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By James Hamilton on Apr 20, 2012 with 9 responses

‘Speculators are the Cause of High Oil Prices’ Debunked

Joseph P. Kennedy II, former Congressional Representative from Massachusetts, and founder, chairman, and president of Citizens Energy Corporation, has a proposal to make energy affordable for all. All we have to do, Kennedy claims, is “bar pure oil speculators entirely from commodity exchanges in the United States.”

Writing in the New York Times last week, Joseph Kennedy (D-MA) explained why he believes that speculators are responsible for the high price that we currently have to pay for oil:

Today, speculators dominate the trading of oil futures. According to Congressional testimony by the commodities specialist Michael W. Masters in 2009, the oil futures markets routinely trade more than one billion barrels of oil per day. Given that the entire world produces only around 85 million actual “wet” barrels a day, this means that more than 90 percent of trading involves speculators’ exchanging “paper” barrels with one another.

It’s true that most buyers of futures contracts don’t actually want to take physical delivery of oil. If I buy the contract at some date, I usually plan on selling the contract back to somebody else at a later date, so that I leave the market with a cash profit or loss but no physical oil. But remember that for every buyer of a futures contract, there is a seller. The person who sold the initial contract to me also likely wants to buy out of the contract at some later date. I buy and he sells at the initial contract date, he buys and I sell at a later date. One of us leaves the market with a cash profit, the other with a cash loss, and neither of us ever obtains any physical oil.

Let’s take a look, for example, at NYMEX trading in the May crude oil futures contract. A single contract, if held to maturity, would require the seller to deliver 1,000 barrels of oil in Cushing, OK some time in the month of May. Last Friday, 227,000 contracts were traded corresponding to 227 million barrels of oil, which is indeed a large multiple of daily production. But it is worth noting that at the end of Friday, total open interest– the number of contracts people actually held as of the end of the day– was only 128,000 contracts, much smaller than the total number of trades during the day, and not much changed from the total open interest as of the end of Thursday. Many of the traders who bought a contract on Friday turned around and sold that same contract later in the day. If the purchase in the morning is argued to have driven the price up, one would think that the sale in the afternoon would bring the price back down. It is unclear by what mechanism Representative Kennedy maintains that the combined effect of a purchase and subsequent sale produces any net effect on the price. But the only way he gets big numbers like this is to count the purchase and subsequent sale of the same contract by the same person as two different trades.

It’s also worth noting that on that same day, there were 146,000 May natural gas contracts traded, which if held to maturity would call for delivery of natural gas at Henry Hub in Louisiana. A single contract represents about 10 million cubic feet, so Kennedy’s calculations would invite us to compare the 1,146 billion cubic feet of “paper” natural gas traded on Friday with the total of 78 billion cubic feet of natural gas that the U.S. physically produced on an average each day in 2011. Once again, the vast majority of Friday’s natural gas futures trades were matched by an offsetting trade during the same day so as to have little effect on end-of-day open interest.

By what mysterious process can all this within-day buying and selling of “paper” energy be the factor that is responsible for both a price of oil in excess of $100/barrel and a price of natural gas at record lows below $2 per thousand cubic feet? I suspect the reason that Kennedy does not explain the details to us is because he does not have a clue himself.

Kennedy’s analysis continues:

Because of speculation, today’s oil prices of about $100 a barrel have become disconnected from the costs of extraction, which average $11 a barrel worldwide.

Here I have a modest suggestion. If Representative Kennedy knows a way to go out and produce another barrel of oil somewhere in the world for $11 a barrel, he would do a world of good if he would actually go out and do it himself, as opposed to simply asserting confidently in the pages of the New York Times that it can be done. People with far more modest fortunes than Kennedy inherited are out there using their resources to try to bring more of the physical product out of the ground.

And many, many more would be attempting the feat if it were remotely possible to produce a new barrel of oil for anywhere close to $11.

If you want to prove me wrong, Mr. Kennedy, then don’t talk about how easy it is to produce more oil– just go do it.

I have a final concern about Kennedy’s policy proposal. How exactly do we define the “speculators” whose participation in the markets is to be banned? Suppose for example, we stipulate that the only people who are allowed to trade oil futures are those who are actually physically producing or consuming the product. If we do that, what happens if a particular producer wants to hedge his risk by selling a 5-year futures contract, and a particular refiner wants to hedge his risk by buying a 3-month futures contract? Who is supposed to take the other side of those contracts, if all “speculators” are banned?

Let me close by pointing those interested in this issue to a recent survey of academic studies of the role of speculation by Bassam Fattouh, Lutz Kilian, and Lavan Mahadeva. The authors conclude:

We identify six strands in the literature corresponding to different empirical methodologies and discuss to what extent each approach sheds light on the role of speculation. We find that the existing evidence is not supportive of an important role of speculation in driving the spot price of oil after 2003. Instead, there is strong evidence that the co-movement between spot and futures prices reflects common economic fundamentals rather than the financialization of oil futures markets.

This article originally appeared on Econbrowser.

  1. By Jesse on April 20, 2012 at 12:52 pm

    This shoudl not be an impossible question to answer.  The specualtors are trying to make money.  I would think that the total speculative premium would be the difference between the total dollars that the end users pay and teh total dollars that the proucers recieve would be the cost of specualtion.  If this data exisits, it should be possible to track it over time.  Obsiously this measure is going to be extreemly variable on the short term, and it has to be for the market to be able to effectivly smooth out the prices to the end users and producers. 

    That being said we should expect some amount of speculative profit to compensate for taking on the risk of price volitility.  I would expect that the end result would be that producers would sell for a bit lower, but more stable price and end users would buy for a bit higher but more stable price than the actaul spot market.

  2. By DAFFA on April 21, 2012 at 9:20 am








    The raise of IRAN an Islamic republic is challenge to ARAB kingdoms. The Raise of IRAN in ASIA should have been watched with alarm by Asian powers like India, China. But these giants are ignoring the developments in IRAN and do not see these developments as a threat. But the western governments, western media are going full blast against the threat from IRAN. To fight this threat, to minimize this threat, To counter this threat – the money should come from people who feels threatened.  


    USA and Europe cannot be threatened by IRAN. Even if Iran makes a missile and a Nuclear bomb, guiding this package in thin air across continents is not possible. Except USA and Russia no COUNTRY  can do this guidance in real life with out the GPS of USA / Russia..   Existence of Israel cannot be threatened by IRAN since there is no vested interest to sustain a hate campaign in both countries.  


    The real threat, if at all there is  threat is to Arab kingdoms. The wiki leaks and the imprisonment of a whistle blower by US. Federal government is the proof.  The cases against Assange in western courts is an added evidence of the secret plan to ROB the citizens of west and rest of the world also with higher GAS prices. 


    Saudi rulers is on record instructing the President of USA to cut the head of the snake. A snake which is very far away from Europe and USA needs to be killed to safe guard Arab Kings by republican USA. Someone has to pay the cost to the contract killers.  


    The plan devised and propagated is Block the sale of Iran oil. Iran will become weak with no oil money and will not make nuclear bomb. The plan on the hidden paper is when Iran oil is blocked from market, the oil prices will raise even double. The extra income can be paid for the military machine manufacturing and fighting forces of west. So in short rob the western citizens to pay for the military machine both fighting and manufacturing, pay under the table the criminal politicians of west IN SWISS BANK ACCOUNTS for raising the Iran threat in high pitch.


    Instead of all the failed UN resolution and European Sanctions, all these western leaders have to tell Arabs, very rich Arabs like Qatar, Kuwait , Saudi  is produce more oil and sell them at US$ 30 a barrel to crush IRAN . At US$ 100 a barrel oil IRAN is a nuclear threat, at US$ 30 a Barrel oil Iran is near Somalia in economy. 


    Members of D A F F A ( Democracy And Freedom For All) were willing to travel to USA to join the campaign against war, enlighten the citizens of a good plan, however the Obama administration refused VISA , indicating US can only export democracy and no one is allowed to import or re export democracy into USA . 






    D A F F A. goal US$1 / gallon oil







  3. By Russ Finley on April 21, 2012 at 12:37 pm

    Money quote:

    By what mysterious process can all this within-day buying and selling of “paper” energy be the factor that is responsible for both a price of oil in excess of $100/barrel and a price of natural gas at record lows below $2 per thousand cubic feet?

    A simple logical statement like that can turn a politician’s reelection game plan on its ear.

  4. By armchair261 on April 21, 2012 at 5:58 pm

    If we do that, what happens if a particular producer wants to hedge his risk by selling a 5-year futures contract, and a particular refiner wants to hedge his risk by buying a 3-month futures contract? Who is supposed to take the other side of those contracts, if all “speculators” are banned?

    If Kennedy’s plan achieved its goal, then, since producers can no longer obtain price insurance, because the insurers are thrown out, we would have a situation where producer risk increases even as the prices for their products have fallen. Perhaps even Kennedy, if he had thought this far ahead, would come to the conclusion that domestic oil industry investment and production would fall.

    Because of speculation, today’s oil prices of about $100 a barrel have become disconnected from the costs of extraction, which average $11 a barrel worldwide.

    Good idea. And let’s eliminate welfare, since the average American household income is about $63,000 per year. 

    I’d like to hear Kennedy’s thoughts on the relationship between gold prices and extraction costs. Or better yet, between the cost of building his home and its current market value.  

  5. By shecky vegas on April 23, 2012 at 1:18 pm

    The Hat Trick is Wall Street speculators, OPEC production and reserves, and MidEast tensions. No one of these directly influences world oil prices, but the three reinforce each other as world events play out. The only duplicity is the speculators claiming no influence when they clearly are hedging on higher prices down the road.

    And claims that rising oil prices are simply a reflection of market basics is not well founded. Despite the demands of China and India, world consumption has drastically dropped, off-setting those demands. Heck, even the Saudis say the current price of oil is not representative of production cost and distribution.

    Granted, they certainly aren’t complaining about it….

    • By armchair261 on April 25, 2012 at 7:58 pm


      Can you cite sources supporting your statement that world consumption has “drastically dropped?”

      IndexMundi says otherwise, here:

      So does the IEA, here:

      The table on page 5 shows global demand figures as follows:

      2010: 88.3 mm barrels per day

      2011: 89.1 mmbopd

      2012: 89.9 mmbopd

      At the very top of the IEA’s March 14, 2012 Oil Market Report, they say:

      • Global demand is expected to grow by 0.8 mb/d (+0.9%) in 2012 to 89.9 mb/d, unchanged from last month’s projection. The relatively subdued economic backdrop – with a global GDP expansion of 3.3% foreseen for 2012 (3.8% in 2011) – and high oil prices both restrain any upside momentum for consumption.” 

       smartplanet also sees demand growth:

      “China and India have been primarily responsible for the astonishing growth in demand. Working over data from the EIA, I find that U.S. oil demand fell 1.65 mbpd in the five years from 2005 through 2010, while China and India’s demand grew 0.96 mbpd in just one year, from 2009 to 2010. From 2005 through 2010, the growth in demand from China and India was double the demand lost in the U.S., and 1.14 times the combined demand loss of the U.S. and Europe.

      As does the EIA:

      Extract: “Worldwide oil consumption will increase by 1.3 million b/d this year and by 1.5 million b/d in 2013″


      Can you please supply your source of data?

  6. By Benny BND Cole on April 25, 2012 at 9:51 pm

    Here is a serious and sober and boring study by Kenneth J. Singleton, Stanford b-school prof.  He says speculation boosted oil prices.


  7. By mac on May 12, 2012 at 9:50 am

    Surely,  no one thinks that speculators alone are responsible for gas prices.

    Do speculators have some effect on gas prices ???

    Probably  so……

  8. By mac on May 12, 2012 at 11:22 am

    For every speculator that gets rich, there is a speculator that dies.


    Sounds good, right  ?

    Sure, but in the mean-time they have ginned up the price if oil for the consumer, regardless of who among the speculators wins.

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