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Oil Speculators to Blame for Gas Prices?

7/26/2012 04:28:00 PM
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An expert on energy markets and the macroeconomics of energy price shocks, Lutz Kilian, writes a nice post on oil speculators here.

Here's a point I've been wanting to make. Oil speculators are people who bet on the future price of oil. When we say that oil speculators are bidding up the price of  oil, what we are really saying is that there are a group of investors buying oil now with the intent of selling it in the future at a higher price. These investors themselves may never actually see a drop of that oil, instead just trading paper claims, but for each oil futures claim being traded, there is a barrel of oil being stockpiled by someone somewhere on their behalf. So the effect of a speculator betting on a future price hike is to stockpile some oil now and sell it later. That means that the current price of oil does indeed rise, but that the future price of oil is lower than what it would otherwise have been, due to the release of the stockpiled oil.

Now, there are two possibilities. Either the speculators turn out to be right in their prediction, or they turn out to be wrong. If they are right, then the effect of speculation is to reduce the volatility of oil prices over time. If they are wrong, then the effect is to increase the volatility of oil prices over time (the will have stockpiled oil when the price was high and sold it when the price was low). In neither case is there a permanent increase in the price of oil, and on average over time speculators have no impact on oil prices.

Now, if speculators tend to be right most of the time, then we ought to let them do what they are doing--eliminating price volatility reduces macroeconomic risk and should be favored. If they are wrong most of the time, then it may be worth improving regulations to discourage this kind of erroneous speculation. But there is something very curious about this--if the speculators are systematically wrong in their predictions, then they are systematically loosing money already. So if this is true then regulators are in for a very strange mission indeed: how do we further discourage an activity that is already very unprofitable?