Here's a non-rocket science question: If you expect a reduced harvest of wheat, corn, rice or any other commodity some time in the future, what would be the wise thing to do about your consumption today? I bet that the average person would answer: Consume less now so that more will be available in the future.
But how in the world can people be encouraged to consume less now? Enter the futures market, which consists of a worldwide group of millions upon millions of traders, often called speculators. Speculators, betting on a future shortage, buy up wheat, corn and rice today in the hopes of making money selling it for a higher price when the bad harvest hits. As speculators buy more and more wheat, corn and rice, they drive up today's prices. As today's price gets higher, people consume less, but more importantly, people do the intelligent thing without bureaucratic edicts. The vital role of the futures trader, or speculator, is to allocate goods over different time periods. And, it's not just wheat, corn and rice that must be allocated over time but all commodities including oil.
There's no guarantee that speculators will make money. They might guess wrongly. For example, they might buy wheat now at $8 per bushel, expecting to make a killing in November at $12. Weather predictions might have been wrong and instead of a reduced harvest, there's a bumper crop driving November wheat prices down to $4 per bushel. That would make the speculator's $8 investment worth $4.
If we don't like commodity speculation, we could easily outlaw it. That way, for example, even though there might be every indication of a reduced fall wheat harvest, today's price of wheat wouldn't rise. We could consume wheat today and not fret about fall.
President Obama has asked the U.S. Department of Justice to investigate whether Wall Street speculators could be manipulating oil markets.
If Obama could convince other nations to put an end to worldwide oil speculation, we might be able enjoy $2 per gallon gas and ignore Middle East conflicts that might impact heavily on future oil supplies.
White House and congressional attacks on oil speculation do not alter the oil market's fundamental demand-and-supply reality. What would lower the long-term price of oil is for Congress to permit exploration for the estimated billions upon billions of barrels of oil off our Atlantic and Pacific Ocean shores, the Gulf of Mexico and Alaska, not to mention the estimated billions, possibly trillions, of barrels of shale oil in Wyoming, Colorado, Utah and North Dakota.
Some politicians pooh-pooh calls for drilling, saying it would take five or 10 years to recover the oil and won't solve today's problems. Nonsense! I guarantee you that if permits were granted to all of our oil sources, we would see a reduction in today's prices.
Why? Put yourself in the place of an OPEC member knowing there's going to be a greater supply of U.S. oil in five or 10 years, which might drive oil prices to a permanent $20 or $30 per barrel. What will you want to do now while oil is $120 per barrel? You would want to sell.
OPEC's collective efforts to sell more would put downward pressures on current oil prices. The White House, U.S. Congress and environmental wackos, by keeping our oil in the ground, are OPEC's staunchest ally. I wouldn't be surprised at all if we discovered OPEC reciprocity in the forms of political contributions to congressmen and charitable donations to environmental groups.
In the wake of higher gasoline prices, the only intelligent thing that Obama has called for is an end to $4 billion in annual taxpayer subsidies to oil companies. To get that done, he has an uphill bipartisan fight on his hands. Oil companies buy off both Republicans and Democrats in order to receive government handouts and special treatment.
Walter E. Williams is a professor of economics at George Mason University. To find out more about Walter E. Williams and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate Web page at www.creators.com.
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"In the wake of higher gasoline prices, the only intelligent thing that Obama has called for is an end to $4 billion in annual taxpayer subsidies to oil companies". I disagree that these are "subsidies" but rather legitimate tax deductions for business expenses incurred in oil production. Much the same as a trucking company can claim running expenses on its fleet of trucks. Anyhow, even if the oil companies were taxed 100% on their profits, it would only reduce the price of gas by 2c a gallon at the pump!
Comment: #1
Posted by: Alan
Wed May 4, 2011 3:05 AM
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Re: Alan - You can't change the term used by the president to suit your needs. If these are subsidies, they're subsidies, you can't just call them "tax incentives" and try to wash-over the situation. This is actually money the government pays-out to the oil companies for various purposes. I have no doubt the oil companies are also claiming plenty of deducations for other purposes, but legally, deductions are money paid BACK to a company, not money given to a company that the company never paid out in taxes in the first place. You can't paint an elephant pink and call it a pig.
As for speculation, the major problem with Mr. Williams assertion is the line right here: "Speculators, betting on a future shortage, buy up wheat, corn and rice today in the hopes of making money selling it for a higher price when the bad harvest hits.". Problem is, most of these speculators aren't actually buying anything. You think people who buy gold, silver, corn, wheat, oil in their spare time in their living room actually take possession of those goods? No, they buy the "Rights" to those goods, and sell them off (at a profit or loss) before they have to take possession. What would your average weekend-trader do with $10,000 of corn? You know how much corn that actually is? Most of these speculators are in no position to actually possess these goods, but that doesn't stop them from buying them up.
That's the problem, these people are looking to make a profit off of goods they don't need, at the expense of people who do need them. Let's say I think that next week bread is going to increase in cost (for whatever reason, maybe I made it up). I go to a bakery and order an entire weeks worth of bread to be delivered next week. This takes over the bakery's whole production (they can't make any other bread). When next week comes, I go to the local grocer and say, hey, I have bread you can buy, I understand your baker doesn't have any available. I haven't worked within the system, I gamed the system. I actually created a lack of goods in order to sell the goods I have. If I hadn't bought that bread, the bakery could have delivered their normal production to the grocer, who could have sold it at normal cost. If speculators didn't buy gas today at $120 today because they thought it would go to $140 next month, gas probably wouldn't raise past $120 to begin with The gas bought today would be used today, not sold next month at a higher price. There is no shortage of oil, OPEC will increase supply to match demand. The problem is, people are buying oil today at above cost, then have to sell it later. The people who buy it later knowingly pay more, because they know that their actions will also drive-up the price when they go to sell later. In the end, these people have artificially driven-up the price of oil, and NONE of them are actually consuming it.
Of course, your argument seems to be that speculators are saving us from ourselves. Driving up prices to prevent some sort of future shortage from coming full-bear on the populace. First, what shortage? There's no shortage, OPEC is a cartel, they control supply. Second, when an actual shortage does hit, price will naturally rise. The market will control itself. We don't need speculators making a profit today, prolonging high prices before there is an actual shortage tomorrow.
Comment: #2
Posted by: Nathan H.
Wed May 4, 2011 11:56 AM
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Mr. Williams makes an interesting assumption about the cost of producing oil from difficult environments when he says that the price could be permanently forced to $20 or $30 a barrel. That is the production cost range in places like Saudi Arabia where the oil is high quality, easy to reach, and comes up with little or no pumping. Alternatives to middle east oil exist, but the cost of production is more in the $60 to $80 a barrel range. How can oil that costs $60 TO PRODUCE be used to drive prices down to $20? Your "you would want to sell" hypothesis also assumes that the the OPEC members are not currently pumping as fast as they can. Most already are. Many, such as Yemen, are in steep decline in productivity. Driving prices down will also encourage greater consumption; goodbye Prius, hello Hummer.
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A question that these discussions bring up for me is "what' the rush?". Oil under the continental shelf and in oil shale is not like a loaf of bread; it does not go bad left untapped. That oil is likely to be much more valuable to our grand kids 30 years from now once we have burned up the easy oil and when technologies exist to reduce the risk to the environment.
Comment: #3
Posted by: Mark
Fri May 6, 2011 1:21 AM
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Speculators don't necessarily cause problems; they highlight conditions and weaknesses in the open market. Back in 2008 Mr. Bush went to the Saudis to try and get them to increase the production of oil. Everyone thought he was trying to lower the price of gasoline but I believe he was trying to avoid an oil market collapse. Too low oil prices are nearly as bad, though in different respects, as high oil prices. It seemed, at least to me, that speculators were running up the price of oil; they were taking advantage of an overly narrow margin between supply and demand. By buying the futures as they were they put pressure on the price of oil and raised it substantially and quickly.
As one commentator here put it they don't actually take possession of the oil unless they keep the futures contract. Forbes magazine ran an article on a company that went belly up because they bought a bunch of the futures contracts and still had them when the bubble bust and everyone was selling as quickly as they could. When the bubble burst oil went all the way down to $35 a barrel. That wasn't good either. Had the price remained that low for too long there would have been much civil unrest (and before anyone thinks that is too good look at Egypt).
Had the Saudis increased production even 5% when Mr. Bush requested they would have removed the incentive for the speculators and oil would likely have settled a little higher than before the run up began but not nearly as high as we are presently.
Now the speculators see another weakness. Our government has publicly stated we won't drill for oil and in fact we will hamper our domestic oil production as much as we can. That takes a lot of production out of the supply side of things. This time the speculators are being much more careful in how much and how fast they run the price of oil up hoping to keep it higher (though not as high as last time) and longer than last time.
In this case we can lower the price of oil without the Saudis help (they have already told us to take a hike). We need the price of oil to be roughly $80 a barrel to make domestic oil production profitable. If our president would announce that the moratorium will be lifted, drilling permits expedited and environmentalists marginalized OPEC countries would be seriously concerned. This would introduce a competitive source that would force them to lower prices. To prevent this they would increase production enough to get oil back below $80 a barrel to prevent American producers from drilling. Chances are we would never even drill in ANWAR or off our coasts for another 20 to 30 years. We would take what we could profitably for $80 a barrel, the easy oil, but probably not the oil that would have the higher production costs.
Instead we sit while OPEC kicks sand in our faces. OPEC could stop the speculators by just temporarily increasing oil production as little as 5% but they won't. The speculators are doing us a favor by showing us the weaknesses in our energy policy, showing us the true nature of our Saudi “friend” and highlighting the serious and dangerous consequences of our current energy policy, "let our “friends” take care of us.” I would rather we took care of ourselves.
Comment: #4
Posted by: Ed Boyle
Fri May 6, 2011 7:45 AM
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Speculators and futures traders also serve to remove the risk from commodity producers. They don't actually need to physically possess the commodities. For example, if you have a very large sum of money on deposit in a bank, you don't actually have that much cash in your possession, yet you still have the purchasing power. Futures are a kind of currency in that they can be redeemed for something of value (usually legal tender or its equivalent). However, they are even more volatile than today's fiat currencies!
Regardless of the actual equilibrium price in 5-10 years of any potential domestic oil, one thing remains true that was already pointed out by Ed Boyle: either it will be lower than OPEC can provide - meaning lower energy costs and more productivity - or it will go unused until it is and provide energy for the next generation. Futures are basically a prediction market that helps us as consumers gauge how much of a supply of a commodity will be available in the future.
Comment: #5
Posted by: Kevin L
Mon May 9, 2011 10:33 AM
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