Last week, maverick U.S. Senator Joseph Lieberman tabled a sweeping plan to rein in the world oil price. As far as Lieberman and many of his congressional colleagues are concerned, the sharp and painful rise in energy prices over the past year or so is the work of a shadowy cabal of unaccountable market “speculators” pummelling consumers with no regard for the laws of supply and demand. His plan would prohibit institutions (like pension and hedge funds) with more than $500 million in assets from investing in energy and agricultural commodities.
Not long ago, this kind of restriction would have been considered draconian, if not outright bonkers. But Lieberman has on his side a Congress desperate to assign blame, and pander to constituents furious over rising pump prices. What they need is a scapegoat, and earlier this year legendary financier and hedge fund manager George Soros gave it to them. Soros walked into Congress and pointed his finger squarely at the aforementioned greedy “speculators” as the source of all our energy woes.
Soros said many important things in his testimony. For instance, he said there are real and legitimate reasons for rising prices. He also admitted that he is not really an expert on energy markets. But those two key caveats were utterly overshadowed by the central theme of his address—that world oil markets are in the midst of an unsustainable bubble, being inflated and manipulated by shadowy and unaccountable traders, driving the market to insane and unsustainable heights. His opinion was seconded by another prominent hedge fund manager, Michael Masters, and has quickly been adopted by a host of commentators who are quick to agree there’s something fishy about oil’s stunning climb.
The most recent voice to join the SorosLieberman choir is Mahmoud Ahmadinejad, the raving, wacko conspiracy theorist and president of Iran. The trend of rising prices “is completely fake and imposed,” Ahmadinejad said in a televised speech last week. “It is very clear that visible and invisible hands are controlling prices in a fake way with political and economic aims.” Clearly, some political messages play just as well in Tehran as in Washington. Hence, Lieberman’s brainstorm: if we could just stop Wall Street from making speculative bets about future prices we wouldn’t be in this fix.
The bogeyman of the shadowy speculator may be a politically expedient myth to win votes. But it’s also a diversion from the truth about our energy markets.
Consider a little recent history. Back in July 2004, with oil prices at US$42 a barrel, analysts at PFC Energy warned clients that prices were too high to be sustained, and that speculators were playing “a key role” in driving the market. By March, prices had
climbed to US$56 and Steve Hanke, professor of applied economics at Johns Hopkins University and a world-renowned expert on commodities trading, said “we’re in the late stages of a bull market that’s about to collapse” driven by reckless speculation. In what must be one of the most regrettable forecasts of his distinguished career, Hanke predicted oil would fall to about US$10 a barrel within months. By September, oil was at US$66 and Republican Senator Pete Domenici called for a gasoline act to protect consumers from “profiteers and speculators” driving prices to excessive and irrational heights.
This recurrent theme has been with us since long before George W. Bush sent U.S. troops into Iraq, and has only gained volume as the price has risen. But ask a consumer to set a “fair” price for oil, and their answer will always be about 30 per cent less than we’re paying today. When oil was $60, people thought it should be $40. When it was $100, then $70 seemed reasonable. Today, most would welcome a drop to $100 a barrel. The underlying assumption never changes: if only the millionaire manipulators and fear mongers would go away, we could afford to fill up the ol’ Hummer again. The only thing the oil market has to fear is fear itself.
But fear, in this case, is not an artificial paranoia, stoked up by shady conspirators in some Wall Street back office. Fear is a real, fundamental and quantifiable element of the oil price. We are talking about a finite resource, upon which we are extraordinarily dependant, and the bulk of which lies buried beneath unstable and often hostile nations. Geopolitics, terrorism, natural disasters and old-fashioned nationalist antipathy are all factors that can and do have serious implications for the stability of supply. The “fear premium” isn’t a sham. It’s real and it’s rational.
In that sort of environment, speculators aren’t the enemy. In fact they play an essential role in the market. Speculators make predictions about the future direction of prices and buy futures contracts, either to protect themselves against rapid price swings or to make a profit. If their predictions are wrong, they lose a whole lot of money and that’s their problem. But if they’re right, then they actually reduce volatility by helping to factor future risks into the current price. As Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, wrote recently, “their activities are stabilizing. Speculation is good.” Mark Perry, a professor of economics and finance at the University of Michigan, puts it another way. “Speculators don’t determine market forces, they respond to market forces of supply and demand,” he wrote recently. “Speculators can’t be blamed for high oil prices.”
But that doesn’t mean politicians won’t try. We have a demand problem (too much, growing too fast), a supply problem (limited resources and questionable capacity for increases), and a refining problem (critical shortage). Maybe all those fears are overblown, and maybe oil will settle down over the next few months. But those forces are real, and they are the factors that set the oil price. We better get used to them because they’re not going away. And neither are the people who speculate about them.
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