Free Markets, Free People

speculation


Why Obama’s war on oil speculators is economic poppycock (onions or corn?)

Economist Dr. Mark Perry has a series of posts at his blog Carpe Diem which makes the case that “speculators” play and key and positive role in commodities markets.

One of the more intriguing posts deals with onions and oil.  Oh, and corn.   Perry quotes a 2008 Fortune magazine article:

"Before the government starts scrutinizing the role that speculators may have played in driving up fuel and food prices, investigators may want to take a look at price swings in a commodity not in today’s news: onions.

The bulbous root is the only commodity for which futures trading is banned. Back in 1958, onion growers convinced themselves that futures traders were responsible for falling onion prices, so they lobbied an up-and-coming Michigan Congressman named Gerald Ford to push through a law banning all futures trading in onions. The law still stands.

And yet even with no traders to blame, the volatility in onion prices makes the swings in oil and corn look tame, reinforcing academics’ belief that futures trading diminishes extreme price swings."

The proof is in the charts.  The first chart compares the volatility in the onion market, in which futures trading was banned, with that of the oil market.

onions

 

Compare the mean and standard deviation differences in the two markets.  Remember blue – no futures trading.  Red – futures trading.

So, you say, comparing onions and oil is like, well, comparing onions and oil!   OK, how about onions an corn.  Again the same difference applies.  No futures trading for onions but there is with corn.

Result?  The same:

corn

The point, of course, is those futures contracts help moderate a market.  Or as Perry says:

The fact that the volatility of onion prices is so much greater than the volatility of corn prices lends further statistical support to the notion that markets with futures trading like corn have lower price volatility than markets without futures contracts like onions.

Bingo.  So, the President’s war on “oil speculators” is an obvious distraction.  But here’s the other side of that – if successful, you may end up seeing oil act like onions.  Is that something most of us would prefer?  Given these facts, it seems the height of folly to attempt to regulate or ban futures trading in oil, doesn’t it?

A few more charts to finish the point.  First, futures trading in natural gas:

natgas

If oil speculation (or, as implied, greed) is the cause of rising oil prices, why aren’t natural gas prices rising as well in futures trades (not as “greedy”)? 

In fact, it is because of “speculators” that we’ve seen the price of natural gas go down.  So futures markets do what?  They react to market signals on supply and demand.  What this tells us is we most likely have an over abundance of natural gas.

So what does the market do? It adjusts the price to the reality of the supply v demand – in this case, the price goes down.  And it also does things like this:

rigs

When natural gas price were up and oil prices down, more drilling rigs were allocated by those markets to natural gas.  As oil prices have risen dramatically recently, while natural gas prices have fallen, there’s been just as dramatic a shift in the allocation of drilling rigs from natural gas to oil.

The success in the natural gas sector has driven supply up while demand has yet to increase proportionately.  Meanwhile, we’d had an abundant supply of oil, which has now become very tight (geopolitics, folks – governments at work and war) driving up the price of crude.  The market is reacting.

And as it reacts, guess what?

cme2

Crude futures are down as they obviously see future supply growing as the market adjusts and reacts.  All driven by “speculators” who are, right now, in the middle of moderating the market.

So, as President Obama continues with his “blame the speculators” nonsense, you have a choice. 

Onions or corn?

Markets or bureaucrats?

PS – if you’d like to read some academic pieces on why “speculators” are a key to a market economy, read this.

~McQ

Twitter: @McQandO


Scapegoating oil speculators–Obama counts on public’s economic ignorance to shift blame for high gas prices

Icould pretty much stop there and say the title tells you the story.  Obama knows high gas prices are not good for his re-election campaign.  He also knows his energy policies have actively worked against ameliorating or lowering the price of gas.

Therefore, it is necessary to find a scape-goat.  Someone or something he can shift the blame too and demonize.  In other words, the usual disingenuous attempt at distraction.

David Harsanyi explains what “speculators”, otherwise known as commodity traders, do:

Let’s start by being thankful for oil speculation — no matter what the motivation of those involved might be. To begin with, speculation allows companies with exposure to fluctuating commodity prices to hedge against rising costs by locking in. Sometimes the bet pays off; other times it doesn’t. But risk and profit are not yet crimes.

Oil speculation also offers consumers and investors information about the future that can help them make informed long-term decisions. Speculators trade commodities based on the information available in the marketplace. They reflect reality; they don’t create it.

But sometimes, unfortunate as it is, prices will rise. "Gouging," the close scaremongering cousin of "speculation," helps persuade consumers not to use what they don’t need. It incentivizes to modify behavior — our driving habits or the size of our cars. We conserve more when prices are higher, so we avoid shortages, and producers intensify their production. (Funny how Democrats get this concept when writing energy policy designed to artificially spike fossil fuel prices.)

In reality, this sort of trading helps moderate the market.  And, being a zero sum game – i.e. if you make money someone else loses it – it is done carefully.  As Harsanyi explains, they “reflect reality; they don’t create it”.  In essence you’re seeing a relatively free market work as it should.

Of course, what Barack Obama wants to do is have government intrude on that market because politically he doesn’t like the reality it is reflecting because it is politically damaging to him.  So:

Speaking from the Rose Garden, the president announced a proposal to spend $52 million to fund increased government oversight of oil futures market trading in addition to harsher civil and criminal penalties for manipulation in energy markets. “We can’t afford a situation where some speculators can reap millions, while millions of American families get the short end of the stick,” Obama said. “That’s not the way the market should work.”

Or, said another way, if you make a profit based on your foresight, you’d be considered a criminal.  If you lose money, I suppose, that’s ok in Obama’s world.

Of course, it’s all nonsense (I mean how would Mr. Obama regulate oil trading in foreign exchanges?).  It is a calculated attempt to use ignorance of how these markets work to cause voters to shift their rage from him to his designated target.  Successful scapegoating means one less issue the opposition has to use against him (not that he doesn’t provide a target rich environment anyway).  He’s counting on this sort of populism to work.

David Kruetzer asks some questions I’d like to see the press ask:

If speculators are making unconscionable profits on energy, why are they only doing it occasionally and not all the time? Why are there only speculators in oil, not natural gas (whose current price is about half of what it averaged over the last decade)? And given how the petroleum market works — for every speculator who makes money on a trade, somebody else will lose money — the president’s theory “requires an endless string of chumps to take the other side of the speculators’ deals.”

And Kreutzer points out the basics of any commodities market, again something of which Obama banks on your ignorance:

For speculation to drive up prices, the speculators must either cause oil production to slow down (which they haven’t) or to pull oil off the market. If the flow of petroleum and its products remains unchanged, the price at the pump will not change. If petroleum is pulled off the market, which can happen even though there are limits to what can be stored, it will eventually come back on the market.

The question becomes, ‘When the oil comes back on the market, is the price higher or lower than when it was pulled off the market?’ The price will only be higher if the amount supplied at that time is lower or the demand is higher. In either of those cases, speculators have helped moderate price fluctuations and will be rewarded with profits. If the price is lower, then the speculators did a bad thing and will be punished by losing money.

So those are the basics of the issue as it concerns such trades and markets.

As can plainly be seen, Obama hasn’t a leg to stand on.  But that doesn’t stop him from claiming that government is the answer to this made up problem. 

Why?  Well other that it is his political nature, he can’t sell the nonsense without some sort of “action”.   It becomes much more believable to those who don’t know better if he’s going to spend millions to regulate the contrived problem out of existence.

Of course he knows his actions will not have any positive effect on gas prices, and, in fact, may actually have a detrimental effect, which is why he couches this attempt at scapegoating the problem via government with “none of these steps by themselves will bring gas prices down overnight”.

But he can claim to be taking action while continuing to blame speculators for the problem and counting on general economic ignorance to carry the day for him. 

Pretty typical of the man, I’ve come to learn.

~McQ

Twitter: @McQandO