For this reflection, we were asked "what role do speculators play in the market?" And "are they responsible for large price hikes?" (For example oil speculators driving up the price, and the price of gas increasing to almost $4/gallon.)
To be honest, I am not too knowledgable when it comes to oil, and probably less knowledgable when it comes to futures. But after doing a little research and reading various articles, I feel like I've gained at least a glimpse of understanding on the subject! I also see how it can relate to the principles in chapter four.
Basic econ tells us that equilibrium is where the market price is at a level that allows quantity supplied to equal quantity demanded. It also tells us that variables such as expectations (aha!) can shift the supply or demand curve. For example, if I expect that gas prices are rising tomorrow I am going to fill up my car today. This would cause an increase in demand, shifting the demand curve to the right and encouraging prices to rise.
When it comes to speculation in oil futures, while fundamental economics tells us that speculation does increase prices, I am not too sure they are entirely to blame. In an article presented to us by our professor, James Hamilton wrote: "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." But amidst all the exchange of speculation, speculators do have some affect on prices. If they think that prices will be higher in the future, then more of them want to buy than sell, so the futures will rise until there are equal buyers and sellers. When this happens, those in physical possession of oil may hold it off the market. "By paying higher prices now, they assure that prices will be lower in the future. In effect, they hold supplies off the market today so that they will be available next week or next year when things become even more scarce." (Tucker, Wall Street Journal)
I'd like to close my thoughts on oil speculation with an excerpt from Mark Thoma's post in Economist's View: "It is immediately clear that speculation defined in this manner need not be morally reprehensible. In fact, speculation may make perfect economic sense and indeed is an important aspect of a functioning oil market. For example, it seems entirely reasonable for oil companies to stock up on crude oil in anticipation of a disruption of oil supplies because these stocks help oil companies smooth the production of refined products such as gasoline. The resulting oil price response provides incentives for additional exploration, curbs current consumption, and helps alleviate future shortages. Hence, it would be ill-advised for policymakers to prevent such oil price increases."
That's all for now...
Ciao!
Sources:
http://economistsview.typepad.com/economistsview/2012/04/speculation-in-oil-markets-what-have-we-learned.html
http://online.wsj.com/article/SB10001424052702303513404577356344113351000.html
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