The Specs Have It
The debate about the speculative impact on the recent run-up in oil prices continues. Yesterday I was on Cheryl Casone' s program on the Fox Business Network with Oil Price Information Service (OPIS) analyst Tom Kloza. Mr. Kloza is considered to be one of the best retail gas price experts in the country. Now Tom was one of the original founders of OPIS and I used to participate in their price projections survey for oil in their early years, which I think I may have topped their survey at least once or maybe twice.
Yesterday, I was surprised to find out that Tom is blaming speculators for the run up in oil prices! In fact his comments reflected earlier remarks he made to MarketWatch where, "Kloza said the price spike has virtually nothing to do with the supply of oil and everything to do with the perception of the crisis in the Middle East. The spike is a direct consequence of growth in electronic trading of oil futures and options and the fear of those traders manifesting itself in this electronic space."
Now wait a minute. While I agree with Tom that the run up in price has a lot to do with the perception of the crisis in the Middle East and the price is rising on the threat to supply in the future, (it is a futures market you know) what the heck does that have to do with the advent of electronic trading? In fact, as long as I have been in the futures industry, and even back when the commodity markets were traded on blackboards, oil prices rallied on the perceived threat to supply. That's true for all commodities and a simple fact of life. Take grains, for example, that rally on a weather report of no rain and the coming of a potential draught. Or do you remember the oil rally preceding the commencement of the Persian Gulf War when oil prices hit a record high before even a drop of oil was lost. In fact the concept of prices rising before an anticipated disaster happens is so common that it has its own adage "buy the rumor sell the fact."
To blame the run-up in price on electronic trading ignores that fact that when you adjust for inflation, this run-up in price of oil is no greater than similar increases in price we have seen in the past. And this is true since the earliest days of oil prices, even before the computerization of the industry. If you want to see real volatility go back and check oil prices a century or so ago and that activity will make today's moves look like gentle waves.
Rising prices, when there is a threat to supply, serve a valid economic purpose. The market will move to ration supply and decrease demand to try and ensure that we will have enough oil or gas or grain or whatever is being threatened should supply be cutoff. That's what markets do. They become very defensive. If they did not anticipate, order could be removed from the marketplace. It could lead to shortages and disruption of supply and wild price moves.