Speculation responsible for high oil prices?

The short answer is no. However, before you stop reading here, our opinion matters less than some, even if we’re more right. US congress has assembled a panel of ‘experts’, and they unanimously arrived at the conclusion that 50% of the oil price rises are attributable to speculation. 

As a result, the House of Representatives voted overwhelmingly in favour of a bill to curb ‘speculation’ in energy markets. Investigations are already underway into possible ‘manipulation’ in oil markets.

We have the following simple question to ask those that espouse this ‘theory’: if ‘speculation’ (or even worse, ‘manipulation’) is responsible for half of the rise in the oil market, where are the accumulating inventories?

Let us explain. Saying that half the price rise in oil doesn’t reflect fundamental supply and demand, but is the result of ‘speculation’ means that the price is too high, way too high actually, for the oil market to find equilibrium on it’s own.

Equilibrium means equating supply and demand. A higher price than the price which establishes such equilibrium (unimaginatively called the ‘equilibrium’ price) would involve supply being larger than demand.

The higher the price, the bigger the incentive to increase supply, and the more expensive oil becomes, so demand will decrease, opening up an ever greater gap between supply and demand.

Now, we argued earlier that supply and demand in the oil market are not very elastic, that is, they’re not very responsive to price changes, but even minimal responsiveness requires that a higher price than the equilibrium price would necessarily involve supply being larger than demand.

That requires inventories of unsold oil to pile up, somewhere, hence our question, where are these inventories??

The answer is, there are no inventories piling up. But wait a minute, you might retort, the extra demand is exerted by the speculators, isn’t it?

Well, not really. We are unaware that speculators are accumulating large inventories of oil. In fact, speculators do not buy oil, they buy oil futures, which are pieces of paper with a promise for an oil delivery at a certain time in the future.

These future contracts are not exercised by speculators, so the fact that no inventories are accumulating means that the oil market is still in fundamental equilibrium, all the oil gets used, even at $143 per barrel. How a US congress can fall for this scam is really beyond us. We would like to know who are on that panel of ‘specialists’…

2 thoughts on “Speculation responsible for high oil prices?”

Comments are closed.