Tuesday, June 24, 2008

Facts vs. Speculation

The Wall Street Journal does an excellent job of explaining why blaming speculators for today's high gas prices doesn't make much sense. Read the entire editorial for yourself, but here is one highlight that caught my eye:

The futures market may be a convenient scapegoat, but it's simply a price discovery mechanism. Major energy consumers – refiners, airlines – buy and sell these contracts to lock in goods at a future price, as a hedge against volatility. Essentially, they're guesses about coming oil supply and demand, as well as the rate of inflation. The political theory is that such futures trading is creating a bubble in the spot market (i.e., oil purchased for immediate delivery) beyond oil fundamentals. Thus, $4 gas.

But there's no inherent reason to "bet" that commodities will go up rather than down. Bet wrong – place all your chips on red, say – and you lose. If a company purchases the future right to buy oil at $140 a barrel and it instead sells for $130, the option is worthless. Besides, somebody has to take the other side of any futures contract: Some are trying to predict where the price will go in the future, while the other side is attempting to sell its future price risk. But no one knows how things will end up.

As anyone who's seen the movie Trading Places with Eddie Murphy and Dan Akroyd can tell you, the commodities market is nothing new. And--if you recall--the evil ??? Brothers lost their bet on frozen orange juice.

Like OJ, oil six months from now will have an inherent worth. Promising today to pay $150 for a barrel will not stop that barrel from being worth $50, nor does it ensure the oil will be worth $200. Blaming investors for the price of oil is like blaming GM stockholders for the decline in car sales.

It's not the money that's the problem. It's the market. Supply and demand.