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Home Publications Blogs Beat the Press Robert Samuelson Doesn't Want Us to Think Speculation Affects Oil Prices

Robert Samuelson Doesn't Want Us to Think Speculation Affects Oil Prices

Thursday, 03 May 2012 07:15
That's what he says in his column today. This seems more than a bit fantastic given the run-up in prices to $150 a barrel in 2008 followed by a plunge to less than $40. Most of these movements might be attributable to growth and then recession in the real economy, but it would require a story of incredibly inelastic supply and demand to fully explain these movements by the fundamentals of the market. There is research (here [link corrected] and here) that shows the opposite of Samuelson's assertion.
Comments (23)Add Comment
written by foosion, May 03, 2012 8:15
Your first research link is to Samuelson's column.

The paper in the second link asserts that trading in futures contracts influences prices, but does not cite any evidence beyond the large volume in trades. How does betting on the price of oil affect real world prices (unless traders take delivery)? Betting on a horse race doesn't itself affect the outcome, no matter how much is bet.
written by skeptonomist, May 03, 2012 8:50
Paul Krugman agreed strongly with Samuelson, at least in 2008 during the oil-price runup, on the grounds that there is no way to hoard large quantities of oil. Actually most refiners do have excess capacity; they would be stupid not to in view of the way oil price is subject to sudden runup. If they think oil price is going to go up, they will top up their tanks and thereby fulfill their own prophecies. Futures trading by actual users can also have the effect of shifting demand in time, a mechanism which is limited by the duration of a contract. But the great bulk of the transactions on the futures market is simply betting, which does not directly affect actual oil price. The "speculation" which does directly affect prices is that of actual users, trying to smooth out price variations.

Oil price in 2008 showed a big zig-zag which is characteristic of speculation, superimposed on a drop in demand due to the recession. But the overall price rise since about 2000 is not primarily due to speculation; nobody has cornered the market by buying up futures.

Absent more middle-east wars, the real determinant of oil price is probably Saudi reserves and production. Do they really have the reserves they claim, and can they increase production if price gets too high?
written by J, May 03, 2012 9:03
I have no idea. Although, it seems possible if one form of derivative can cause huge distortions then it's possible oil derivatives can do the same thing. I am more inclined to think it's more possible than not considering all that has happened. Foosion, I don't think the traders actually have to taken possession. That would defeat the purpose of most contracts if you actually had to take possession with every transaction. It may depend on whether they are claiming price premiums for their contracts or perhaps even the transaction costs of orchestrating such a scenario.
Re: Foosion's horse race comparison
written by Jeff Johnson, May 03, 2012 10:02
In the comment above foosion wrote: "How does betting on the price of oil affect real world prices (unless traders take delivery)? Betting on a horse race doesn't itself affect the outcome, no matter how much is bet."

In a horse race the more that is bet on a horse, the shorter the odds. The betting influences the expectations of subsequent bettors, and influences their payout. A seller or buyer of oil could certainly notice a run up in derivative prices or volume, which could influence their expectation of fair value. This same effect can happen between stock options and prices. With oil, couldn't a producer who notices a premium in the futures market interpret that as a buildup in demand, and withhold supply until a corresponding increase in spot prices is seen? And wouldn't actual users buying and selling contracts to speculators adjust the prices they will accept based on spreads in the derivatives markets?
prices and trading
written by pete, May 03, 2012 10:28
Duh...trading moves prices....but this is a chicken and egg thing. What causes the trading? Price expectations. Get the circularity! When there is a fear of a shortage, refiners may bid up the price of oil, and speculators may take that bet, i.e., going short, not long. James Hamilton has many fine articles on this topic. The CFTC had a study showing there was no difference between large posisions of hedgers or speculators, until the political machine withdrew the report and told them to come to a different conclusion. That's science!
written by foosion, May 03, 2012 10:53
Jeff is the only one to suggest a mechanism connecting futures trading and underlying prices, and the best he can say is futures trading "could" have an effect.

Here's Krugman:

"Oil speculation is back in the news. Last year I was skeptical about claims that speculation was central to the price rise, because what I considered the essential signature of a speculative price rise — physical withholding of oil from the market, in the form of high inventories — just wasn’t showing."
Krugman Has an Imaginary View of the Commodity Markets and So Does Samuelson
written by Jesse, May 03, 2012 11:02
Krugman's major hypothesis, before he changed his mind, was that there was a 'spot' market that set price, independent of the speculation in the futures market.

And so I ask, where is it? Where is the quoted bid/ask in the 'spot market?'

There is a growing divergence between physical and paper markets, but the prices quoted are still derivative of the futures markets. Take gold or silver for example since they are relatively smaller, more compact, than oil. And it becomes easier to see the truth.

What is the 'Spot Price?'
written by Jesse, May 03, 2012 11:06
Spot price in commodities for the most part is a derivative of the front month of the futures market. There are some quoted physical prices touted, such as the AM and PM price fix at the LBMA for metals, but even those have been shown to be leveraged 50:1 or even 100:1.

The mispricing of risk and the deterioration of genuine price discovery is going to bite the US financial system rather badly in the not too distant future. And economists once again will stand around and say, "Who could have known?"

speculation v. manipulation
written by pete, May 03, 2012 12:03
The conversation is getting somewhere. Krugman seems to be talking about manipulation, storing the commodity and buying futures to drive up the price and then profiting (maybe) by unwinding these two. That is far different than folks making (speculative) bets on the price of oil and having those trades impact price, i.e., have the price reflect that information. Speculation greases the wheels for commercial traders who wish to unload commodity risk. Per se it has no value, that is, good or bad, other than keeping volatility down by supplying liquidity at the appropriate time. Attacks on futures traders go back at least 100 years. When ag prices fall, farmers blame speculators. When stock indices fell in 1987, the SEC blamed futures traders. When oil rises to $150, blame the futures traders. Are they also blaming futures traders for natural gas at $2 then? Bear Stearns blamed the (speculative) short sellers for its demise. Silly economics. Shoot the messenger.
and another thing
written by Eclectic Obsvr, May 03, 2012 12:30
A particulary bad Economix piece by Casey Mulligan on social safety net. The comment thread on it is predominantly one of "what kind of bubble do you exist in?" but that won't stop him from this nonsense.
spot and future prices
written by Barkley Rosser, May 03, 2012 12:41
I think the essential point has been made. Samuelson makes a goofy argument that in effect denies that there can be any bubbles in futures markets, which is nonsense. In this case, it has been pointed out that the spot price is in effect the front end of the futures market. It is correct that all Krugman showed was that there was not manipulation, something that could also be said about the real estate market. But certainly there was a speculative bubble in the real estate market.

As it is, the presence of speculators increases the volatility of the market, makes it easier for there to be a speculative bubble. As Kindleberger and Minsky both argued, most bubbles begin with a fundamental shock, but then keep on going. That there were fundamental pressures for higher prices during the period immediately prior to 2008, does not disprove that there was a speculative bubble in the spot price of oil during the first half of 2008, which by now most observers think. Anybody who wants to see more discussion by me on this, check out my paper "A Minsky-Kindleberger Perspective on the Financial Crisis," pretty far down on my website at http://cob.jmu.edu/rosserjb .
backward barkley?
written by pete, May 03, 2012 1:00
Speculators increase volatility? Wow. What kind of model is that? It is a lack of speculation...such as the inability to short sell real estate, which allows bubbles to form. Hence Shiller/Case attempt to have real estate futures so short sellers could participate. Not too successful. Finally John Paulson speculated that real estate prices were too high and started shorting everything he could find, made a ton of money and probably did much to burst the bubble. More speculation, not less, is clearly needed.

This kind of thinking reminds me of CNBC talking heads "Prices were up today as there was a lot of buying...." So funny. Every trade is a buy and a sell. Every speculative long position in oil is matched with a short position.

When there is a fear in the market, and prices spike, and then drop back, that is not a bubble. The problem is some folks "know" what the price of things should be, and "know" that the market is wrong. This is very presumptuous if not outright dangerous thinking.
written by skeptonomist, May 03, 2012 1:07
One thing that makes the oil market unique is its instant sensitivity to political events, and both real users and speculators will try to anticipate such events, so there can be bubbles in advance of real shocks, even if the events don't occur.

What happens with respect to Iran is especially relevant. Does Obama really want to prevent Iran from selling any oil on the world market? If the sanctions were really effective, price would go up and a large increase in oil price would not help his chances for re-election. This situation could change for any number of reasons.
speculation and noise
written by pete, May 03, 2012 3:29
best to think of speculators as noise traders in traditional informed/uninformed models. More noise traders (more speculators) means that (law of large numbers) there is a higher likelihood that the price won't move much, basically because they are idiots and their trading offsets (long v. short).

this fits in perfect with evidence from the hedge fund industry, where profits typically average 0 with plenty of winners and losers. like paulson making money in 2008, losing since then. i.e., hedge funds are just noise traders...greasing the wheels. (and redistributing income from the 1% to the hedge fund managers and staff)
sorry, pete, but no
written by Barkley Rosser, May 03, 2012 3:37
pete, So sure, if one compares a market with no futures markets and hence no "speculators," particularly one that involves time such as many agricultural markets, there will be a stabilization that occurs when such are introduced compared to when none are there, and also with a corresponding increase in production as the hedging farmers feel confident that they can get a price they plan for when they sell.

But more generally, as the ratio of "speculators" who chase trends in markets rises compared to "fundamentalists" who trade only on, well, fundamentals rises, markets tend to become destabilized and trends, aka, bubbles are more likely to appear, even in the presence of short selling. The latter does not help much to stabilize things, sorry. You sound like Milton Friedman declaring that flexible exchange rates would be very stable because speculators will always lose money.

The lit on this is simpy huge, pete, if you are actually an economist and no anything. The definitive paper that showed that trend-chasing speculators could not only survive but make more money than fundamentalists is "Noise trader risk in financial markets" in the JPE in 1990 by DeLong, Shleifer, Summers, and Waldmann. The lit on how increasing the ratio of trend-chasing speculators can destabilize markets is simply enormous and growing. For some oldies but goodies, try Baumol in ReStat in 1957, Zeeman in JMathEcon in 1974, Brock and Hommes, JEDC 1998. I could go on and on.
written by bmz, May 04, 2012 6:59
BTW guys,greatcomments today!
written by liberal, May 04, 2012 10:04
Building on what Jesse says above, I've read that it's not really correct to view the oil "spot" market as a textbook spot market---e.g. a lot of oil is sold via long-term contracts whose prices are determined by the prices in the futures market. But I don't know enough about this topic to really opine.
nice theory, don't fit the facts
written by pete, May 04, 2012 11:25
Facts are that speculators (i.e., active traders) are idiots and do not make money, on average. Hedge funds are on both sides of every market, since it takes people on both sides of the market to trade. Speculators cannot all line up on one side of the market...it really simply doesn't add up. For every trend chaser there's a contrarian. Thats why each year some funds make and some lose money. The papers by Summers and deLong were clearly just coming up with a cute theory to fit an event like the 1987 crash. Sandy Grossman chipped in at the time blaming portfolio insurance guys. Everybody had a cute theory to explain the crash. Stuff happens.
response to pete
written by Barkley Rosser, May 04, 2012 1:45
One minute you are asking for a "model," the next you want facts. First, hedging farmers are not the same as hedge funds, who indeed do play both sides of the market. Nevertheless, while many speculators lose money, some make it and make it big time. It is called buy low and sell high, and some people pull it off, from Cantillon in the Mississippi and South Sea bubbles in 1719-20 to Joe Kennedy in the 1920s. The DeLong et al paper does not say all speculators make money, just that some do and do better than anybody else, which is what we see in the real world.

So, please, pete, no more tripe about how speculators only stabilize markets. Not true in theory or reality in general, although certainly true for some important cases that I have already delineated.
Shocks, boundaries, and relatively large objects
written by David, May 04, 2012 2:50
If I fall into a full bath tub, there are big waves; if a car drives into the pool, also big waves; if an asteroid falls in the ocean, species get wiped out.

So, large shocks can have large effects in bounded systems. The futures market is definitely bounded. One JP Morgan's index futures traders has been making huge trades to the effect that other traders noticed 'distortions' in market prices (that is a $10 trillion market) [see http://www.bloomberg.com/news/...dexes.html]. Also, just last week there was a $14 million (plus disgorgement) finding against one company by the CFTC for oil market manipulation http://www.cftc.gov/PressRoom/.../pr6239-12; something that the Republicans seemed to ignore studiously, seeing as how it doesn't fit the party line.

One problem is that if a small arbitrage opportunity arises in the market, someone with deep pockets can profit off that arbitrage. Whether a price inflation induced by such an arbitrage maneuver can persist in the market is a principal question, then. But one part of the market can attempt to manipulate the market, yet for how long?

I find the horse race analogy is seriously flawed, by the way. There is no margin, no mark-to-market, etc.
Evidence undisputed
written by David, May 04, 2012 10:11
" Federal Court Orders $14 Million in Fines and Disgorgement Stemming from CFTC Charges against Optiver and Others for Manipulation of NYMEX Crude Oil, Heating Oil, and Gasoline Futures Contracts and Making False Statements" [url= www.cftc.gov/PressRoom/PressRe...39-12
written by eric, May 05, 2012 12:09
Speculation influences oil prices, but the speculation is highly dependent on supply and demand inelasticities. Basically, the world's oil production is much, much more constrained than it was ten years ago. Between 2002 and 2005, oil prices went up and oil production went up. Then, between 2005 and 2008, oil prices went up, but oil production did not. If the supply were not constrained, production would have gone up and prices wouldn't have spiked as they did. You should really look at those numbers, Dean. The story they tell is very different from the housing market, with which you are very familiar. It's as if house prices followed the trajectory they did, but people had stopped building more houses in 2003. You'd be like, WTF! And since that is basically what happened in the oil market, you should be having the same shocked reaction. Everyone in the industry with eyes to see knew that production was not increasing despite the higher prices and the furious drilling, so everyone expected prices to keep going up, so the price went up. But then the economy crashed, driving demand down, so prices went down. This is all pretty basic economics. Look at those price and production numbers for 2002-2005 and 2005-2008. They're amazing.

written by pj, May 05, 2012 5:02
"Betting on a horse race doesn't itself affect the outcome, no matter how much is bet. "

You wanna bet? Horse owners wager, too.

Horse owner sees his entry bet big as an overwhelming 1-5 favorite in a weak field. Horse owner see greater value ahead, advises jockey to save a winning effort for better odds. Horse owner cleans up three weeks later at 4-1.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.