Speculators: Ogres of Oil?
By Hoppie Dawson
Most politicians, Republicans and Democrats alike, consider market speculation to be an unfair, selfish practice. According to them, a small group of people can easily control the market and raise prices for huge profits, while the rest of us are stuck paying the consequences. Nowhere is there more controversy on this topic than in the energy market, especially concerning oil. Some are so eager to blame the rise of oil prices on speculators that they have moved for new laws to be passed to regulate and limit market speculation, or make it virtually impossible altogether (Some ideas for new laws would require the investors to actually take delivery of the barrels of oil they contract for). It’s hard to imagine such an effective castration of the U.S. economy, but of course politicians will hop on whatever bandwagon they need to, regardless of the damage done.
Republican Presidential candidate John McCain states, “While a few reckless speculators are counting their paper profits, most Americans are coming up on the short end - using more and more of their hard-earned paychecks to buy gas.” Instead of attributing the rise of oil prices to reasonable causes, such as inflation, the dropping value of the US dollar, or increased demand from industrializing countries like China, McCain blames the rising prices of oil on evil speculators that can magically control the energy market, as if the laws of economics don’t apply to them at all. Of course, to punish these speculating demons, McCain plans to enact more government regulation in the market, allowing the government to decide how much money speculators should be making.
Barack Obama’s ideas are equally ludicrous. He says, "For the past years, our energy policy in this country has been simply to let the special interests have their way -- opening up loopholes for the oil companies and speculators so that they could reap record profits while the rest of us pay $4 a gallon.” He, too, will press for more laws regulating speculation in the energy markets, and he’ll also pressure other countries to do the same.
If the claims of America’s leading politicians aren’t absurd enough, Ali al-Naimi, the Oil Minister of Saudi Arabia, can easily beat them. He recently reached a new level of ridiculousness with this claim: “I am convinced that supply and demand balances and crude oil production levels are not the primary drivers of the current market situation." What!? Supply and demand aren’t the drivers of the market anymore? Well then, what are the “primary drivers?” King Abdullah claims they are “speculators who play the market out of selfish interests." Are the claims of these politicians truly valid, or are they simply a clever way of scapegoating innocent investors and appealing to a general public that is furious with rising oil prices?
Shockingly enough, these politicians never cite any research, data, or any kind of evidence to prove that speculation is driving up oil prices. Why? Because they have none. Samuel Bodman, the U.S. Energy Secretary admitted that officials have yet to find any evidence that speculators are raising prices. However, some critics of market speculation pretend to have evidence. For example, Michael Masters made a speech to the U.S. senate last May, stating, “Assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008.” If his figures are accurate, that is a rise in the total value of commodity index funds of $247 billion.
That seems like a very large increase, but later on in the speech, Masters provides the counterargument to his own point, estimating the worldwide equity markets at $44 trillion dollars. That means that the rise in the value of index investments over those five years is about 0.6% of the total market (not very much). He goes on to say that “the prices of the 25 commodities that compose these indices have risen by an average of 183% in those five years!” Absurdly enough, he’s attributing the majority of a 183% rise in prices of commodities to the rise in index funds, a mere 0.6% of the market. Something about those numbers just doesn’t seem to match up, does it? The commodities market is so large that even if speculators could affect it, they simply don’t have the monetary power to make a noticeable change.
Masters, and others who think that speculation causes prices to rise, fail to distinguish between causality and correlation. Just because prices rise when speculation rises doesn’t mean that speculation causes the price increase. In fact, it makes far more sense the other way around. Obviously, the rising prices of commodities provide a good investment and consequently attract more speculators. Even more than that, the rising prices raise the value of already present investments, which simultaneously raise the value of total commodities investments. In other words, speculators are doing their job and making good investments, raising the value of their portfolios. It seems that none of these investor-haters ever mention the actual increase that is due to the value of the investments and not the number of investors.
However, an article entitled “Double, double, oil and trouble” from The Economist last May exposes the truth behind the numbers: “Although index funds have grown quickly, that growth stems in large part from the rise in value of the futures they hold, rather than from fresh investment flows. [Paul Horsnell of Barclays Capital, an investment bank,] estimates that index funds swelled by $13 billion in the first quarter of this year… of which all but $2 billion derives from the rise in commodity prices.” So, the increase in index investment value is mostly due to the increase in commodity value, not new investments.
Speculators do not raise oil prices. Other factors do: OPEC governments that try to artificially influence the oil market; a U.S. government that won’t allow oil production off its coastline; a China that has demanded more oil to prepare for the Olympics (Oil firms have been ordered to stock 50% more fuel and some power plants are switching to diesel, as noted in “Double, double, oil and trouble”); and numerous governments that force ridiculous regulations on what should be a free market. Speculators are not evil wizards and witches who control the market with spells and potions. They are capitalists who earn their money from investing in a market that operates upon the laws of supply and demand.
