If greedy speculators were to blame for the $7.50 per barrel (and 10.6%) increase in oil prices during the first half of this year that motivated your anti-speculation bill in early July, do oil speculators now get any of the credit for the $43.60 (and 41%) drop per barrel in oil prices during the last half of 2014?
1. Oil is a speculative asset. The price of oil today and the price expected for oil ten years from now are necessarily linked. See Hotelling pricing of natural resources.
If you believe that the oil price is going to be high ten years from now, then you try to leave more of it in the ground today, raising its price today. If you believe that the price is going to be low ten years from now, you try to sell it now, while you can still get a decent price. This drives the price down today.
2. Although I cannot find the post now, I recall James Hamilton suggesting that the oil market is subject to speculative overshooting and undershooting. More recently, he wrote,
It’s just a matter of how long it takes for the high-cost North American producers to cut back in response to current incentives. And when they do, the price has to go back up.
3. Why would someone expect oil prices to be low for the next several years? Perhaps low-cost energy supplies will emerge (note that fracking is not low-cost) rapidly. Perhaps world economic growth will be very slow for many years. However, it strikes me as at least plausbile that low-cost energy supplies will not emerge and that world economic growth will be decent, in which case I would expect the price of oil to rise. Most important, there is still the possibility that all the money-printing going on in the world will amount to something, and even if the supply-demand balance in energy markets stays where it is, the nominal price of oil will go up a lot. If I were a speculator now, I would be inclined to be long oil.
4. It is possible that what is going on is a cave-in on the part of speculators who had been betting that money-printing would cause a lot of inflation. One can interpret the decline in interest rates and the softness in commodity prices as reflecting speculators giving up on those positions.
5. As is often the case, in looking at financial markets I find myself feeling confused and out of synch.
Politicians seem to be clueless about how these markets function. Speculation on futures markets involves taking long or short positions in futures contracts. Each futures contract expires at a predetermined date, at which time its price must converge to the spot price. Otherwise, there is arbitrage profit to be made.
Speculators profit when they are correct. They have no more reason to encourage high prices than they do low prices (a short position profits from falling prices). If futures prices deviate from fundamentals, they must eventually return due to basis convergence. Speculators who encouraged the deviation will lose money.
I’m not sure what people even think they mean by blaming speculators. Can OPEC even corner the oil market?
“If you believe that the oil price is going to be high ten years from now, then you try to leave more of it in the ground today, raising its price today. If you believe that the price is going to be low ten years from now, you try to sell it now, while you can still get a decent price. This drives the price down today.”
In an economist’s model, this would be true. In the real world it is not.
Oil reservoirs have an optimal production rate that maximizes the amount of oil produced from the reservoir over its life (about 30 years.) There is a maximum rate per year that can be pumped and in most places this is regulated. Hence, if you leave some in the ground this year, you don’t get that production back until the end of the field life. At any reasonable discount rate (adjusted for risk) oil today is worth more than oil 10, 20, or 30 years from now.
Hence you pump at the maximum rate today unless the marginal extraction cost is greater than the price. At that point you shut down. (Note that there are shutdown costs.)
Only when a large producer or regulator is acting strategically do they leave oil in the ground that could be pumped today.
When the price drops as it has recently, producers might not drill up any new oil, but what’s already drilled will be produced.
For a new well in the US using fracking, the data I’ve seen indicates the price needs to be in the $60 range. Hence I suspect that drilling new wells will take a breather once current commitments are fulfilled. But if you’ve already drilled the well, then a much lower price is required to actually close down current production.
With the current increased supply and decreased demand that looks to me like 2-4 years of relatively low ($60) oil prices.
“if you’ve already drilled the well, then a much lower price is required to actually close down current production.”
Which is why the Saudis are maintaining (and even increasing) production despite falling prices. They’re hoping to undercut American domestic production before it comes online.
Looking at the graph on James blog, why would you not speculate that Bernie Sanders deserves credit for the dramatic drop in oil prices?