Oil Prices & Speculators. James L. Smith RFF First Wednesday Forum May 2, 2012

Transcription

1 Oil Prices & Speculators James L. Smith RFF First Wednesday Forum May 2, 2012

2 What Do We Know? 1. Oil prices have done some weird things.

3 The Great Oil Price Spike, Jan 2004: $ 34 July 2008: $145 Jan 2009: $ 34

4 What Do We Know? 1. Oil prices have done some weird things. 2. Financial traders have swarmed into the market.

5 The Increasing Role of Financial Traders

6 What Do We Know? 1. Oil prices have done some weird things. 2. Financial traders have swarmed into the market. 3. It appears that financial traders may have caused oil prices to do some weird things.

7 The Debate -- on Wall Street and Main Street Why Were Oil Prices So High? Speculators vs Fundamentals the bubble will burst the shortage will persist"

8 What are Fundamentals Anyway?

9 Quantity Index (1975 = 100) Global Oil Consumption, Consumption Source: BP Statistical Review of World Energy, 2011

10 Quantifying a Shift in Demand Price If Supply is inelastic, the increase in demand is not fully revealed. S P 2 P 1 D 1 D 2 Q 1 Q* Q 2 Quantity

11 Quantity Index (1975 = 100) Global Oil Demand, Demand Source: J. L. Smith, J. of Econ. Perspectives, 2009 (updated)

12 Quantity Index (1975 = 100) Non-OPEC Oil Supply, Demand Supply (Non-OPEC) Source: J. L. Smith, J. of Econ. Perspectives, 2009 (updated)

13 Quantity Index (1975 = 100) OPEC Production Did Not Fill the Gap Demand Supply (Non-OPEC) OPEC Production Source: J. L. Smith, J. of Econ. Perspectives, 2009 (updated)

14 Oil Prices are High Because OPEC Capacity is Low Since 2000 Demand increased by 53% Non-OPEC Supply decreased by 23% OPEC production capacity increased only by 7%

15 The Quantity Theory of Futures Financial traders brought new money to the futures market that drove up the price of oil. Fixed supply of oil Greater demand Higher price (duh) Like the Quantity Theory of Money M V = P Q

16 The Quantity Theory of Wine

17 Quantity Theory of Futures Fails Because Unlike 2009 Bordeaux, futures contracts are not in fixed supply. Unlike 2009 Bordeaux, the purchaser of a futures contract does not take delivery (cash settlement). Unlike 2009 Bordeaux, cash settlement requires each trader to sell back what he initially bought, or buy back what he initially sold. Unlike 2009 Bordeaux, buying pressure = selling pressure = no pressure.

18 Small Gold Trader Makes Big Impact Splash MARKETS: JANUARY 28, 2011 Small Gold Trader Makes Big Splash Daniel Shak's Aggressive Bet Grabbed Sizable Chunk of Contracts, But Prices Fell and Wager Went Bad By CAROLYN CUI And GREGORY ZUCKERMAN A huge trade by a tiny hedge fund has sent shudders through the gold market. Thanks to the nature of futures trading, Daniel Shak's $10 million hedge fund held gold contracts valued at more than $850 million, more than 10% of the main U.S. futures market, and the equivalent of South Africa's annual gold production. But as gold prices started falling this year, the trade, which was a combination of being long and short gold contracts bets that prices will both rise and fall started going bad. Monday, he liquidated his position, and is returning money to clients. As a result, the number of gold contracts on CME Group Inc.'s Comex division plunged more than 81,000, to about 500,000, the biggest single reduction ever. While his trade didn't account for all of the contracts, an average daily move is about 3,000 to 5,000 contracts.

19 What Do We Do? 1. Think carefully. 2. Review all the evidence. 3. Learn from the past.

20 Where do the Speculators Fit In? It is still rather generally believed that futures markets are primarily speculative markets. They appear so on superficial observation, as the earth appears, from such observation, to be flat. -- Holbrook Working, Stanford University,1960

21 Déjà Vu, All Over Again The popular fear of engrossing and forestalling may be compared to the popular terrors and suspicions of witchcraft. The unfortunate wretches accused of this latter crime were not more innocent of the misfortunes imputed to them, than those who have been accused of the former. No trade deserves more the full protection of the law, and no trade requires it so much, because no trade is so much exposed to popular odium. -- Adam Smith, The Wealth of Nations, 1776

22 Thank You