Speculation and Oil Prices

While gas has ‘comfortably’ hovered between 2-3 dollars - it’s clear that a U.S where $5 a gallon for gas would not be economically sustainable without government intervention or major reforms. The U.S has fought both diplomatic and military battles to keep the oil flowing. My questions are:

  1. Since the accessibility of oil is a vital interest to the United States why is speculation of oil prices legal?

  2. If speculation of oil was outlawed or severely curtailed. What would happen? How would life change? Would society keep going?

  3. Is there a maximum dollar amount that investors can speculate? Is there a percentage or dollar amount cap? Is there any mechanism that stops oil from getting to $400 dollars a barrel?

  4. Energy companies are very profitable. Why doesn’t the U.S have its own oil company that can provide gas to citizens at a subsidized price? Sort of like the USPS vs. FedEx.

  5. Why does acute changes in Middle Eastern politics cause gas prices to change the very next day. This is remarkable to me. What mechanism is involved to trigger that?

  6. Why does the U.S have to purchase barrels of oil everyday at variable prices. Why can’t it purchase a year supply for $90 a barrel; you know, bulk-pricing of what have you.

Thanks for reading! :slight_smile:

  • Honesty

It’s not clear. Other countries regularly do so.

Free market. Global market. Making it illegal in the USA wouldn’t do anything globally.

Moot point. Or rather, it’d mean we have a one-world government and a centrally-managed economy. It’d be like Cuba.

Nope. Nope. Yeah, supply and demand.

Because the US still has (nominally) free markets. If you really want to talk subsidies, there’s no requirement that the company be government-owned. In fact every time some idiot releases the reserves, that’s already kind of a subsidy.

Supply and demand.

The US doesn’t buy the oil (well, not most of it). Customers buy the oil, at the market price. You can buy a year’s worth of oil at a negotiated price (not necessarily today’s market price). You know what that’s called, though? Speculation.

What if it were not? Oil is a global commodity, will sell for the global price. Make it illegal in the USA, and the speculation contracts will be sold overseas. Disallow US oil companies from buying futures contracts overseas, and then they buy on the spot market.

You don’t really think big. Gas in Canada is $1.15 or so per litre - now that George Bush’s economic policy ensures our dollar is worth more than yours - that’s $4.50/gallon. England costs 1.30pounds/litre, about $2.10 US - so a gallon is $8 or so. The rest of Europe is much the same. Here in North America we live in a fool’s paradise where such prices are disgustingly cheap. Prepare for that to change.

Why would it not be sustainable. What will change is how people live. A Sunday drive will become a luxury. Long bus rides will replace drive commutes. When you sit on the bus 2 hours each way, you will move closer to work. Those offices in remote suburban industrial parks will think about moving closer to the city core. And so on… all it takes is the realization that prices are not going down any time soon.

See above. Spot market prices would be higher in times of short supply, and much more volatile. Plus, there would be more incentive to trade futures for overseas investors, since there would be a fixed pool of US companies obliged to by only real deliverable-now contracts. If the US government tried to also reign in prices with mandated controls, less exploration would happen in the USA. Exploration money goes where it can make the biggest profit.

Reality will. Speculation beyond what people will normally pay is a “bubble”. It becomes a game of hot potato, and soon enough people decline to pay that someone is left holding an unsellable contract. How much could you spend, MAXIMUM, on gas? What would it take for 3 or 4 of you all going the same way to carpool, like we did in the 1960’s? As prices go up, consumption goes down.

They do. It’s called Exxon, and Mobil, and Conoco, and Shell. If you mean, why doesn’t the government run a company and do what private companies do… suggest that to a buddy of yours in the tea party and see what they say. Besides, it’s easier (if the Republicans are not in the way) to just raise taxes on private companies.

(Aside to moderators - this is not a political slam; the debate over higher taxes vs. encouraging business, and government ownership in private business, is a common debate. I am just pointing out which sides are most identified with certain positions,)

Greed. Prices are easy to go up, nd slow to come down. Theoretically it is not a monopoly, but there is a certain “follow the leader” mindset at work where when one company acts as a market leader and sets a price, the others follow. It’s not a cut-throat market; everyone will likely sell every drop of gas they have at about the sme price.

Why would anyone sell to you at $90/bbl if they think the price could go up? However, all oil companies buy futures contracts (at going market rates) from time to time.

You’re welcome.

You’d see much higher price fluctuation. If companies that need to buy oil couldn’t lock down prices with future contracts, they’d have to buy all their oil on the spot market, which meant they’d be vulnerable every time the price of oil changed, and that uncertainty would probably be reflected in higher prices.

As a general rule (the most general rule possible, as I am not a financial wiz) people with a stock speculate on future prices. If you expect the price to rise, you may charge more for it now, under the idea that, to replenish your stock, you will be paying more for it. It’s not illegal to buy a sack of nuts for a dollar, charge people $1.10, then hear your supplier is going to charge you $1.20 tomorrow, so you change your price to $1.30, so you’ll have cash on hand to buy. And yes, when the supplier shows up with a surprise 99 cent nuts, you don’t owe your customers anything, but you could lower your selling price to attract business. Yes, I’m talking about nuts, not the fuel our culture requires, but it is the same problem – people need food, industry need raw materials, the land we plop our constructions on is also undergoing speculation.

What I had heard was the price of gasoline on the New Jersey turnpike is only allowed one price change a week. This causes people to flock there, only to find a massive price increase as they wait, the owner having to make up a weeks worth of losses and anticipate the next week of cost increases. So that’s one example of speculation control that may not be optimal for everyone, or anyone.

In my understanding, you’re talking about hedgers, not speculators, both of whom are participants in futures. But my understanding is sketchy, at best.

In my limited readings, I’ve recently noticed an increase of articles claiming speculation is to blame for rising oil prices. For instance: The Fix for High Oil Prices? Regulate the Speculators.

There seems to me to be a huge (and unsettled) debate about the role and culpability of futures speculation in inflated prices. And note, as Krugman did in a blog post from 2009, that even if speculation is to blame sometimes, it doesn’t mean it’s detrimental all the time.

I’m pretty fascinated by the topic, but admit that I don’t have the knowledge to really grasp it, so I’ll likely just read along from here on out…

My understanding is that trading in futures (whether commodities or securities) does not affect the eventual spot price at all, any more than betting on a horse can affect the result of a horse race.

Obviously if the speculators are actually taking delivery of the commodity, that’s a different story.

I don’t think you can compare the U.S with other countries, though. Food, clothing, postage stamps, everything that we purchase is based on a presumption of cheap and accessible oil. If gas shoots to $5 dollars over the next month and stays there, I don’t see how things progress in America without something giving in; carpooling can only go so far in mitigating high gas prices.

That would be a really bad idea. The United States would have to buy the oil at market prices and then sell it for less than it paid. The difference would have to be made up from other revenue like taxes.

If the American government was selling oil for lower prices, that would increase consumption - so more taxes. And everyone who had been buying oil at market prices would switch to buying subsidized government oil - again more taxes.

I think we can certainly compare to other countries, they all rely on oil for much of their economy as well. And we’d adapt just fine. The quicker the transition the more turbulence, but our economy wouldn’t fall apart. I don’t know why you think the US is so special?

http://www.foxnews.com/story/0,2933,166038,00.html The Saudi oil minister agrees that 60 percent of the price of oil is due to speculation.
There is some degree of notice when it is done in America ,so they opened a Dubai and a London exchange to escape even the small degree of scrutiny that it gets.

You can’t achieve a saving by making a bulk purchase, because buying in bulk does not get you a discount. In fact, if you phone around looking for a very large volume all at once, you will “move the market”, and cause the price to go up.

You can however fix the price of the oil you expect to use. Most large users of a commodity will do this to some extent, whether they are airlines, utilities or government.

This is called hedging and is done by entering a fixed-price contract. The fixed-price contract can be either physical or financial.

The physical fixed-price trade is easy to understand. I will take physical delivery of a certain quantity of oil from you in August, and I will pay you a fixed price that we agree now.

The financial trade is a little more complicated, but equivalent. I know I will be buying 10,000 barrels in August at a variable price (the spot price on the day), so I enter into a swap trade, or a contract for differences, with you. This is a kind of spread bet, where if the spot price is above the agreed price, you will give me the difference, but if the spot price is below the agreed price, I will give you the difference.

For example, we agree a swap for 10,000 barrels at a “strike” price of $120 per barrel. August arrives, and the spot price is $124. I have to pay my supplier $124 x 10,000 = $1.24 million. But you pay me $40,000 in settlement of the swap contract. So the net cost to me is $1.2 million.

In fact, no matter what the price was on the day, the cost would have been $1.2 million; hence I have succeeded in fixing the price of oil.

In this example, I have gained $40,000 (relative to just waiting and paying the spot price), and my counterparty has lost $40,000. So this activity is a zero-sum game. The net profit of all the trading activity (whether hedging or speculating) done in respect of that barrel of oil is zero. No cost is borne by the end-user.

But everything we purchase is made in Asia, and transportation cost is a small part of the price. Adding another 20% to the transportation portion of the price isn’t likely to upset the demand curves too much for consumer goods. Instead the demand for gasoline will drop, and the demand for air travel will drop. You say,

But what you don’t understand about economics is that an equilibrium must be reached.

Honestly Honesty, can you real not see the larger picture? If you can’t, I have no idea why you are focusing on oil prices alone. Why not just mandate prices for everything which is what you are getting at.

If you can see the bigger picture, you will realize that we are dealing with a valuable commodity that everyone wants some of. Something will have to give if oil prices shoot up but that has already happened a lot in the last few years because of the labor market and other factors. People will have to build smaller houses, move closer to work, whatever it takes. It sounds like you expect the American government to lock everyone in to the same lifestyle they have become accustomed to for better or worse. That isn’t possible. The question is why you think it is desirable? Market pressure in oil could introduce positive changes as well like more use of cleaner energy or better designed neighborhoods.

It is a stupid debate anyway. There is nothing anyone can do to stop it. No other country has to sell oil to the U.S. at prices we dictate and direct subsidies come from taxpayers with added administrative costs plus none of the flexibility of the free marker.