Speculating About Speculators

There has been a lot of talk concerning the influence of speculative activity on the price of oil. All of the sudden, we are hearing that speculators are responsible for oil prices going up and for the fact that we have to pay more at the pump. Of course, this all fits in with the need of certain portions of the political class to find a narrative that identifies and excoriates certain human villains for the increase in the price of oil—thus making us feel better about having found and excoriated those villains and causing us to believe that if only we punish the villains, we will be able to solve the problem of high oil prices at the same time, or at least be well on the way towards solving the problem of high oil prices.

Well, it just ain’t so. Read the whole thing, but here’s the key passage:

. there’s nothing about futures or options that makes it any more attractive to bet that commodity prices will go up than to bet they’ll go down. Guess wrong on the direction, and you lose money.

And that’s basically all you need to know about speculation. When you speculate on the price of a commodity, what you are doing is betting on whether that price will rise or whether it will fall. Not whether you wish it would rise or fall. Not whether you hope it would rise or fall. And your money will do nothing to cause the price of oil to rise or fall. It will do so based on—wait for it! —the laws of supply and demand.

Right now, we don’t have that much in terms of supply. We have huge demand—especially from the Chinese and the Indians. We have precious little refining capacity as well. This raises the price of oil and causes us to pay more at the pump. Speculators understand this and that is why they are currently betting that the price of oil will go up. But their bets don’t cause the price of oil to go up and if any speculator bet on oil prices to go up during the 1980s—back when oil prices were actually crashing through the floor—that speculator would have lost his or her shirt.

It’s amazing how much you begin to understand about economics when you realize that economic forces are significantly beyond the control of human beings to influence and that they are significantly more under the influence of the laws of supply and demand. Once that knowledge becomes widespread, we won’t waste our time blaming people like speculators for the fluctuations in the price of oil.