San Diego Housing Bubble News and Analysis

Speculation can work both way. Speculation just amplify the supply & demand imbalance. Right, people think demand will out strip supply, so they bet that price will go up. However, if the imbalance swing the other way, where supply is suspected to dramatically increase or if demand is expected to dramatically decrease, price would drop through the floor, well pass the "fundamental" price. So, instead of trying to patch the problem by going after "speculators", why not fix the root cause of the problem, which is supply & demand imbalance.

Thanks for the input asianautica. That's interesting about the impact in both directions. I hadn't thought of that.

Even if addressing the problem re: excess speculation is a "patch" it seems like an easy fix to at least stabilize things in the near term.

I am not against opening refineries or more drilling, but those are more long-term solutions as I understand it.

I agree that more drilling and refineries will be a long-term solution. But I don't like "patch" solution for short term. I would rather them put a massive tax to reduce the demand by 20-30%. That would cause price to swing the other way. The extra tax $ can be put to use in drilling/refining/ and alternative fuel research.

Boy, if there are two words that shouldn't be next to each other they're "massive" & "tax". Okay, maybe "explosive" & "Diarrhea" are worse combination.

I suppose a huge tax could drive down the price. But it seems keeping over-speculation in check serves not only to possibly lower oil prices, but regulating this activity would also maybe dampen price volatility as well.

Let's do both: drill domestically & close the speculative loop hole. Not sure how I feel about a new gas tax. That wouldn't be fair to the working poor. We really need to focus any new taxation on the rich instead.

I agree that "massive tax" is not ideal, but this type of problem cannot be fixed easily in the short term. I think if the US government would say "we'll be willing to drill as much as we can to satisfy our own oil demand", that would be enough to turn the speculator bearish and price will drop accordingly. The only problem is, I don't think the government would ever say such a thing.

They came out today at close to the end of the NYMEX session and changed the margin requirements on oil which caused the sell off.

They are also going to change the number of oil contracts "non industry participants" can own at one time. I am not sure when this change is going into effect but it will be soon. It may have happened today along with the margin change.

John

It seems like NYMEX has been playing with the margin requirements a lot lately. This would squeeze out the little guys because they have to throw in more cash to increase their equity position, but would this really discourage major hedge funds and the like who may not be so deeply leveraged?

Do you happen to have a link to info about the proposed non-industry limits?

Thanks.

Renterclint,

No, but I will try and find out more information today and link it.

John

For every speculator who profited from the runup in oil prices, there was a seller. IOW, one speculator gained, another lost the same dollar amount.
That is why the politicians' rant against "speculation" is simply a feint to divert our attention from the supply and demand fundamentals that have driven the price up. Those same politicians could favorably impact supply and demand via drilling, encouraging conservation, and other politically painful measures if they had the integrity to do so.

renterclient-Do not spend to much time on irrelevant minutia of the oil futures market. What should be of concern to you is the fact that world oil production will most likely go into terminal decline within 5 years or less and that demand will forever outstrip supply.

In the next few years oil could go to $300 as it could to $80 due to short term elasticity and long term fundamentals. For learning more about this situation and everything you ever wanted to know about the futures market go here.

http://www.theoildrum.com/node/4334#comm...

The oil price can be thought of as a composite signal, resulting from a speculative signal superimposed over a fundamental signal. If we can determine the magnitude and sign of the speculative signal at each time, we can ascertain whether speculation was the main driver of the latest price rise or not.

To that purpose, an essential source of data is the weekly Commitments of Traders (COT) report from the CFTC. For the report, each trader is classified either as "commercial", if the trader uses futures contracts in that particular commodity for hedging (meaning they deal with the physical commodity in the spot market), or "non-commercial." Traders holding less positions than a specified number of contracts (different for each commodity) are "nonreportable". For "Nonreportable Positions," the number of traders involved and the commercial/non-commercial classification of each trader are unknown.

Thanks jficquette.

EconProf,

I get your point about how every buyer has a seller - but that might be oversimplifying things a bit. With each of these selling events there are market implications. It seems that when sales get exagerated or over-applified by rampant speculation, these individual sales events become aggregated into an entire market movement where not just speculators lose, but the true industry-related hedgers who are attempting to mitigate their business risk fall on the losing end of an over-inflated market.

I do not think this needs to be a political issue. Regardless of what politicians are saying or what their motives are, there are real instances where unregulated speculation has distorted commodity markets & the unassuming end-consumer gets hurt in the process.

See this article for example:
http://www.washingtonpost.com/wp-dyn/con...
This article illustrates how one hedge fund manipulated the natural gas market. As an entire market was artificially manipulated, utility companies had to continue to operate & hedge their risks. In the process utilities paid too much for energy & we consumers were left paying a higher bill.

I'm not saying supply & demand is not the main issue, and I agree that we should open more refineries & drill domestically. Encouranging conservation is great too. But there appears to be a real issue here with this speculation, and it seems wrong to brush it away like it's some sort of political ploy.

Unfortunately, as commodities & other investments have gotten increasingly complex with swaps & derivatives as well as over-the-counter & new alternative foreign trading markets popping up, simply closing a US regulatory loophole probably will not fix the speculative impact for the long-haul.

"The oil price can be thought of as a composite signal, resulting from a speculative signal superimposed over a fundamental signal. If we can determine the magnitude and sign of the speculative signal at each time, we can ascertain whether speculation was the main driver of the latest price rise or not."

arraya, I have never claimed to be a mental giant, but this passage you just posted makes my head hurt! I think I got my signals transposed rather than superimposed...

Does the COT address the swaps & other derivatives that are directly related to the commodities futures? It sounds like there is a lot of activity going on with virtually no oversight.

And btw, I think you are right on the $$ about demand forever outstripping supply. As China, India, & other companies continue to develop & the foreign middle-class grows, demand will be out of control. Oil reserves are finite. It is definitely time to plan for our long-term energy future.

But I disagree that the current state of commodity speculation is irrelevant minutia. It is a current problem that if addressed directly could provide economic relief regarding energy prices & likely food prices as well.

Curious if anyone follows this site and what the pigg community thinks of it:

http://www.lifeaftertheoilcrash.net/

Maybe I don't know enough about the subject, but why don't we just let the market sort things out? The best way to promote a more diversified usage of energy is to have an increase in oil prices. Look at how many more Prius' there are on the road, and how many more people are carpooling, taking mass transit, or riding their bikes instead of driving. I am sure that countless young (and old) entrepreneurs and inventors have been created as a result of the recent runup in energy prices. This is the free market at work. The government and taxes only serve to complicate things IMHO.

Greekfire described the free market approach pretty well--and how it solves problems if we just let it alone to work.
The price system is also a signaling system. Higher prices encourages consumers to conserve at the same time it encourages suppliers to reallocate resources to produce more, plus come up with substitutes. Government interference thwarts the natural and healthy tendencies of both suppliers and demanders to eventually solve the problem.
Much of the current high world oil price can be attributed to government price controls in developing countries. China, India, Indonesia and many others have government-set prices that discourage conservation by consumers. I understand that Venezuela and Iraq have gasoline well under $1 per gallon. Of course their long lines of cars are pictured on our TV news coverage, but the dolt reporter never states what the government fixed the price of gas at. Also, how many Americans reading the news about electricity shortages and blackouts in Baghdad know that their electricity is not even metered? Sales of air conditioners there are high, but why should anyone take any electricity-conserving measures if it is free when it is on.

From what I know it seems like rampant speculation really could significantly impact oil prices. I’ll put it in laymen’s terms:

For example: ABC Auto Supply wants to buy oil and the price today is $100/barrel. ABC knows they will need oil this month & next month. ABC is afraid the price will go up to $150 next month, so they buy a future contract to buy half of the oil they will need next month for $125. If the price actually does go to $150 next month, ABC will not incur an increase of $50/barrel. Because of this hedge, they only incur $25/barrel increase.

Two points.

The scenario in which future price of a commodity is considerably higher than spot is called "contango". Contango creates an opportunity to profit. You buy the commodity at spot, sell a future, store it, then deliver the commodity to the customer one or two months down the road. Your profit is equal to the difference between future and spot prices, less cost to store. Any contango situation will be rapidly corrected by the market because there are people always watching; if they see an opportunity to profit by buying a couple of futures and then renting a tanker to keep 100,000 barrels of oil for a month, they will do it. Inventory-building will go on until there's no more profit to be made; either because spot and all futures prices equalize, or because the world runs out of cheap ways to store commodity and storage costs run too high.

There's no evidence of contango in oil. Most of the time, spot prices lead the increases ahead of future prices. There's also no evidence that anyone actively stores massive and increasing amounts of oil anywhere.

The second point is that oil demand curve is steep but not vertical. If speculators succeed in raising the price by 100%, demand will inevitably drop. With no changes at the supply end, you'll discover that there is excess supply that has to go somewhere, maybe soaked up by investors with big oil storage capacities.

Oh, but you can say "hey, maybe that excess supply is still in the ground"? Maybe oil producing nations are holding back some of the oil for some reason. But then there's no reason to blame futures speculators. OPEC could bring oil to $140 entirely on it's own, by cutting production, or simply by not scaling up production as fast as needed by the global economy.

Actually its not true that for every seller there is a buyer. For every contract sold their is one bought but one party could sell 1000 contracts to 1000 buyers.

This is how markets are worked over. Russian takes the money they get from Europe and buy oil futures with it. They don't have to worry about delivery because they are also the shippers.

We send about $1.3 Trillion to oil producing countries yearly and a lot of that money ends up being used to buy more oil futures.

Another factor is the Wall Street firms are huge into oil contracts to offset the hits on sub prime. In fact, GS is rumoured to have over $80 billion in long positions in Oil. JP Morgan has leased storage facilites at the port of New York to actually accept delivery of oil.

Banks, and Wall Street firms are taking the free fed money and piling into commodities with it.
This is what happens when you have the fed and government manipulating the system. It will always create an excess in some other area.

John

Okay-

Apparently this issue is much more complex than I originally gave it credit. Thanks to everyone who responded!

As I began to research the subject a little more, I discovered a couple web/newspaper sources claiming that the so-called "Enron Loophole" was effectively closed late in 2007.

What got me really thinking about the issue were several recent televised stories on oil speculation. The last of these recent segments layed out an elaborate time-line of how a certain Texas senator & a member of the CFTC conspired w/ Enron executives to create this loophole. I do not recall any of these stories explaining that the Enron Loophole had been closed. Funny...

I am surprised that nowhere in this discussion has anyone addressed one of the recurring themes on this blogsite: the decline of the dollar! Yes, speculators can cause short term volatility, some of the spikes and pullbacks. But the long term trend is strictly up (as with all commodities), largely in response to the dollar's declining purchase power. The best way to halt the climb of inflation in commodities is to reign in our government's deficit spending and loose monetary policy, not to restrict the activities of speculators. The speculators will stop betting on future price climbs if the government stops debasing the currency and giving them reasons to make that bet!

Of course, the dollar decline isn't the only factor. Americans bought an awful lot of gas guzzlers in the past few years, Hummers, Navigators, Escalades, and not just SUV's but big cars with poor mileage too. Surely, many of these vehicles (and the gas for them) were purchased with the "equity ATM" during the bubble. Want oil to be cheaper? Stop using it! If in aggregate we, the human race, raised our fuel efficiency and made a serious push towards replacing oil with alternative energies, we could keep oil affordable in the time before it ultimately runs out.

As an aside, I think more drilling is like the "moral hazard" in banking. In lending we need better lending standards, not a bail out for recklessness. For energy we need better solutions than something that is dirty, affects the climate, causes political tensions and bloodshed, and will ultimately be used up. We don't need to facilitate future dependence on either easy credit or oil.

Arguably, we are already paying a "massive tax", just not directly at the pump. The government has borrowed trillions of dollars to conduct military activities in places where "we have a vital economic interest". Even beyond the Iraq war, in times of relative peace we operate bases throughout the Middle East and patrol the waters with warships. You do pay for that in your income tax (or at least you will someday when the bill comes due). I would guess that oil would be a LOT more expensive if the US military didn't intervene so agressively to ensure its accessibility.

In addition there is the matter of inflation. It has been shown by many people (so I won't go through the exercise) that monetary devaluation is an insidious kind of tax. The government takes purchase power from your wages and savings and spends it. Yes, we have explosive dia..., er, um, I mean a massive tax.

underdose,

That is a good point about the inflation factor. It sounds like oil typically runs adversely to the dollar & other commodities for many reasons.

The Fed has their hands full with trying to prop up our troubled credit system, so I think they do not dare raise interest rates any time soon. Inflation seems like the furthest issue from their minds.

As for government spending... it really doesn't matter whether we're dumping $$ in military actions, into saving Medicare & Social Security, into stimulus checks, or whatever... we need to wake up & start demanding our leaders push for fiscal responsibility. Currently, it seems like none of us consituents are willing to give anything up. Some have suggested that increased oil prices is good in that it forces us to stop using so much & seek alternatives. So maybe we will eventually stop defacing our currency via increased national debt when our foreign investors finally start demanding a higher return on our government securities. Although I suppose they already are demanding higher returns which is why our dollar is sucking sand.