A friend keeps telling me that speculation drove the price of oil to extreme heights last year. I'm not too well schooled in futures yet, but I don't see how this could be the case. The 'price' of oil that is quoted in the media is what, the spot price or the near-month price? And doesn't any forward contract have to converge to the spot price at expiration? Then how could speculation drive up oil prices, since speculators, by definition, are buying and selling contracts and exiting prior to notice, not buying and selling spot oil? Doesn't supply and demand have to govern the price of oil? If I am confused, please straighten me out. If I am not confused, tell me how to straighten my friend out--although, I think I probably won't do so since he is such fun to argue with. thanks
The arbitragers play a key role in this. When speculators drive up the future price, arbitrager will try to profit by -selling the (overpriced) future now -buying spot now incur the cost of carry for delivery on the expiration date -delivering the goods and profit from the "riskfree" opportunity on expiration date When the buying pressure on the spot (from arbitrager) exceed the selling pressure on the future (due to speculator keep pushing future price up), spot price eventually gets driven up. I hope this make sense, since I haven't touch Level II CFA material for awhile. PA
to say that "speculators" drive up the price reflects the negative attitude of the speaker toward the situation, the speaker is mostly a victim of the situation, e.g., a gas consumer. to give you an analogy, a person who hates Arabs a lot would call those Arabs who throw rocks at US tanks "terrorists." for example, Joe Lieberman will jump up at every opportunity to call an Arab a "terrorist." on the other hand, an Arab would call the guy who drives the tank an "invader," and worship the guy who throws rocks as a "hero." In summary, to call market participants "speculators" actually reveals the speaker himself more than anything else. ok, to answer the question of why price goes up: demand surpasses supply. It was a time countries such as China bought a lot, airlines bought a lot. After they finished buying, price went down. But of course, if Martians decided to buy after China, oil price would have continued to rise, probably to $500 a barrel, just like gold (remember the Indians bought tons of gold a short while ago?). you may also find that some of those who call others "speculators" happened to be the buyers themselves. Many airlines who hated "speculators" have bought heavily into crude oil futures, many of them have lost billions of dollars as a result of their own "speculation": Air France, Air China, China Eastern, Northwest.....
While the definition of the word may be neutral, the connotation is definitely negative. it is often associated with risky action, gambling, etc.
I don't understand how people say that the price is driven up. when demand exceeds supply the price at which someone is willing to sell at becomes higher naturally. The bottom line is that at that moment in time two people agreed on a price. The buyer has reason to believe that the price will continue up while the seller has just as much reason to believe the price will not rise any longer, otherwise why would he be selling? Isn't the seller as much as a speculator as the buyer?
You have to understand that the The most powerful and influential speculator in the commodities market is the US Federal Reserve bank. Since the start of 2005/07 the dollar's correlation with U.S. crude oil has averaged 85%, so most of the time as the dollar fell versus the euro, oil rose. When the crude oil hit a record $147.27 a barrel in 2008 the dollar was trading at record low of $1.60 at the same time. When the dollar got stronger and trade at the $1,25-$1,30 levels the WTI trade at $34-$40. commodity prices tend to benefit from a weaker dollar because a declining U.S. currency makes dollar-priced commodities cheaper for non-U.S. buyers. In other words, you get more oil for a million euros whenever the dollar weakens against the euro and you are encouraged to take that extra oil now in an environment where spot oil is cheaper than futures prices.
I have a difficult time with the supply demand equation. The real estate bubble was not based on supply and demand, but easy credit. Perhaps the rise in oil price was based on too much money (leverage, margin requiremnts, etc.). What came first, the spec pushing oil prices up or the media announcing peak oil? I think the spec in oil came first. The media exacerbated the problem just as they did with housing bubble.
The energy market is unique by nature. With the credit Boom, countries like china and india (and almost the rest of the world) became more "richer", The Oil markets was in a very strong Backwardation in 2007 and early 2008.. When the Credit Boom burst those "new rich kids" stopped buying commodities. Of course is a more complex and sophisticated situation than my explanation, but I'm trying to simplify things for you. like the other poster said, arbitrageur play a big role, also we have a HUGE ponzi scheme with GoldmanSachs/Oil ETF rollover scam (this play a very important role). The commodities OTC market is a 600 Trillion dollar a year monster, futures market is nothing compares to that. OIl producing countries like Saudi Arabia, Venezuela etc have their currencies attached to the USD dollar, even Oil and some others metals are tied to the USD. Today we have parasites like JPMC buying and storing physical oil.. Those banks not only are trading physical oil, but they are the ones offering the swaps, they are the ones trading the physical Freight markets, they are brokering the OTC markets, underwriting those ETF scams and trading the futures too. Morgan Stanley has for years run a large business buying, selling, transporting and storing jet fuel and gas oil, making it one of the largest importers into the United States. That's why we need the Glass-Steagal act back. But it is much easier for the bureaucrats in washington to blame the futures trader while they're bailing out these corrupt banks. What we need is more especulators in this market, no otherwise. a strong USD, and we need the Glass-Steagal act back. That will be a good start.