Alan Reynolds - Scapegoating the Speculators

Alan Reynolds has written another interesting article on energy and pricing entitled "Scapegoating the Speculators." After the Democrats tried to claim that the price of oil had gone up greatly because the U.S. oil companies were responsible for manipulating the price and most of the public did not buy into their arguments, they and others, including John McCain, began focusing more and more on an explanation that the price of oil was higher due to speculators. Alan Reynolds offers some very interesting perspective on this claim.

But first before considering his argument further, why is this an important matter? If, as the Democrats are saying, speculators are driving up the cost of oil or even if they are not but are perceived to be doing so, then the Democrats can address the problem of high gas prices by passing a law to control the speculators. This gives them more power over the financial markets and will result in more campaign contributions from financial people who will want to get on their good side. What the Democrats and their occasional Republican ally (John McCain in part) will not then have to do is to allow U.S. oil companies to drill for more oil and gas. As environmentalist extremists and Global Warming Alarmists, these people do not want to allow more oil and gas to become available. They actually do want the price of oil and gas to go up even more, but they do not want to be seen as the responsible party for that price increase. This is all about perception in the eyes of the public. The Democrats do want to manipulate the supply of oil and gas to make the price go way up, but they do not always, especially with an election coming up, want to be perceived as having done so.

So, what does Reynolds say? Commodities speculators are just as happy to bet that oil prices will go down as to bet that they will go up. They are trying to anticipate the expected relationship of oil supply to oil demand. If next month's oil futures contract is for oil at a higher price, then producers may slow their sales on the spot market and try to wait a bit for the higher price. [This is usually a good thing, since it helps to level out prices by keeping supply and demand on a more even keel.] Refinery's are likely to buy more oil now rather than in the future if the future price is expected to be higher, thereby boosting the present price. But, if this combination of reactions to the higher future price occurs, then oil inventories will increase. At this time, U.S. oil inventories are modest, so this speculative boost to oil prices does not appear to be the case!

He notes that speculation that the price of oil would go up decreased after the price exceeded $100 per barrel. On 11 March, there were 113,307 long contracts (those expecting a future price increase) on the New York Mercantile Exchange. By 10 June, there were only 25,246 long contracts, meaning that there are nearly as many contracts going short (expecting a price decrease) as going long. Off the commodity exchange, one can bet on the future price of oil by investing in the US Oil Fund. Those betting short on this fund outnumber those betting long by a two to one ratio. These speculators are betting on the price of oil going down!

Reynolds says there is no mystery behind the rise in oil prices. There is booming demand for oil and products made from it in India, China, and the Middle East. The supply of oil from the U.S., Mexico, Venezuela, Nigeria, and Russia has fallen.

Back to my comments: U.S. oil production is falling because Congress and President Clinton have not allowed more exploration and drilling for oil in the U.S. Production continues to fall in Mexico because their nationalized oil company is run incompetently. Oil production in Venezuela is down because of the tyrannical reign and complete irrationality of Hugo Chavez. Nigeria's production is down due to internal unrest and sabotage. Russia's production is probably down because the oil companies there were taken over by ex-KGB thugs tied in with Putin.

Prices are always determined by supply and demand unless government sets the price. If government does set the price too low, then people stop producing and supplying that good or service. If we want to use oil at a reasonable price, then we have to allow the production of a goodly supply of oil. So, instead of wasting our time and money while we pay far too much for our gasoline, Congress needs to allow the exploration and production of oil on the federal lands in the contiguous 48 states, in Alaska, and in our coastal waters. This will increase supply and that will bring down the price of oil and its products, such as gasoline. Of course, with oil and gasoline as expensive as they are now, people will make greater efforts to conserve them as well. The magnitude of the world's demand increase is likely to run well ahead of conservation efforts alone, so both oil production increases and more efficient usage are the proper response.