators are not taking delivery, how is it possible that they could be driving prices higher? Also, if speculators were taking delivery, there would have been clear evidence of speculators renting oil tankers and storing the oil, hoping for higher prices later. There was no such evidence.
Evidence #7 – Data is in line with what should happen when there is oil supply tightness and a reasonably well-functioning futures market. The chart below shows the spread of the spot price versus the 6-month futures price. During the oil supply tightness in the 'run-up time period', the spread was negative during most of that period. This makes sense because during periods of tight supply the spot price tends to be higher than the futures price. This is consistent with a well-functioning futures market.
The evidence speaks for itself. We challenge anyone to provide evidence to the contrary. Speculators have been blamed for something that the evidence refutes. The 'charges' do not stand up to scrutiny. Speculators should be acquitted of the 'charges'.
Has anyone considered blaming the money printing authorities for higher oil prices? Trillions of dollars have been created from nothing; all to 'liquify' the world economy. Much of this liquidity has driven commodity prices higher. Our concern is to foster an understanding of today's money. Today's money is a fiat note. That means it is issued at the discretion of a powerful authority. This is a key way that our money system differs from free enterprise capitalism. No matter how many times the words are said, it does not make it so. Our system is not 'free enterprise capitalism'. Central control of the issuing of money is an aberration of freedom & of capital. Blaming speculators for rising oil & gasoline prices (when trillions of new dollars are being created out of thin air) is severely misguided. It must make the real culprits happy. It deflects the spotlight from the ongoing capitulation of their manipulation.
References
- https://www.dailymarkets.com/economy/2012/04/23/strong-evidence-from-academic-research-speculation-has-not-driven-high-oil-gas-prices/
- https://www-personal.umich.edu/~lkilian/milan030612.pdf
- https://www.eurasiareview.com/23042012-speculation-in-oil-markets-what-have-we-learned-analysis/
- https://www.cnn.com/2012/04/19/opinion/kilian-oil-speculation/index.html?eref=rss_topstories&utm_source=cnn.com&utm_medium=twitter&utm_campaign=Feed%3A+rss%2Fcnn_topstories+%28RSS%3A+Top+Stories%29
- https://www.dallasfed.org/assets/documents/research/eclett/2011/el1110.pdf
- https://www.dallasfed.org/assets/documents/research/eclett/2011/el1111.pdf
- BP Statistical Review of World Energy Report 2011
