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July 2, 2008

“Speculator” not a dirty word

Something is bothering me. It’s the bad rap “speculators” are getting these days because of skyrocketing oil prices. I feel compelled to defend these speculators, some of whom are my former colleagues – good ‘ole floor-traders. The politicians and pundits blaming them for high gas prices don’t seem to understand how they contribute to smooth market functioning.

Speculators are the reason an Iowa farmer has the option to sell his or her product in Chicago well in advance of harvest. While the decision to sell might turn out to be a good or bad one, there’s no doubt speculators are the folks who provided that farmer with the option to manage his or her risk. A good speculator will research supply and demand conditions, predict future prices, and then take future “positions” in products like corn or oil with the intention of making a profit.

Liquidity and price discovery are the benefits of this type of speculation. Think about an online auction. As more and more people take part in the auction, the greater the likelihood the item for sale will be priced accurately. That’s the point where supply and demand comes together. Yet in the current environment some of the legislative proposals being tossed around in Washington would actually reduce the number of speculators in the market. Puzzling…

Oil prices are increasing simply because world demand is growing faster than supply. World oil demand jumped from 82.5 million barrels a day in 2004 to 86.8 million barrels a day in 2007. Yet world supply grew only from 83.4 to 85.5 million barrels a day during that time period. If demand is growing faster than supply, prices rise. The people bashing speculators must be assuming that oil price hikes are the result of someone hoarding oil somewhere. But where’s the evidence?

By: Wade Rousse

Posted by Wade at July 2, 2008 1:43 PM

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Hey Wade,
I was a student of yours at UIC, and when I got the email from you, I couldn't help but see what the ol' ragin' cajun was up to these days. Congratulations with the job, btw. Anyways, onto the actual topic. I completely agree with the statements you made here. The worst part of all this, is the lack of understanding people have in this area, and yet because unlike most international trends, they're seeing the effects negatively in their daily lives, they have many strong opinions on the matter. I don't know how many people have brought it to my attention that the price of oil is rising, making it harder for the average American to get to work, and yet the CEO's of oil companies are getting huge bonuses for their revenues. Of course, the point that they're trying to make is that the price of oil rising is a direct effect of CEOs deciding to make more money...it never occurs to them that "America" is only a piece of the oil companies' markets, and that in fact the increase of revenues and oil prices are simply correlative, and are not actually based so much on a causal relationship.

Now, in the case of the speculators, I guess my question is: Is it so important that the speculators are actually responsible, or just that they are someone to blame? Scapegoats are a natural outcome of negative effects that have the potential to create even more personal negative effects to the person who creates the scapegoat. In this case, it is the politician. I mean, let's face it, oil prices are the most personal concern that is being considered in any sort of congressional election right now(personal being directed at the effect that issue has or has had on the average person's everyday life). Only so many people care about such unending hot topics such as abortion or green initiatives (although that's beginning to change), and other more ideological concerns. But oil is economic, and it is highly economic on a very micro- and macro- level. And Americans are not happy about this rise. I mean, ppl. that don't even pay rent or a mortgage, still pay for gas. In today's suburban/3 car family world, it is almost as fundamental as food. In some cases it is more. You're asking for evidence. I'm John Aldrich, and I'm saying "who cares about evidence?" If I'm an incumbent, and I've run into an issue that might actually effect my re-election, because it effects every constituent I have, who cares who you point the finger at? We can't invade China and say, "Hey, since you guys have become something more Capitalist, you're starting to see more economic growth and really hurting our oil prices, so can you slow it down a bit, or else?" So, they need a scapegoat... As long as it lasts long enough for peoples' lease on their SUV to expire, who cares? Once we get these changes rolling and the alternate fuel subsidies start to pay off, we're in the green. But until then, we're gonna blame it on the speculators. Maybe somewhere along the lines we can start a conspiracy about Nigeria's gov't holding out on their supply of oil, and that's why oil prices are hurting. Or we can blame Alaskan environmentalists.

My question is then, what is the motivation for blaming the speculators without showing substantial evidence? I guess, I've already stated my hypothesis. But that leads me to a greater question of motivation: What's really to blame, if they are just a scapegoat? The politicians themselves or the system of benefits and sanctions to which they adhere to?

Posted by: Michael Welton at July 3, 2008 7:06 AM

Michael, I really appreciate your thought process. You must have been well trained in economics (smile).

Posted by: Wade at July 3, 2008 8:06 PM

I have a lot of friends that believe speculators cause all of the worlds problems. They believe that the government should somehow not allow speculation to occur. It is often difficult to carry on a conversation with these people.

Who is a speculator? Is it the person who buys gas today because the holiday weekend is coming and wants to save a buck? Or is it the guy who goes out and buys a motorcycle at the age of 20 because he doesn’t think his lady will allow him to buy them when they are married? How are these people different from floor traders? Presuming they are different, how could any organization (government, special interests, ect.) prevent speculation from occurring without fixing prices?

Posted by: Zach Meiborg at July 6, 2008 9:19 PM

Hey Wade -

I'm glad you informed your former students of this new blog page you and Ms. Ivanac-Lillig are heading. It's a wonderful way for us, former students, to continue to interact and be a part of your everyday work. If you remember, last week I bumbed into you on Adams & LaSalle. I wanted to ask a few questions but I knew you were probably pressed for time and I also needed to get back to work. So I'll get right to it...
Any citizen in their right mind should understand that the rising oil prices are a result of supply and demand, as you've pointed out in your most recent blog. With global demand for oil on a recond high and supply unable to keep up, naturally prices will increase. A fundamental issue that politicians unfortunately avoid given that most citizens don't care, they just want cheaper gas.

Recently, it was announced that non-compete contracts have been awarded by the Iraq Oil Ministry to several oil companies, the largest contracts going to a handful of major 'western' oil companies, despite substantial bids by other 'eastern' companies. These controversial contract details never topped the news headlines, perhaps out of convenience. But, avoiding any discussion of the possibility that oil was the root cause for a U.S. led Iraq invasion, it was determined that these contracts were given so that maverick companies like, Exxon Mobile, Shell, Total, BP can provide thier expertise and modern technolgoy in servicing the oil fields and help satisfy a growing global demand. David Fyfe, a Middle East analyst at the International Energy Agency, was quoted in a June 19th article from the NYTimes saying that within several years Iraq's oil production could reach up to six million barrels per day, up from a current 2.5 million barrels per day now. Future projections sound great as this could possibly lead to falling oil prices globally. However, considering that underdeveloped, yet booming economies, like China, will in a few years be more developed, and will demand more oil, and that this supply possibly is still a few years away, will this increase in oil supply alleviate an inevitable continuous growing global demand? Or, as consumers of oil, should we continue to expect soaring oil prices? Are we too late? (Why haven't we devoted and investing more time and money in R&D for alternatives energy sources? -- just an afterthought, no need to address this question)

Posted by: Matt at July 8, 2008 5:07 AM

Matt, should we have as a nation substantially increased our investment in R&D for alternative energy sources? Absolutely! Have we lacked the leadership? Absolutely! However, the economics will prevail. The pricing mechanism will work, at some elevated price level consumer behavior will change, alternative sources will become profitable and brought to the market, and ultimately our energy consumption “footprint” will change. The transition may be a little painful.

Posted by: Wade at July 8, 2008 1:54 PM

It's funny goodluck

Posted by: Vtaoveir at May 2, 2009 8:02 AM

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