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The · Psychohistorian


Speculation

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Gasoline prices have increased this year. As usual when something bad happens, people look for someone to blame. It has recently become popular to blame "speculators" for fuel prices. But what does this mean? Who are these "speculators"?

Well, let's first define what speculation is. Speculation is the purchase of property on the hope that its value will rise - as opposed to buying it for use, as most of us do with gasoline, or buying it for its earning power. If you've got any stocks or mutual funds in your retirement account, you're a speculator, because you're hoping to sell them for more than you bought them for; if the account is limited to certificates of deposits or money market funds, you're not.

How can speculation cause price increases? Well, sometimes people miscalculate, and overestimate how much something is worth. This happened with stocks during the internet bubble; their price got inflated well over their value. Speculators who sold before the bubble burst generally made money, and when the bubble did burst, the speculators holding the stocks after it burst got caught holding the bag.

In commodities like oil, the situation is a little more complex. End users, like motorists, buy petroleum based fuel to use it. Theoretically, speculators could buy oil and store it somewhere in the hopes of, say, price increases due to increases in future demand, for example by owning tankers and just sailing them around while the price goes up rather than actually selling and delivering the oil to someone. Most tankers are owned by oil producers, though, who have an interest in unloading that oil, especially when prices are high; they want to take advantage of those high prices by getting the tankers back to their oil fields so they can pump and sell more oil.

Most of the speculation in commodities takes the form of futures trading - trading in contracts for oil to be delivered at some point in the future. Oil prices can vary a lot from day to day, because users can't easily change the amount they use, and producers can't easily change the amount they produce; a small increase in demand or a small decrease in supply can cause a big price spike. Large end users, like airlines, don't like to be exposed to price spikes, and they are willing to pay a slightly higher average price for the fuel in order to be insulated from severe price variations. Commodities traders - the speculators - agree to provide oil at predictable prices in the future. These traders then make money if they can actually buy oil at a cheaper price, and lose money if they end up having to pay more.

Are the speculators causing the price increases? It seems unlikely. The ones who are benefiting from the futures contracts are the consumers, like Southwest Airlines, that previously covered most of their fuel needs with futures contracts priced much lower than current prices. The speculators are the ones losing money - they're having to pay today's high prices to cover their lower priced contracts with Southwest Airlines and other consumers.

It's likely that the cause of the high oil prices is plain old supply and demand. The pumping capacity is not increasing very fast, while large developing economies like India and China are increasing demand much more quickly. The result is that the price rises until those who can most easily give up the oil quit buying it. This is exacerbated by the fact that the demand for the dollar has dropped, making the dollar worth less just as the oil is worth more.

Is there someone that we could blame? Well, we could possibly blame the Arabs for not having enough spare pumping capacity, but most people think it's up to them how fast they want to pump their oil, not up to us to dictate it to them. We could possibly blame the Indians and Chinese, but they still use far less oil than we do per person, so we'd be on weak ground there. The fall in the value of the dollar is largely due to efforts to bail out weak mortgages, so we could blame the folks who took out mortgages they couldn't afford - but it might be simpler just to refrain from bailing them out in the first place.

The other thing we could do is skip the blame and face up to the fact that the world's supply of oil is limited. We just have to live with that - and take the appropriate steps to adjust, like buying more fuel efficient automobiles, moving closer to work, or working closer to home.
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