Speculative Nonsense

With high recent oil prices there has been a lot of talk about what is causing high oil prices. Oil companies are being called into Congress to explain their record profits and an investigation is underway to investigate speculators for “fixing” prices. I wonder Congress never seems to investigate oil companies when prices are low. Federal taxes on gasoline are above 18 cents per gallon. This does not include state taxes on gas which can range from 8 cents to 32 cents per gallon. Of course state and federal governments are never greedy.

First, we have to understand that prices are never set they are signals of information to suppliers and buyers. High prices induce consumers to cut back while inducing producers to try to create more. OPEC has a large role in determining how much oil can be produced which in a way acts like a cartel. OPEC looks at proven reserves in order to see how much a country can produce which doesn’t seem to make any sense. Countries should be free to produce as much oil as they want and sell it on the open market.

Congress also has a large say in the supply of oil. What is ironic however is if Congress allowed companies to drill within the United States futures prices would start falling since the future price reflects current and future conditions. In 2008, it was estimated in ANWR (Alaska National Wildlife Refuge) had over 4 billion barrels of oil. Even the United States interior department estimated there was around 134 billion barrels of undiscovered but recoverable oil.

Allowing companies to also build refineries wouldn’t hurt either. Even if Congress allowed companies to build refineries it would take at least 10 years to build in the United States considering all the permits required. In an odd way oil companies could not be in favor of drilling or allowing refineries since it acts as a barrier to entry for anyone that wants to get into the industry. If you could keep competitors out and restrict the supply it would be easy for a company to maintain not only their competitive advantage but their profits as well.

Despite what people think speculators are providing a valuable function by informing people what futures prices are going to do. If this were true why aren’t people quitting their day jobs in order to become oil speculators? By definition, this is a zero sum game. In a futures contract someone who thinks oil is going up and someone who thinks oil is going down. People make it seem as if anyone could speculate and make money. People complain about people speculating up the price of oil, however they should blame the people that believe the price is going down because otherwise a futures contract could never exist! Speculators put their own capital at risk and can lose a lot of money (especially if they are leveraged). These speculators are reducing the price volatility of oil not increasing it as some would speculate.

I tend to think people often look at outcomes instead of the inputs that lead to those outcomes. If people went a step beyond and thought about the actual causes of why prices are high it could do wonders for critical thinking skills.