Sigh. I've got news for Senator Obama. Last I checked, there were more NYMEX oil contracts on the short side than the long side. In other words, more people were speculating that the price of oil would be going down rather than up. If Obama were to curb or end speculating under these circumstances, the short-term price of oil would almost certainly go up.
What about the long-term price? James Hamilton, over at the Econbrowser blog, wrote this excellent analysis of the effects of speculation in the real world back on May 22:
There are individuals who use this physical commodity-- namely, consumers who use the gasoline to drive their cars-- and separate entities that produce it-- most importantly today, the national oil companies of the oil-producing countries. The key question is, How would the behavior of these two parties change as a result of a new higher price for the basic commodity they are consuming or producing?
If your answer is, neither consumers nor producers change anything they do at all in response to the price increase, then I agree you could make a case that speculators by themselves could make that price any old number. But I don't believe it is accurate to assume that both consumers and producers would do exactly the same thing, no matter how high the price goes. At a higher price of gasoline, consumers will use less of the physical commodity. Not much less, I grant you, and that's why I agree that speculators are able to have more of an influence than I might have expected. But I would insist that if you drive the price of gasoline sufficiently high, consumers will respond.
And that's a problem for any "paper oil" theory-- if consumers are buying less of the physical commodity, what's happening on the production side? If production doesn't change, then oil must be piling up somewhere in inventory, possibly some just idling in tankers in the Persian Gulf. But no one has an incentive to keep adding more and more oil to inventory forever. So ultimately, the "paper oil" theory is going to require a reduction in the production of actual physical oil.
And that leads you to the question, Why would producers want to cut production? If the answer is, they make more profits with lower production and higher prices, then they would want to make those same production cutbacks with or without the speculation, and you'd have to blame the whole phenomenon on the operation of those profit calculations themselves, with the speculators just a device that got us to equilibrium between supply and demand more quickly.
Now, I personally do accept the view that the "paper oil" speculation has made a contribution in recent months to the increase in the price of physical oil. I believe that this speculation has resulted in a slight decrease in the quantity demanded that has required some modest supply reductions or accumulation of inventory by producers. But I expect that producers will find these changes not to be in their best interests as the demand adjustments become more prominent, at which point the price must return to that governed by the underlying physical fundamentals.
Ultimately, the price must be such that the quantity of physical oil demanded at that price is equal to the quantity of physical oil supplied. Any speculator who promises on paper to buy oil for more than the physical stuff is actually selling for will find themselves at that point with a big, fat paper loss.
Read the whole thing here. In a nutshell, Hamilton explains why the price of oil will always fall back to a price that is "governed by the underlying physical fundamentals." It's simple supply and demand. Once consumer behavior changes - i.e, when demand destruction sets in, as we've seen in recent months - producer's behavior will also change on the supply side; they'll produce less oil. If producing less oil for a higher price is more profitable for oil companies, than they would have been doing so all along, profit maximization being the ultimate goal of any money-making endeavor. So speculation may have short-term affects on price but in the end the economic fundamentals will rule; indeed, speculation may well end up bringing the market back into equilibrium sooner than otherwise. And speculators who ignore these facts will get burned.
Hamilton has another terrific post on speculation here, taking some other economists to task for some of their outrageous claims regarding the effects speculation has on the price of oil.
Obama is a demagogue; a slick one, but one nonetheless. He is playing off people's fears and ignorance, looking for bogeymen (i.e. oil executives) and pointing fingers. The energy fix we find ourselves in right now is, to be clear, a shortage of light sweet crude. Everyone knows where the solutions lie; more drilling, in ANWR and off-shore, more nuclear power, the exploitation the oil shale and oil sands territories, the use of more coal and natural gas. But none of these solutions can be found in Obama's so-called energy plan. Rather, he wants to redistribute $50 billion more in rebates and "crack down" on oil speculation. How do either of these "solutions" produce more oil?
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