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  • More, Not Less, Speculation Please

    This week Speaker Nancy Pelosi (D-CA) will try to close out her “summer energy agenda” with a bill claiming to end “excessive” speculation in oil markets. Instead of allowing the House to vote on any bill that would actually increase our supply of oil (like bills that would end bans on exploration in the Arctic National Wildlife Refuge or the Outer Continental Shelf), Pelosi claims she can lower gas prices tightening government control of oil futures markets. But as Heritage analyst senior policy analyst Dr. David Kreutzer shows, there is zero evidence that recent high oil prices are caused by speculation:

    One characteristic of a speculative bubble is the simultaneous increase in price and increase in inventories. This supports the theory that a speculative bubble is increasing today’s price, but without rising inventories, there can be no link between higher futures prices and an impact on the current supply and current price. This is true for corn, wheat, and anything traded on futures markets, and it is true for petroleum as well.

    If, after a period of simultaneously rising prices and inventories, the inventories are reduced and the price holds steady or rises, then there was no speculative bubble after all. This pattern would instead be confirmation that futures markets anticipated higher prices but didn’t cause higher prices. That is, in aggregate, traders on the futures markets correctly anticipated deteriorating supply and demand conditions, saved petroleum for the worse times, and provided additional barrels when they were most needed.

    This is, in fact, exactly what we have seen. … American petroleum inventories were at a record high of 347.5 million barrels while price was at $70 per barrel (not including the Strategic Petroleum Reserve). By the summer of 2008, these inventories had dropped below 300 million barrels while prices made their most dramatic rise in history.

    Former member of the Board of Directors of the Chicago Mercantile Exchange Jeffrey Carter explains why speculation is needed for a smoothly functioning market:

    Many statistics have been thrown around about oil speculation. Airlines claim speculation is driving prices higher because speculators trade 66% of all the futures contracts. This is likely a correct statistic. Speculators do the bulk of trading volume because they buy and sell the market. Speculation is the grease, called liquidity, which makes the market engine function. High levels of liquidity mean the market is more competitive and gives participants a tighter bid/ask spread. This makes transaction costs cheaper, and it’s much easier for consumers (airlines) or producers (oil companies) to hedge business risks. For every buyer (long), there is a seller (short). It is a zero-sum game. Speculators can lose money. Amaranth Trading lost billions in 2006 because they were wrong. The volatility of the market makes it a very risky way to make a living.

    Posted in Energy [slideshow_deploy]

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