[quote]Bill Roberts wrote:
“Speculative activity” is not the problem, though there are a lot of politicians saying so right now and a lot of media people saying it.
The question is, What will oil be worth in the future at particular times?
This is fundamentally an arena of guessing and a matter of opinion, but it’s not only completely legitimate but it is helpful to the market that trading occurs in these futures.
For example, suppose you run an airline. How does it make sense for your company to be absolutely wide open to the possibility – it can’t be ruled out anyway – that say in December 2009 jet fuel prices might be triple what they are now?
That could destroy your company. While your firm can absorb some of the risk of increased price itself, it may be foolish to absorb all the risk – that is to say, to have to buy all the fuel you need at then-market prices rather than having at least some of it at an already-agreed price.
Buying some amount of futures for Dec 2009 at say 110% of the current price may be a smart move. True, prices may drop and then you wasted money, but at least your company isn’t wrecked, whereas if prices go through the roof you’ll sure be glad that you paid only 110% the current price.
Now, the value of the futures depends and should depend on the collective opinion of all the generally-pretty-smart-and-informed people that are trading in this market.
It is true that if it’s believed that prices will be high in the future, this also tends to drive current prices higher, because why pump every barrel you can now if some of those barrels could be pumped next year instead for a much greater (if it’s believed to be much greater) price?
An idea that there should be no futures market in oil is unrealistic. And the claim made by others that the amount of trading is the problem, that more trading causes higher prices, is also wrong.
Futures go higher because it actually looks to most people like the supply/demand situation will result in higher market price in the future. They go lower when most people start thinking that the futures market overestimated.
Very simply, the increasing demand from China and India, which previously had never been such a big factor, combined with Democrat control and Democrat absolute obstinance against drilling caused the market to believe oil prices would be way, way higher in the near and longer-term future.
They probably overestimated and probably, as it always does with time, the market is correcting.
Futures trading results in smoothing of price (less extreme momentary variation) and this is good for everyone. When the traders make large profits, the profits are not out of the pockets of consumers: they’re out of the pockets of traders that bet badly.
But I guess blaming traders makes a good scapegoat for politicians?[/quote]
Overall good post. Don’t mistake me, I am not blaming traders or capital participants for anything. I am simply stating a fact that there is speculative activity in the market place. We simply cannot ignore anymore the existence of speculation in leveraged markets and influence that it does have.
The experience in the 90’s with the bond vigilantes taught us that much. I absolutely agree with you that politicians, on both sides, look for easy scapegoats in order to tell the story that they want heard.
However, in most cases, the influence that speculation brings to our fiscal policy can often be a benefit (ie bond vigilantes leading to a balanced budget, speculation in energy marketplace leading an renewed drive for energy independence and innovation, currency speculation forcing governments to actually deal with the problems that exist on their balance sheets, etc…)
Your analysis is spot on with regards to the airline scenario, as you probably know that is one way that Southwest Airlines has been able to keep themselves more financially viable when so many of their competitors have struggled.
Remember also that when we talk about futures contracts there are more reasons than just supply/demand why contracts fluctuate and vary over time. When we are specifically talking about oil, the cost of carry and future expectations on that cost certainly also lead to varying amounts of price discovery.