Cafe Hayek - Latest Comments in Oil Speculation

Re: Oil Speculation

SteveO — Tue, 15 Jul 2008 21:35:52 -0000

Welcome Cooper:

To try to keep it very simple, (and I apologize if I pitch this below your swing, I don't know what you know):

"Hedging" in its simplest form just means a balanced response to risk. Like "hedging your bets". People often diversify their risk in investments by not putting all their money into one stock or fund.

Speculators are people who buy and sell options and/or commodities. Oil and corn are commodities, which you or I can buy and sell. But, I can also sell you the right to buy corn at a fixed price tomorrow. If you think corn is going to go up, you can buy my option. You can exercise that option, and actually buy the corn, but you don't have to.

Options are only ultimately useful if in fact the actual change in price matches the prediction. If you buy an option planning on a price drop, you better hope the price drops. Same-same for a price increase.

People "hedge" against the future price of oil, by buying oil today. (Or oil futures, or options). If oil is $100 a barrel, and I'm pretty sure it's going to $150, it would be smart for me to buy as much as I can at $100, and store it. Or, buy options that I think will allow me to buy at any price less than what I predict it will go up to.

The reason most of the people who read this site think it's no big deal is that every time a commodity or option is sold, both buyer and seller think something different is going to happen. Just like betting on Alabama-Auburn football. You can't place an Alabama bet, unless someone else thinks Auburn is sure to win.

Essentially, a trader who sells a commodity or option, and one who is buying, are both secretly whispering "sucker" under their breath. The seller is glad he got it off his hands. The buyer thinks he got a sweet deal. With lots of people buying and selling options for increased and decreased prices, it all pretty much cancels out.

There's no way all those forces can be working in the same direction, because if everyone believed the same thing, there wouldn't be anyone willing to buy (or sell, whichever the case).

Hope that helps. There are plenty of online articles with simple explanations of stocks, commodities, options, futures. Hopefully this will give you an idea of the *debate* about the issue.

Re: Oil Speculation

Cooper Brown — Tue, 15 Jul 2008 15:06:56 -0000

I am a 20-something who doesn't know a thing about hedging & speculating. Could someone give me a Speculation & Hedge 101 crash course so I can know what to think for myself rather than take everything at face value. I came across this website and completely bought the airlines story at the top, but everyone else's arguments turned out to make more sense.

Re: Oil Speculation

John Dewey — Mon, 14 Jul 2008 03:23:12 -0000

Ken: "Or maybe you want to fly around in 30+ year old aircraft which have exceeded thier design life while at the same time demanding low fares."

The average age of the U.S. passenger airline fleet is about 13 years, Ken. Northwest and American distort that industry average, with their aging DC-9's and MD-80's. But those aircraft have an outstanding safety record, and there is no reason for airline passengers to fear flying in them. U.S. passenger airlines collectively spend billions of dollars maintaining their fleets in top condition. Airline CEO's and CFO's fly constantly on those jets, and they are not going to jeopardize their own lives by skimping on maintenance.

For what it's worth, Southwest Airlines is still buying aircraft and still planning to replace its older 737 Classic jets with newer 737 NextGen aircraft. If flying older aircraft bothers you, Ken, then I suggest you fly Southwest and avoid American and Northwest.

Re: Oil Speculation

Rudy — Mon, 14 Jul 2008 01:54:34 -0000

Ken, why should we check out the Commodities Act of 2000? That law simply was an agreement on a jurisdiction-sharing plan between the Commodity Futures Trading Commission and the SEC. Both departments had battled for decades over who should have regulatory authority over the single-stock-futures.

So, oil prices are high because of speculation in oil futures? Are Boeings planes so expensive because of steel/alloy/aluminum futures too? Did you know you can also purchase derivatives on weather data/future forecasts too, does that mean that I could save the world from no more crop failures and everyone in the world will have full bellies? Man, the power of commodities!!

Re: Oil Speculation

Ken — Sun, 13 Jul 2008 21:19:11 -0000

For those of you who do not think that speculation plays a significant part in oil prices, you should do some research; start with the Commodities Act of 2000. Maybe you can pretend that you have the assets to be an oil speculator to see the possible returns. Wall Street needs to look else to make their millions. And if you think the health of our airlines is not important, you may also want do some research on what the sale of a 747 or 777 does for our GDP. Or maybe you want to fly around in 30+ year old aircraft which have exceeded thier design life while at the same time demanding low fares. We need to eat and in order to eat we need to drive and yes fly.

Re: Oil Speculation

John Dewey — Sun, 13 Jul 2008 17:25:50 -0000

Steve: "Is there any way to pinpoint the cause of the problem so we can come up with a solution instead of just talking about it."

I assume by "problem" you mean the tendency of airline executives to demonstrate their ignorance of basic economics. My solution would be to just get out of their way and let the worst ones fail. Unfortunately, most members of Congress are equally ignorant.

Re: Oil Speculation

SteveO — Sun, 13 Jul 2008 10:34:19 -0000

Now I'm going to have to switch my moniker since someone else showed up with my name.

In response to the other "Steve" above, I'm not sure that there is a "problem" for which "we" need to find a "solution".

Prices of all kinds of items have fluctuated up and down over the course of human history. I don't know a "solution" for that.

I have written a paper on 3rd world development aid, and how this is what it would look like (not like a bunch of hippies collecting millions of dollars and dropping it on the people) but I doub't anyone would be interested in reading the whole thing here.

I'm currently driving an hour round trip to attend one class. It's frustrating, but I'm pretty excited that I own a car, a house, and can afford to go to school.

The "solution" to many problems as I see it is that people need to start adding up the positives column instead of taking it for granted, and only accounting for the negatives in life. Oddly enough, I had a major philosophical life change by taking an accounting class. Thanksgiving is every day for me now.

Re: Oil Speculation

Steve — Sun, 13 Jul 2008 03:03:10 -0000

Is there any way to pinpoint the cause of the problem so we can come up with a solution instead of just talking about it.

Re: Oil Speculation

Rudy — Sun, 13 Jul 2008 00:48:43 -0000

Nope, only had 22 minutes to write something back before flying out on a trip. The supervisor probably never reached the word gamete before hitting delete; my letter certainly wasn't politically correct. Did you have any other thoughts on the post besides the spelling?

Re: Oil Speculation

Steve — Sat, 12 Jul 2008 21:58:19 -0000

Rudy:

I hope you told your employer "gamut", which indicates a range or spectrum, and not a "gamete" which is one-half of the gendered sex cell pair that fuses during fertilization.

Re: Oil Speculation

PeggyLee — Fri, 11 Jul 2008 22:12:49 -0000

I have listened to the Senate Hearings on oil speculation and suggest that you go to Senator Levin's website and read his 5/8/06 statement regarding energy trading. Especially regarding ICE, Intercontinental Exchange. These same issues were discussed before the Home Land Security and Government Affairs Committee last week. They are talking about excessive speculation in Commodity Markets. It made me a believer. I know it's not the only reason for the high price of oil. There is adequate supply but demand has defied the law of supply and demand. For a tongue in cheek article read AmericanGoy's blog titled So why are gas prices rising. It's worth a look.

Re: Oil Speculation

JT — Fri, 11 Jul 2008 13:20:10 -0000

A speculator is someone who buys a share of oil without the intention to take delivery of the oil?

Does that mean I am an airline speculator when I buy 1% of the shares but never intend to take delivery of 1% of their assets? I could use a 777.

Re: Oil Speculation

Rudy Schober — Fri, 11 Jul 2008 12:32:08 -0000

I work for a major airline. We received notes to contact our Congressperson on the speculation issue. Below is the letter I mailed back to my supervisor....

I have to make a couple of comments on the future speculation topic.

The fact that oil prices are high is mainly due to central bank policy, not speculations in the oil commodity. The increase in the price of oil is the result of inflation (as well as supply/demand issues). It's interesting that when inflation sets in that the blame can run the gamete from the corporations, 'evil speculators', immigrants, or to foreign governments.

Speculators cannot indefinitely inflate or depress the price of a commodity. If you are speculating in an attempt to prop up the price above the equilibrium, then I need only short my position and wait for my windfall of cash when the price corrects. If speculation worked over the long run then it would only require a sufficiently large pile of money to corner each market. It's not that simple. (Take Delta in 2006 when the bankruptcy court gave the airline permission to hedge fuel. Delta's contracts came due in mid 2006, at the same time the market price of petroleum had a slight down turn and Delta lost well over $100 million).

Using speculators as the scapegoat isn't anything new. People even higher than CEO's are on record blaming speculators for the ills of markets. One of major complaints President Nixon made in 1971, before he took the U.S. off the gold standard, was that 'speculators' were at the root of the problem and it had to stop. The problem wasn't due to speculation in the gold commodity at that time either, the underlying true reason was the federal government printing too many dollars to support gold at the fixed exchange rate.

Here in the US the price of oil has more than quadrupled since Bush entered office in January 2001. If you price oil not in USD but in gold, the price is barely changed in that same 7-year span.

The cause of widespread increase in prices in the US (including oil) is from a marked and sustained increase in the US money supply. Again, rapidly increasing oil prices (as measured in US dollars) is the effect and not the cause of this inflation. The problem of an ever increasing money supply is the true villain – it’s been a federal action, not a speculating action.

Does this mean that the price of oil would be static without the government printing presses running overtime? Of course not. Markets are in constantly motion. We have a fixed supply of oil on the planet, and an increasing demand from a growing population and industrialization around the world ( China and India ). Some countries that use to be oil providers have even turned into oil importers today, such as Indonesia or Malaysia . With a fixed supply and an increasing demand we would expect the price of any commodity to increase, be it from wheat to oil.

Rudy Schober

Re: Oil Speculation

John Dewey — Fri, 11 Jul 2008 11:54:24 -0000

sethstorm: "How much of that damage was due to a government that was bent on deregulation?"

Hard to say, isn't it? Airline travel was deregulated in 1978, during the Carter administration. Eastern and Pan Am survived 13 more years. TWA survived 22 years.

sethstorm: "Interesting that the quality has also gone down during this same time**."

"Quality" of service - the features under the control of carriers - declined because that's what consumers wanted.

After deregulation, air fares gradually dropped, increasingly forced down by no-frills carriers such as Southwest. Air travel became economical for a much larger percentage of Americans. Airlines experimented with all sorts of options for luring customers. They eventually discovered that amenities such as meals and towels were just unimportant. For smaller city passengers, direct flights were not as important as low fares, so connections through hubs became the rule.

Deregulation by itself didn't end the rule of the legacy carriers.

The biggest change over the past 3 decades, IMO, has been the availability of information. The internet - developed long after deregulation - finally ended the premium fares the legacy carriers such as United and American depended on. The lock that travel agencies and legacy carriers had on passenger travel disappeared in just a few years.

Re: Oil Speculation

Chris — Fri, 11 Jul 2008 11:44:50 -0000

sethstorm --

To re-phrase your question: "How much of the damage was caused by airlines which couldn't adjust to a competitive environment"?

It's true that quality has gone down since deregulation -- that's because regulation held the prices up. As a result, airlines had to compete more on quality to get passengers -- When I was a child, I got free decks of cards, pilots wings, airplane models, etc... on plane flights. I'd rather have a less expensive flight than playing cards.

The only real "regulation" the airlines need is to revoke all the laws exempting them from things such as state tort law, false advertising law, etc....

Re: Oil Speculation

matty — Fri, 11 Jul 2008 11:09:59 -0000

This is q. funny. Airlines and the broader airline alliances pay internal fuel analysts to strategically source fuel, buying when price is perceived to be low and also putting alot of effort into distributing to the hubs of each airline to ensure that transport costs of moving the fuel are also low. This just shows airlines' own fuel policy is dramatically failed and essentially airlines have speculated as much as anyone else...

Re: Oil Speculation

sethstorm — Fri, 11 Jul 2008 10:17:05 -0000

These were the 5 largest U.S. airlines in 1980:

United

Pan Am

American

Eastern

TWA

American is the only one that has never been bankrupt. Both United and American have laid off tens of thousands of employees since 9/11. The combined current workforce for the other three is currently .... ZERO!

How much of that damage was due to a government that was bent on deregulation?

Interesting that the quality has also gone down during this same time**.

** Heavily dependent on what class one flies for the majority of flights.

Re: Oil Speculation

Stretch — Fri, 11 Jul 2008 07:39:13 -0000

Yup, I got this too. At least the airlines are getting more subtle. Last time I got a letter like this it was specifically asking me to endorse a new tax that would pay for airport upgrades.

I just love getting letters from airlines asking me to petition the government to make air travel even more expensive.

Re: Oil Speculation

Hobson — Fri, 11 Jul 2008 07:04:27 -0000

The reason the oil price is where it is at any given moment is because at that price, and that price only, the amount of money being bet by speculators that the price will rise from the current price is exactly equal to the amount of money being bet by other speculators that the price will go down from there. One set of speculators will win each bet, and the other set will lose. With half the bets winning and half losing, how can an otherwise respectable CEO say that speculators are driving up (or down) the price?

Re: Oil Speculation

John Dewey — Fri, 11 Jul 2008 06:57:52 -0000

David Graf: "I have a hard time believing that our leaders are going to allow major airlines to go bankrupt given the resulting direct and subsidiary job losses and the loss of service to the public and communities."

These were the 5 largest U.S. airlines in 1980:

United

Pan Am

American

Eastern

TWA

I have known former Eastern and TWA employees, as well as former employees of Braniff. "Our leaders" didn't prevent the loss of their jobs. Why do you believe "our leaders" will do anything different now? Why do you think they should?

Re: Oil Speculation

Keith — Fri, 11 Jul 2008 06:48:46 -0000

I wonder how the CEO's feel about speculation in airline stocks.

I'll bet there are a whole bunch of people out there buying airline stocks that never have any intention of flying somewhere.

Re: Oil Speculation

Matt C. — Fri, 11 Jul 2008 06:26:02 -0000

Dick Langlois who blogs over at the Organizations and Market did the exact opposite of what was requested.

http://organizationsandmark...

Re: Oil Speculation

dtt — Fri, 11 Jul 2008 05:19:04 -0000

I got 4 of these email yesterday as well. The one that stood out was United's signed by Glenn Tilton. Tilton was the former Chairman and CEO of Texaco (acquired by Chevron in 2001). If he believes this nonsense, then I see why United is in trouble.

Re: Oil Speculation

Per Kurowski — Fri, 11 Jul 2008 05:09:28 -0000

If you have already posted it sorry, but I can't resist

http://money.cnn.com/2008/0...

Re: Oil Speculation

David P. Graf — Fri, 11 Jul 2008 05:02:04 -0000

The email is for real. Forbes even has a story out on it at: http://www.forbes.com/feeds...