In Defence of Speculators

Looking at those funds which are speculating in the oil futures, Ambrose E-P has this to say:

It is unclear whether the US Commodity Futures and Trading Commission would resort to such methods if oil keeps rising. The key players these days are pension funds and investors building up positions in long-term futures contracts through commodity index funds, now worth some $250bn.

They are encouraging oil companies to invest in exploration by guaranteeing high prices five or 10 years ahead. Arguably, they are performing a public service.

There\’s no arguably about this point, nor his first one, that price controls in many countries, allied with subsidies for oil consumption, are driving up prices.

It\’s a point that Adam Smith made all those years ago: that speculators do indeed perform a valuable service by pursuing their own enlightened self interest. Sure, they\’re just trying to make a profit, but what is the effect of their doing so?

Think through it this way: there\’s going to be a shortage in the future (or at least, we think there is going to be). So, do we want to carry on with prices (and thus consumption) just as they are until that shortage arrives? Adam was talking about corn, but the logic works just as well for oil here. Do we want to carry on gaily eating lots of bread until we go to the granary and find it empty, with three months still to go to the next harvest? Do we want to carry on gas guzzling at $40 a barrel and then, in a year or two\’s time, find that the petrol stations are empty?

No, clearly not, we\’d rather start to moderate our consumption now, wouldn\’t we? For by doing so we\’ll use less now and that hole in the granary will be smaller, fewer petrol stations will be empty, because we\’ll not use so much in the immediate future, before that paucity of supply finally makes itself apparent in the physical supply.

And of course higher prices are both the signal for us to do this, to economise upon consumption, and also the cosh which forces us to economise on said consumption.

Pretty good system? Eh?

Further, such higher prices encourage farmers, in the case of corn, to plant more for next season, with oil, they encourage more exploration….and we do need to note that exploration isn\’t just a matter of trying to find more pools of oil, it\’s also a matter of technology, or working out how to get more out of the pools we know about. I\’m a little behind on this point but I think it\’s true to say that we currently only get some 25-30% of the extant oil out of each reservoir that we do find. That\’s a number that has doubled in the past few decades and there\’s no particular reasono to think that it can\’t be raised again.

So a very good system, eh?

And it all depends upon those speculators. They move prices around in time for us and a damn good thing they do as well.

3 thoughts on “In Defence of Speculators”

  1. Adam? Rather familiar.

    This description of speculators is only sort-of-true, isn’t it? When oil went under $10/bbl in 1999, they must have been predicting a huge glut in oil in the decades to come, and now they are predicting a major shortage. Markets can overshoot, and if we are in a ‘bubble’ then they aren’t performing a brilliantly useful function.

  2. Pingback: Money, The Honest Messenger | Charles Crawford

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