Speculation & Scapegoats

7/4/08 – Independence Day

On this patriotic day regretfully I am reminded of yet another definition of politics.

Politics is the business of adaptive dishonesty. (When in doubt, which is the usual situation, find somewhere or someone to blame.)

Here we have the search for one or more scapegoats to blame for $4 + gasoline rather than trying to come up with workable solutions. After all the search makes headlines in an election year and solutions require real work and probably won’t be recognized by the electorate for many years. The current potential scapegoats are the “speculators.”

This term also requires a definition, and I do not have a very good one to offer. So this term falls into the pondering category. Perhaps a better term is the “non-physical” player. These individuals invest in such items as the oil commodity with no intention of taking physical possession of the commodity or their own use or to deliver it to another party.

I think we are all speculators in our daily lives. My wife speculates in orange juice futures. When we are low on orange juice she replaces our supply knowing that periodically, but not predictably regarding timing, orange juice is on sale at the store. So she either buys only a few cans speculating that a sale will be coming or sees what she speculates is a good price and really stocks up. She is discovering price and her purchasing decisions give buying sentiment signals to the store. Should she go to jail? (To insure the domestic tranquility, I will not get into any other crime against society.

Now how do these players or indeed any player play in such markets? Here we are talking about the futures markets for oil. The primary market is the NYMEX. Let’s say that player #1 is a consumer of oil and is concerned that the price of oil will increase over time. He decides that the futures price of oil of $145 for delivery in December of 2010 is low compared to his perceptions of the future. His order to by oil for 12/10 must be matched by a willing seller for that contract.

Enter player #2. This player may or may not have actual access to oil for delivery in 12/10, but believes that the $145 price is equal to or higher than his expectations of the future. He is willing to take the risk that he can either buy back his 12/10 position at a lower price or can actually buy the oil for that delivery.

By the time that both the willing buyer and the willing seller act the agreed price may be $145.07. This new price offers “transparency” or price discovery information to the markets considering other transactions for these 12/10 contracts.

Both players #1 and #2 can be considered to be speculators in that they are speculating on the future price of oil. However if they did not plan for the future, whether or not their foresight turns out to be correct, many would suggest that they would not be exercising their fiduciary responsibility and could end up in jail.

Needless to say if oil price was not volatile and was perfectly predicable, there would be no need for such future contracts. But as noted in my report, the laws of nature and of supply and demand do not allow for such stability and predictability. Therefore, the future markets offer a real service as a vehicle to cover the needs of the markets.

Points to Ponder 

  • If both #1 and #2 are non-physical players playing with paper or virtual oil, are they driving price or adding to volatility? And could or should willing buyers and sellers be limited to at least one physical player and what is to prohibit that physical player from closing out his contract before actual delivery and, therefore, becoming a non-physical player? 
  • In that the nationalization of the oil industry will not work because the USA cannot “nationalize” the global markets, perhaps capitalism and free markets our economy is based on is as good as it gets. After all we seem to accept the premise that democracy is really a rather ugly concept, but it beats all forms of government. 
  • So how can “We the People” get our elected representatives to properly ponder and come up with solutions to make these free markets work truly freely and efficiently? As we ponder that the following from my report, Confessions of an Energy Price Forecaster may offer some insight.

The U.S. Congress is the world’s greatest deliberative body. Yet it is neither great, deliberative, nor of one body.
Mark Twain

  • The Law of Unintended Consequences never seems to sink in, especially in Congress. Of course, Congress seldom has to live with consequences unless the electorate has a good memory and throws the bastards out of office. Regrettably, incumbency and poor memory are not conducive to accountability.
    Most of the time energy policy is in response to an energy crisis. However, a crisis is really only in the mind of the beholder. A crisis can take the following forms:
    - The current shortage (or glut) of oil
    - The rise (or fall) in oil price
    - The exhaustion of the world’s supply (or suppliers)
    - Obscenely high (or low) profits
    - The strengthening (or weakening) of our enemies (or friends) 
  • What Congress is beholding today is anyone’s guess. These legislators certainly won’t tell us, because they would then have to defend their current actions. And who could ever get reelected on that track record?

Sound policy is not made in a crisis situation. We can only pray that our elected leaders can respond in our best interests to any crisis. Does the current level and trend of energy prices constitute a crisis?

Nevertheless our leaders are expected to do more than just be crisis managers. They need to make policy to prevent a crisis. Here we hope that deliberate deliberation would lead to well-reasoned policy where all consequences of that policy have been considered. Ponder that and let all of us know if you have a solution.

Click here for more information about Confessions of an Energy Price Forecaster: A 12 Step Program to Enlightenment

Click here for John Tobin's full bio


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