Summary:
Paul Krugman denouncing the idea that speculators are behind the rise in oil prices. Evidence for this is that there is no physical hoarding: inventories have remained at more or less normal levels. Instead, it’s the result of fundamental factors, mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China. Doesn't mean that prices won't fall again (they probably will, as demand adjusts), but era of cheap oil is over. The claims that speculation is the cause is largely wishful thinking on the part of the political right, i.e. that we can somehow return to the good old days of abundant oil. (Published: 12/06/08)
Notes:
- many voices declaring that rising oil price is a bubble, unsupported by the fundamentals of supply and demand
- two questions:
- Are speculators mainly, or even largely, responsible for high oil prices?
- If they aren’t, why have so many commentators insisted, year after year, that there’s an oil bubble?
- speculators do sometimes push commodity prices far above the level justified by fundamentals
- but: when that happens, there are telltale signs that just aren’t there in today’s oil market
- what would happen if the oil market were humming along, with supply and demand balanced at a price of $25 a barrel, and a bunch of speculators came in and drove the price up to $100
- would have major consequences in the material world
- Faced with higher prices, drivers would cut back on their driving;
- homeowners would turn down their thermostats;
- owners of marginal oil wells would put them back into production.
- As a result, the initial balance between supply and demand would be broken, replaced with a situation in which supply exceeded demand.
- This excess supply would, in turn, drive prices back down again
- unless someone were willing to buy up the excess and take it off the market
- i.e. the only way speculation can have a persistent effect on oil prices, then, is if it leads to physical hoarding — an increase in private inventories of black gunk
- this actually happened in the late 1970s, when the effects of disrupted Iranian supply were amplified by widespread panic stockpiling
- stockpiling hasn't happened this time:
- all through the period of the alleged bubble, inventories have remained at more or less normal levels
- tells us that the rise in oil prices isn’t the result of runaway speculation;
- it’s the result of fundamental factors
- mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China.
- The rise in oil prices these past few years had to happen to keep demand growth from exceeding supply growth.
- Saying that high-priced oil isn’t a bubble doesn’t mean that oil prices will never decline
- a pullback in demand, driven by delayed effects of high prices, may send the price of crude back below $100 for a while
- it does mean that speculators aren’t at the heart of the story
- Why, then, do we keep hearing assertions that they are?
- Part of the answer may be the undoubted fact that many people are now investing in oil futures
- feeds suspicion that speculators are running the show, even though there’s no good evidence that prices have gotten out of line
- also a political component
- Traditionally, denunciations of speculators come from the left of the political spectrum.
- In the case of oil prices, however, the most vociferous proponents of the view that it’s all the speculators’ fault have been conservatives
- people whom you wouldn’t normally expect to see warning about the nefarious activities of investment banks and hedge funds
- explanation of this seeming paradox is that wishful thinking has trumped pro-market ideology
- realistic view of what’s happened over the past few years suggests that we’re heading into an era of increasingly scarce, costly oil
- but: they want to believe that if only Goldman Sachs would stop having such a negative attitude, we’d quickly return to the good old days of abundant oil
