Commodity Speculators...Good or Bad?

If one were to ask Watchblog readers the following question, I would guess that a majority would answer YES.

The question is simply, if you expected a reduced harvest of wheat, corn, soybeans, coffee or any other commodity some time in the future, would you reduce your consumption of that commodity today? Reduced consumption would be the reasonable and prudent action but how in the world could everyone, everywhere be convinced to voluntarily reduce their own personal consumption? Some might be tempted to say that government should do that job by subsidization or taxation. This would assume of course, that the government really has the correct information about the future supply of any particular commodity at any given point in time. They don’t, and neither does anyone else on the planet.

Commodity markets formed to address the risk of scarcity and abundance and that affect upon price. Millions upon millions of commodity traders all over the world bet on future supplies of commodities. Anticipated future shortages of a commodity cause traders to buy more of it today in hopes of selling it in the future for a price higher than they paid. As a result, the current price of that commodity rises and less is consumed. This action preserves more of the commodity to be available when the future shortage arrives.

Conversely, traders anticipating a surplus of a commodity at some point in the future may choose to sell that commodity today, at today's prices, hoping to buy back the commodity at a lower price than they paid for it. As a result, the current price of that commodity falls and more is consumed. This action consumes more of the commodity today to be replaced by the expected greater future supply.

There is no guarantee that traders will make money. They can be as likely as government to guess wrong. Some wish to end speculative trading in commodities or greatly limit the freedom of traders. It could easily be outlawed or severely reduced by congress. And, in doing so, even though future supplies are expected to be reduced, today's prices would not be affected.

Now, let's consider oil...the commodity. Some have written that even if the US were to relax regulations, and restrictions on drilling, the impact on today's prices would be minimal because of the years it would take for that new oil to reach the market. Is that really true?

Let's examine how OPEC might react to news that the US was going full tilt to produce more oil. If OPEC is receiving $100/barrel of oil today, and anticipates, because of US actions, that oil will be $50/barrel in five or ten years, what would be the prudent action by OPEC? Anyone who is honest about the nature of humans and governments will answer that OPEC will sell all they can now at the higher price, rather than later at the lower price.

Selling more oil now will place downward pressures on current oil prices. It will not take five or ten years for actions taken today to have an affect on prices today.

By keeping our oil in the ground we are OPEC's strongest ally. President Obama, and the leaders of the other 27 nations did the correct thing for consumers, and their nations economy, by releasing 60 million barrels of reserve oil. Now, the president should lead the way in calling for more oil production here in the US. And, as this will further enrich oil companies, the carrot should be combined with the stick of greatly reducing, or eliminating oil subsidies.

The political resistance to such bold action would be furious and come from both sides of the aisle, but for different reasons. A discussion of this resistance, which would be interesting, is not the point of this article.

If oil, and other fossil fuels are critical to our nation today, and if the price of those commodities can be reduced today, it is my belief that it would provide tremendous financial relief for each and every American, boost our nation's economy, and create a vast number of jobs in the private sector.

The discussion of increasing national debt limits, cutting government spending, changing the tax code, and more is important, even critical to our continued and long-term well-being. However, not one of those political issues can help us immediately in the way that lower cost energy can and will if we have the courage to act responsibly.

Posted by Royal Flush at June 25, 2011 2:58 PM
Comment #324998

Well balanced article. What is impressive about the action is that the IEA countries, led by the US, took proactive action to address the real and speculative impacts of the Libyan oil disruption. Its about time that consumer nations got ahead of the curve on oil shocks.

“Now, the president should lead the way in calling for more oil production here in the US.”

Agree. Obama actually has called for more oil production and has released additional reserves for exploration and extraction. But, he should be clearer about this issue and end the environmental standoffs with the establishment of reasonable but enforceable national standards balancing safety and the environment with our national needs for energy. It should be noted that despite the Gulf disaster and the moratorium, oil production in the US hit a ten year high in 2010 and is anticipated to increase in the future.

What I think is lacking is a national energy policy providing for an integrated and prioritized approach to meeting our future energy needs. It is not oil or gas or wind or solar or smart grids, etc. It is all of the above if we are going to meet our energy needs of the future. It is the infrastructure problem of this generation.

Lost in the shuffle of this debate is the most effective measure available: efficient use of energy. If there is one lesson that should have been learned from the oil shocks of the 70s is that the biggest bang for the buck came from conservation measures. It is the least controversial and costly approach but receives the least attention. That is probably overstated since hybrid and electric cars are a major focus. However, it seems to me that we have only scratched the surface of energy efficiency.

Posted by: Rich at June 25, 2011 6:55 PM
Comment #325002
Well balanced article.

I second that. I actually thought this was a C&J piece until I got to the end.

the carrot should be combined with the stick of greatly reducing, or eliminating oil subsidies.

In my opinion, this is critical. I’m more than happy to roll back restrictions against offshore drilling/drilling on federal land if we eliminate subsidies for the fossil fuel industry. However, fossil fuels will remain subsidized fuels until we find a way to price the costs of greenhouse gas emissions.

Posted by: Warped Reality at June 25, 2011 7:25 PM
Comment #325009

The primary purpose of commodity trading is to hedge risk, and ensure a price at a future date of delivery. However, if someone wants to reduce risk, someone else must take the other side of the transaction, and assume risk.

Markets do not function without ‘speculators.’

Having said that, speculation can become overblown, resulting in a bubble. That’s fine. A market will work itself out; unless, of course, the item in question is crucial to national security or the health of the economy. At that point, government intervention becomes necessary. A free market is not a suicide pact.

Obama showed brilliance in using the oil reserves to cream oil speculators. In the future, just the threat of intervention will be enough to prevent that particular market from becoming overheated.

Posted by: phx8 at June 25, 2011 9:18 PM
Comment #325076

The original intent of derivatives, in particular futures, was to stabilize prices. But that only happens if people don’t have the capacity to manipulate the market, changing available supply in order to drive up or drive down prices.

Unregulated speculation has a way of destabilizing the economy, because it becomes more like high-stakes poker with the high-rollers cheating than an honest game of skillful price setting. Oil companies play along because naturally it yields a terrific price for them. But the rest of us, and the economy that depends upon us, suffers for that.

There are many ways to become rich, not all of which benefit society in terms. A good economy always has the people looking to increase their wealth lead to make this deal: I will do something of value to you, for what you give of value to me.

We have to constrain the selfish and the greedy in such a way that they are forced to do something good for the rest of us if they don’t want to face ruin. Otherwise, the race to the top will become a race to the bottom as well

Posted by: Stephen Daugherty at June 28, 2011 8:42 PM
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