Are speculators to blame for soaring gas prices?
On Monday, dozens of congressional Democrats sent off a letter asking federal regulators to crack down on “fraud, abuse, and manipulation” in the oil markets — in effect, arguing that Wall Street is inflating gas prices. That raises two questions: Is this true? And can anything be done about it?
Many analysts agree that trading activity is pushing up oil prices over and above what supply and demand would normally dictate — and much of this has been driven by fear over a possible conflict with Iran. “Speculation has inflated oil prices by more than 30%,” says Fadel Gheit, an oil analyst at Oppenheimer & Co. That’s in line with other estimates: A recent paper (pdf) by the Federal Reserve Bank of St. Louis found that “financial speculative demand shocks” were responsible for at least 15 percent of the huge run-up in oil prices between 2004 and 2008. The tricky part, though, is figuring out what this speculation actually amounts to — and whether it serves any legitimate purposes.
When people talk about “oil speculation,” they’re usually referring to one of two types of activities. First, there are buyers who actually need oil and want to hedge against wild price fluctuations. But that’s not all that’s going on. Over the last decade, large financial institutions, hedge funds, and other investors have rushed into the oil market to take advantage of big price swings. These traders aren’t buying oil for personal use — typically, they’re betting on which way prices will move. And there’s a lot of money in this: In 2004, there was just $13 billion invested in commodity index trading strategies; by 2008, that had swelled to $260 billion.
These speculators can influence the price of oil in a variety of ways. Say, for instance, that traders buy up a large number of futures contracts — because they think that Iran might threaten the Strait of Hormuz and disrupt oil shipping lanes. That pushes up the price of oil for future delivery. Oil producers, in turn, could respond by holding some oil back from the market, so that they can sell it for this higher price later on. (They can do this by building up inventories, or by paring back on production, or by ordering their tankers to move more slowly in transporting oil for delivery.) That pushes up the current price of oil — not because there’s a shortage, but because traders made certain bets.
Now, many economists argue that this type of speculation can serve a legitimate purpose. “If there’s a risk of a supply disruption in the future, then we’d want to store a little more oil right now so that we had that contingency for later,” says James Hamilton, an oil expert at UC San Diego. “That’s what speculation amounts to. If we were right to be worried, it will turn out to be a good thing. If we’re wrong, then the run-up in price will turn out to be a waste. The question is, are we right or wrong? I’m not sure.”
In essence, says energy analyst Stephen Schork, a lot of oil speculation works like insurance. Countries and companies that need oil are willing to pay a “risk premium” now in order to ensure that they’ll have oil at a reasonable price in the future, even if shortages erupt. Schork adds that oil speculators are typically piggybacking on fundamentals — like the fact that global supplies are tight. By contrast, in the natural gas market, speculators are actually pushing prices down to decade-low levels. “That’s because the fundamentals in that market are the polar opposite,” Schork says.
Indeed, the idea that speculators play a secondary role is essentially what the St. Louis Fed paper, written by Lucia Juvenal and Ivan Petrella concluded. They found that about 44 percent of the price increase between 2004 and 2008 — when oil zoomed up to $140 per barrel — was driven by shifts in global demand. Countries like China, India, and Brazil kept using more oil, while production from countries like Saudi Arabia couldn’t keep up. But an additional 15 percent of the price increase was caused by speculators. And many of those traders turned out to be betting the wrong way. When prices crashed back down to $30 per barrel after the financial crisis hit, those investors lost a lot of money.
Meanwhile, not all speculation is benign. One fear that congressional Democrats have raised is that a few large traders might corner the oil market with unusually large positions and manipulate prices to their own advantage. This is what many people mean by “excessive speculation.” In their letter to the Commodity Futures Trading Commission (CFTC), the Democrats noted that the agency has been dragging its heels on enacting “position limits,” which would prevent any one trader from dominating the oil futures market.
Many analysts, however, are not so optimistic that the CFTC can actually prevent this sort of speculation. Some are cynical about the political landscape. “The CFTC cannot stop speculation because the financial lobby is too strong,” grouses Gheit. Others raise more practical concerns. Schork, for one, points out that the global oil market is too large for U.S. regulators to police. “If you go and put a position limit on [contracts in the New York Mercantile Exchange], fine,” he says. “But a significant amount of trading is in the Brent market, which isn’t in New York. You’ll do nothing to relieve volatility.”
So that’s the fairly unsatisfying bottom line: Wall Street is helping to drive up oil prices, but it’s not always nefarious, and many observers seem pessimistic that anything can be done about it.