Robert J. Samuelson / Politics

Don't Blame the Speculators

"We still need to work extra hard to protect consumers from factors that should not affect the price of a barrel of oil. ... We can't afford a situation where speculators artificially manipulate markets."

-- President Obama, April 17

WASHINGTON -- We should exorcise the politically convenient notion that high oil prices result from the market maneuvers of greedy "speculators." It's convenient because it suggests that a solution to high pump prices -- or a partial solution -- is to banish the offending speculators from the marketplace. Thats fantasy.

Despite periodic debunking, it returns whenever oil prices surge. In mid-2008, with crude prices approaching $150 a barrel, the Commodities Futures Trading Commission (CFTC) created a task force to study whether speculation caused the run-up. The task force included experts from the Agriculture, Energy and Treasury departments, the Federal Reserve, the Federal Trade Commission and the Securities and Exchange Commission.

Here's the main conclusion:

"Current oil prices and the increase in oil prices between January 2003 and June 2008 are largely due to fundamental supply and demand factors. ... The Task Force's preliminary analysis to date does not support the proposition that speculative activity has systematically driven changes in oil prices."

Four years later, the consensus remains. Testifying before Congress in March, Howard Gruenspecht, head of the nonpartisan U.S. Energy Information Administration, said:

"The increases in crude oil prices since the beginning of 2011 appear to be related to a tightening world supply-demand balance and concerns over geopolitical issues that have impacted, or have the potential to impact, supply flows from the Middle East and North Africa." (The reference to potential disruptions involves Iran.)

Speculation remains a popular theory because it seems to explain oil's wild price swings. In 2002, crude prices averaged about $25 a barrel. By 2008, the average was roughly $95. In 2009, it plunged to about $60; now it's above $100. These gyrations baffle most people. Conspiracy theories are appealing.

The actual explanation is more humdrum. Oil demand is what economists call "price inelastic." People need it to drive cars, heat homes, fly airplanes and run factories. So small shifts in supply or demand can result in big price moves. A large jump in demand or loss in supply raises prices sharply; similarly, prices may plunge when demand dips (from, say, a recession) or supply increases (from, say, new fields).

The 2008 CFTC report found that, from the late 1990s, growth in world oil demand especially from China and other developing countries -- outstripped new production capacity, so the market tightened and prices rose. From 1996 to 2002, spare production capacity averaged 3.9 million barrels a day (mbd), about 5 percent of world oil demand of 77.1 mbd in 2000. By 2008, spare capacity had dwindled to 1.7 mbd on global demand of 86.5 mbd. In this period, China's oil use rose two-thirds, from 4.6 mbd to 7.7 mbd.

Although the Great Recession temporarily led to lower prices, the modest recovery has raised global demand to nearly 90 mbd, shrinking spare capacity. It's now between 1.8 mbd and 2.5 mbd, Daniel Yergin of the consulting firm IHS CERA recently testified to Congress.

It's true that outside investors (aka, "speculators") have dramatically shifted money into commodities -- raw materials. "Commodity index funds," which invest in a basket of commodities (oil, wheat, corn), have attracted hundreds of billions of dollars. It's easy to imagine all this money chasing prices up in futures markets, just as speculative stock market frenzies push share prices to unrealistic levels. It's also wrong.

The stock and futures markets operate differently. In the stock market, herd psychology can lead to speculative bubbles or panics. In a bubble, almost everyone seems to win (until the bubble bursts); in a panic, everyone seems to lose (until the panic subsides).

By contrast, futures markets are "zero-sum games." One investor's gain is matched by another's equal loss. Here's why. Under the standard futures contract, one investor agrees to buy the commodity (say, 1,000 barrels of oil) at a future date for a given price and another investor agrees to sell for the same price. If the actual price on the settlement date has gone up, the buyer reaps the gain; if it's gone down, the seller wins. The loser pays the winner; actual commodities are rarely transferred.

In theory, prices on futures markets could raise prices on spot markets, where real oil is bought and sold. Some studies find a link, but most do not, reports a survey by economists Lutz Kilian, Bassam Fattouh and Lavan Mahadeva. Instead, futures and spot prices reflect "common economic fundamentals."

Casting speculators as scapegoats for our dependence on high-priced global oil is easy and misleading. It obscures the only real solution: Use less, possibly through an energy tax, and produce more.

Copyright 2012 Washington Post Writers Group



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