Mittwoch, 8. Juli 2009

Speculation and the Oil Price

According to press reports, France, the UK and the US want to limit speculation in oil futures to reduce price volatility.

Two questions:

1. To what extent can speculation actually influence the oil price?

2. Is it bad if "speculators" drive up the price?

Let's see:

ad 1:

As discussed in previous posts, the way it works is like this: If people expect the oil price to go up, they can drive up the price for future deliveries, thus encouraging others to store physically available oil as opposed to selling it to end users. This reduces the oil available for consumption today, and therefore drives up the spot price. It's hard to say what the effect on price is, but in a tight market, rather marginal supply changes can have big price effects.

ad 2:

So we established that "speculators" can potentially drive up the price if they think prices will anyway rise in the future. In theory, they can create a "bubble" on the spot market, but only if they encourage enough people to put oil into storage. But if so, is this a bad thing?

I would argue it isn't: If we all agree that oil is a finite resource, and will become progressively more scarce in the future, then it is the job of a functioning market to drive up today's price so that people use oil more efficiently today and leave more of it unused for tomorrow. Arguing for a low price today is shortsighted (and selfish, if the argument is made by people beyond a certain age).

In other words: "Speculators" that drive up the oil price don't cause harm. Quite the opposite: They help to achieve efficient intertemporal decision-making.

Though of course there's always the "us vs. them" argument: "We" (the people from oil consuming countries) don't want to pay too much money to "them" (the people from oil producing countries), even if that means inefficient intertempral allocation.


  1. Let say:I have a contract for 2010 jan
    if I will reach that point of time,then the future price will be spot,and I have to sell/buy oil to eliminate the contract,and I could open a new contract in the future.
    If I use future buy,and I use spot sell,AND the oil price is monoton growing,then I continously can roll over my contract into the future.
    And as a new player enter to the market,he will create a new "buy" position in the future,which will drive up the price.
    If the liquidity is infinite,then this play can go untill the end of the world (:-P)

    Untill all of the player just put money into the market,the prices will go.

    But I think the fall in the prices in the past week is a singal about the slowing down of the liquidity pump in china.

  2. Buying oil futures is just a waste of money as long the market is in contango. As you write, someone is actually storing the oil to deliver. The buyer of the future is paying for the storage. So I'm with you: It's making oil cheap in future and thus basically a good thing. Just I doubt it's a good investment.

  3. This article claims that oil volatility might increase due to th position limits. Might by true.;2431179

  4. Not the contango is the mayor driver of the decisions.
    If the big money managers allocating more money into the commodity market then the price will increasing,and the contract roll over will bring you gradualy increasing profit.
    After it,the diference between the spot and future price is not so interesting.

  5. Contango causes people to store oil. If you buy futures in a contango market you basically bet on the contango not being steep enough, i.e. the future spot is even higher than the forward price.

    Do you know who's earning the risk premium? Being long or being short in Oil?

  6. I'm not quite sure how you define "risk premium" in that context. Can you explain?

  7. I agree that position limits might increase oil volatility: If speculators store oil when the price is low and release it when the price is high, that basically helps to reduce sharp movements.

    Of course if their predictions are bad and they predict a further price increase just before demand drops, they will unnecessarily drive up the price. But that's not their intention, because they themselves get hurt in the process(they buy oil hoping for a rising price, but then the price drops).

  8. Ok,I thik you miss my point.
    The requirements are:
    -increasing quantity of money
    -investors with high risk appetite
    -a commodity market
    -peak oil theory

    So,they are sure about that the price of the oil will go up.
    Due to this,they pour a lot of money continously (we have low intrest rate,so a lot of money) into the future market,and they are roll-over the contracts continously.
    Because the amount of money which enter the market increasing ,the price increasing too.
    If we have a lot of free money (loan) then the buyers will able to get loans to buy the oil.

  9. I would argue that there's essentially two ways this can go:

    1. If investors are right about the underlying trend (peak oil, increasing scarcity and all that), then the fact that they are driving up prices is essentially good, because it "spreads the pain" between today and tomorrow (instead of low price today and extreme price tomorrow, it will be a higher price today, and a less extreme price tomorrow).

    2. If investors are wrong, and for whatever reason oil will not become more scarce (or they overestimate the degree of scarcity), then this turns into a bubble. The bubble can keep inflating as long as enough investors believe in it, but if the fundamental markets never catch up with it (i.e. scarcity never materialises), then eventually the bubble will pop.

  10. @Thomas:

    Risk premium is the premium an investor is willingly to pay to be on the right side of the deal if the world economy crashes. I suspect that might be short in oil. Then again, I can imagine the world economy because of lack of oil (Say Israel bombs Iran). Then being long in oil sounds better...