Oil Scapegoats

Who to blame for rising oil prices?  Why not speculators

Hedge funds and big Wall Street banks are taking advantage of loopholes in federal trading limits to buy massive amounts of oil contracts, according to a growing number of lawmakers and prominent investors, who blame the practice for helping to push oil prices to record highs. … Some Democratic and Republican lawmakers allege that gaps in oversight are allowing deep-pocketed speculators to manipulate prices. …

George Soros, one of the nation’s leading investors, testified in a Senate hearing this week that index funds were contributing to the rapid rise in commodity prices and were possibly creating a bubble. If it were to burst, sending prices tumbling, the fallout could wreak havoc on banks, retiree funds and colleges across the nation. … Under pressure from voters, lawmakers are pressuring the CFTC to take even more forceful action to regulate the commodity markets.

This is nuts.  "Manipulation" is an action that causes a harmful chain of events that comes back to benefit the actor.  Maybe a large supplier like Saudi Arabia could "manipulate"  by holding back production and to benefit them by raising the price of what they sell.  But hedge funds are not suppliers.  By pushing up prices now via speculation they are betting on higher future prices, not causing them.  If anything, their act causes reduced usage now leaving more oil for the future, which lowers future prices, which hurts them.   They only gain via the chain of events whereby they win their bets and inform the rest of us that oil will be scarcer than we thought, which if true is exactly what we need to hear. 

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  • mitchell porter

    Robin, perhaps I’m missing something, but don’t you begin by casting doubt on the idea that speculation could cause a rise in prices, only to concede that “hedge funds” can “push up prices now” by “betting on higher future prices”?

    It’s interesting that the Post mentions Michael Masters’ testimony. The journalist writes of “hedge funds and big Wall Street banks”, but Masters spoke of “corporate and government pension funds, sovereign wealth funds, university endowments and other institutional investors”.

  • Mitchell, I tried to reword to be clearer.

  • mitchell porter

    I agree it’s clearer. And for me it highlights further the difference between what Masters said and what the article reports. Masters says the “index speculators” are trying to profit, and that this is elevating prices, but not that they are manipulating prices.

  • This is nonsense. For every long in commodities, there is a short. Why don’t people say the shorts are manipulating the market? What chnages prices is people chainging their collective opinion about the present and the future. Saudi Arabia will not increase production, Israel may attack Iran, the other Gulf states may abandon the dollar. Do the idiots in Congress read the papers, or just posture for the crowd?

  • Legal scholar and scientific generalist Nick Szabo has written about the rise in commodity prices. (Not suprisingly he agrees with Robin.)

    A quick summary of Szabo’s explanation: the increase in dollar inflation caused investors quite reasonably to move to inflation hedges. Historically, they moved to precious metals (and gold of course has skyrocketed last few years) but in the sophisticated financial markets available to investors these days, derivatives based on commodities offer most of precious metal’s advantages, and in fact have an advantage gold does not have: it is unlikely that the Fed Gov will “confiscate” the commodities (require owners to sell them to the Fed Gov at a priced dictated by the Fed Gov) like they confiscated gold under FDR.

  • Caledonian

    Being helpless against stressors is the most painful state of all. When people are confronted with troubles, they want to feel that they can do something in response, even if it’s actually useless. So when people face difficulties that they cannot control or effectively respond to, they seek out self-deceptive beliefs that, if true, would permit control or effective response. This is most especially true when people had some hand in creating the problem that torments them – they don’t wish to acknowledge their own culpability and so need someone else to blame.

    People want villains that 1) are malevolent, so they can be struck back at without guilt, 2) have the power to inflict the harms upon them, but 3) don’t have enough actual power to defend themselves or threaten their attackers in reality.

    Thus, blaming poor harvests and livestock troubles on witches, evil spirits, Jews, etc. Attacking the scapegoats doesn’t accomplish anything other than making people feel better – but “feeling better” is what drives almost all of the things humans do.

    People are looking for scapegoats for the ever-increasing oil prices. They don’t want to reduce their usage. They don’t want to admit the causes for the increase are largely beyond their control and have to be adapted to. They want to punish someone, and they want to believe that will make the problem go away.

  • spindizzy

    Caledonian: excellent comment. This has nothing to do with economics and everything to do with group psychology.

  • Chuck

    “When people are confronted with troubles, they want to feel that they can do something in response, even if it’s actually useless. So when people face difficulties that they cannot control or effectively respond to, they seek out self-deceptive beliefs that, if true, would permit control or effective response.”

    Also, when people are confronted with troubles, they actually need to determine if the difficulties are caused by something they can control. There is a step in there between investigation and irrational action.

  • “Maybe a large supplier like Saudi Arabia could “manipulate” by holding back production and to benefit them by raising the price of what they sell. ”

    But if they hold back production, then they sell less.

  • Peter St. Onge

    Good point. Anytime prices move, those who 1) don’t understand why, or 2) are on the other side of the trade always complain.

    Below is an article from YE ’05 on Soros selling out of oil. Meanwhile gurufocus.com has him underweight in oil today. Maybe congress should investigate the financial interests of those who testify…


  • Caledonian

    Also, when people are confronted with troubles, they actually need to determine if the difficulties are caused by something they can control. There is a step in there between investigation and irrational action.

    I don’t think that actually represents the normal human response. Most people use their experience of the world and the ‘folk knowledge’ of their society to determine how they should respond to a problem. If there are no examples of people dealing with the problem, people assume it can’t be dealt with. If they’re being dealt with in certain ways, people will use those methods – even if they have negative side effects that could be eliminated.

    It’s a long and difficult struggle to build up collective knowledge about how problems can be addressed. Relatively few people have an experimental bent that leads them to try new things and new methods.

  • Alan

    @ Calendonian–great point! The act of scapegoating may constitute an example of the fallacy of the single cause in action. The query, Who is to Blame? presupposes some effective agency, rather than the existence of multiple correlative factors, only some of which may be human agents.

    While some cognitive apparatus for recognizing and intepreting animate agents may have been a critical part of our evolutionary heritage, priming us to anticipate intention in uncertain situations, that same apparatus can also lead our thinking astray.

    What Calendonian writes makes good sense: the act of blaming a putative agent apparently does confer psychic benefits by breaking down a bewildering universe into a social world full of more or less predictable agents. People go to great lengths to banish uncertainty, or at least appear to do so.

  • ad

    Why don’t people say the shorts are manipulating the market?

    They do whenever the stock market crashes. As Caledonian said, they look for someone to blame.

  • Caledonian

    Humans commit logical fallacies because (on some level) committing them satisfies some drive or perceived need, even if it’s just a desire to take a shortcut and stop having to think. (Minimizing cognition is a very powerful drive.)

    I suspect that when an irrational act or stance satisfies multiple drives at once, people cling to it – and it’s quite difficult to get them to abandon it, which requires either finding a rational solution that meets the same needs as least as well, or raising the need for rationality until it overwhelms the competing needs. Neither is especially likely.

    Therefore, I hypothesize that we’ll have to look for multiple contributing factors in any case of widespread irrationality.

  • Douglas Knight

    Yes, this idea of manipulation is nuts, but people actually try to do it, like the Hunt brothers. And Soros’s paragraph is quite reasonable: bubbles happen. Noise traders really do a lot of damage; they’re not just there to feed the rational investors. Noise legislators do damage, too, but it’s plausible that they’ll promote transparency in this instance.

  • clint

    OK, so it is not really manipulation, but it is a passive long-term long position by some Big Boys…ie. institutional investors buying buying buying, and never selling. Not to manipulate, but because that is what they do — invest.

    You may not like it, but that is what is happening.

    This from the May 20th Senate testimony of the manager of Master’s Capital Management:


    see CHART 1 and:

    You have asked the question “Are Institutional Investors contributing to food and energy price inflation?” And my unequivocal answer is “YES.”

    What we are experiencing is a demand shock coming from a new category of
    participant in the commodities futures markets: Institutional Investors. Specifically,
    these are Corporate and Government Pension Funds, Sovereign Wealth Funds,
    University Endowments and other Institutional Investors. Collectively, these investors
    now account on average for a larger share of outstanding commodities futures contracts than any other market participant.3

    These parties, who I call Index Speculators, allocate a portion of their portfolios to
    “investments” in the commodities futures market, and behave very differently from the
    traditional speculators that have always existed in this marketplace. I refer to them as
    “Index” Speculators because of their investing strategy: they distribute their allocation of dollars across the 25 key commodities futures according to the popular indices – the Standard & Poors – Goldman Sachs Commodity Index and the Dow Jones – AIG Commodity Index.4

  • Robin, your reasoning is not quite right. There is no clear-cut obstacle to shrewd speculators influencing prices in ways that cause fools to generate a bubble that the shrewd speculators can sell near the peak of (but I don’t see what the CFTC should be expected to do about that uncommon possibility).
    The clearest problem with the claim that futures are currently pushing up prices is that there’s currently no good reason for people who buy and sell actual oil to price it higher than what keeps supply and demand in balance. If the futures enabled sellers to get better prices by delaying delivery, the futures could reduce current supply. The futures for most delivery dates are virtually identical to spot prices now. But I don’t find it hard to imagine that a bubble will soon cause futures to reward sellers for delaying supply.

  • nick

    derivatives based on commodities offer most of precious metal’s advantages, and in fact have an advantage gold does not have: it is unlikely that the Fed Gov will “confiscate” the commodities (require owners to sell them to the Fed Gov at a priced dictated by the Fed Gov) like they confiscated gold under FDR.

    Actually this last is AFAIK Richard’s excellent deduction, which now that I see I readily agree with (and wonder why I didn’t already think of it 🙂 I’ve talked about how gold is insecure, and about how commodity derivatives and baskets (e.g. commodity index ETFs) act as a currency substitute or hedge and are generally better in this regard than gold (e.g. because of diversification), but Richard has put the two together.

    One caveat: there are political risks trading commodity ETFs and derivatives as well. If trade in them is effectively restricted in response to the current hysterics, and it costs too much to route around these regulations (e.g. in overseas markets), much of the utility of commodity derivatives and ETFs as money substitutes and hedges for many people would be lowered, and (since this utility is responsible for much of the present price) the result could be a significant bear market in commodities. Furthermore, the Federal Reserve might get its act together, in which case also commodity derivatives become less attractive (this latter is of course also a risk for gold). So I’m afraid there is still quite a bit of political risk in holding commodities or their derivatives (There is also of course political risk in holding dollar-denominated debt instead of commodities. Choose your poison).

  • mitchell porter

    So, in the tradition of the commentators being less interested in the meta issues than Robin is (sorry Robin) – does anyone think they can explain the actual magnitude of the increase in oil prices since, say, the start of 2007? They have doubled since then, at a rate much steeper than previous doublings.

    It seems like the possible causes could be classified under “supply”, “demand”, “issues with the dollar”, and “speculation and manipulation”.

    1) Supply. There are always actual and potential short-term disruptions to supply being priced in, like war. Then there are longer-term issues, like a plateau or decline in worldwide production.

    2) Demand. Still going up worldwide on account of global economic growth.

    3) Issues with the US dollar. The dollar has been declining in value, and investors may also be fleeing dollar-denominated securities.

    4) Speculation and manipulation. There may be a speculative bubble in the oil price, and perhaps it is even being abetted by shrewd and powerful speculators.

    So how about that $70+ price doubling since January 2007? There have been no significant new wars or new disruptions to supply. The IEA forecast of the increase in daily global demand from 2007 to 2008 is about 1.5 million barrels, out of a total demand of about 87 billion barrels per day. Global supply is flat but not shrinking. Over that period, the US dollar index fell from about 82 to 72, just a 12% drop.

    Looking again at the prices, and rounding up the present value to $140, I see there’s been a doubling since mid-August 2007. The price movements in the first half of 2007 could be regarded as being of a piece with those in the period 2003-2006. August 2007 is when the credit crunch set in, and the associated atmosphere of global financial crisis.

    So while some part of the recent price rise might be due to “peak oil” worries about supply, the fall in the dollar, and renewed fears of war with Iran, I am inclined to think that most of it is due to the movement of money out of housing and junk bonds, and into commodities. Blame it on subprime!

  • Steve Gelmis

    I found your comment inconclusive. Are you refuting Michael Masters’ thesis about the mechanisms by which speculators have used regulatory arbitrage to circumvent the way the markets were meant to operate, or are you making the narrower point that in the case of oil, speculative excess may have longer run positive effects?

    If the latter, I can agree that given our government’s gutless lack of an energy policy worth the name, climate change and peak oil (at whenever commencement date) make it a good and necessary thing for some oil demand to be destroyed by higher prices. Carbon taxes by other means…though tragically, without the revenue to reinvest.

    It’s somewhat harder coming to the same conclusion about the benefits of equivalent speculation in food though, when it results (as just one example among many) in Haitians eating dirt+motor oil patties in order to have the feeling of something in their stomachs. I’m not entirely convinced that there aren’t more humane ways to signal the need for greater food production as the diets of large pop countries shift to more meat, etc.

    Even with respect to oil, the hyper-volatility of excessively speculative markets actually disrupts the signals needed to support long run capital formation and development of substitution products and services.

    Given that markets can only operate within some rule framework, it would seem that the specific rules by which markets are administered do matter and are a reasonable subject of debate. While it is both fair and prudent to assess parties to that debate on any propensity they may have to seek scapegoats, there’s also a risk of that perception being more an artifact of loss of detail resolution when filtered through a general media outlet.

    For those interested, I thought this piece gave a cogent treatment of the issue of speculators distorting markets using regulatory arbitrage:


    As I understand it, Soros’ thesis is that the self-reinforcing nature of momentum investing causes market behavior to eventually (though temporarily) overshoot the real-world underlying demand-driven trend, and in so doing damage the real economy through mis-allocation of resources. Other than perhaps how far the overshoot can go before mean reversion takes hold (and therefore how large the destructive consequences can become), I don’t see anything there to make his observation controversial from a common sense perspective. It’s just that we regulate markets more as if these sorts of distortions don’t take place. There is an highly entrenched market fundamentalism informing regulatory practice which oversimplifies the benefits of free market price discovery and discounts the ways in which market mechanisms tend to fail or drive pro-cyclical instability. It’s a cultural blind spot…perhaps a legacy of our battle with communism last century.

    When a sufficient number of speculators bring big enough table stakes to the game they can drive prices higher just by bidding against each other and swamping the scale that the incumbent market participants previously operated within.

    What’s more, as the trading chart pattern becomes ever more steeply parabolic during an incipient bubble — and therefore seen by people who make investments in part based on the patterns in those charts as less likely to be convincingly sustainable to, new players are attracted in to place short bets, which (as happened Friday) if a move up is triggered by other events (slip in the dollar, change in sentiment about intermediate interest rate movements) all have to cover their losses at higher prices, contributing to the further upward price spike. Most short players do not have an unlimited capacity to see their bets go further and further under water, so the argument about every speculative long position being offset by a speculative short one, while technically correct, fails to comprehend the time dynamic which can flip the trading range into successively higher bands for no more fundamental reason than the arrival if new players and the defensive conversion of shorts into longs (as they cover).

    Since demand for many of these products is very inelastic in the short run, the ultimate buyers that take delivery must tolerate the bid up prices. The artificial scarcity can then infect the real economy by distorting participant behavior, such as the prompting the hoarding of rice, or the imposition of government export restrictions, which constrict actual supply and pro-cyclically reinforce scarcity expectations in the trading exchanges.

    At some point the spike does collapse back toward the mean of actual demand levels, but given the destructive effects of such pricing distortions, it seems completely legitimate to question whether the rules governing the game can be tweaked.

  • Robin, haven’t you ever heard of synergy, that something can both cause and be a prediction of something? You fell for the false dichotomy, the “they are X, not Y” etc. Do better next time.

  • nick

    Over that period, the US dollar index fell from about 82 to 72, just a 12% drop.

    The problem with this statistic is that it’s just relative to other currencies. It assumes there is some currency out there, or some basket of currencies, that is a stable standard of value that we can measure against. But there isn’t. It’s quite possible, and indeed currently quite probable, that the euro etc. supply has also inflated (relative to demand for the currency), so that all major currencies are falling relative to a hypothetical stable standard of value. They are just falling by on average 12% less than the dollar is falling. Just because there is no standard to measure them against doesn’t mean they can’t collectively fall (or equivalently, that they can’t all collectively inflate, as defined by greater supply, less demand, or both for the currency).

    Also important is that the euro is too new and untested by time, and other currencies too small, for them to make good substitutes for the dollar. So when the dollar starts becoming dodgy, people turn to commodities to hedge debt denominated in unreliable currencies (which currently means practically all debt — not just “junk” debt). So we have three monetary factors each causing commodity prices in dollars to rise:

    (1) More dollars chasing the same (in the short term relatively inelastic) supply of commodities. This directly effects only the dollar prices.

    (2) Greater demand for commodities as a substitute or hedge for currency-denominated debt, to hedge against further possible inflation. This increases commodity prices in all currencies.

    (3) A flight to safety from the credit crunch, creating more demand for safer forms of debt (e.g. U.S. Treasuries), and thus even more demand for commodities to hedge the currency risk from holding that debt. This increases commodity prices in all currencies.

    No “manipulation”, and there may not even be a bubble (although a bubble could easily arise under such conditions of high uncertainty). It’s mostly or entirely just a rational and efficient response to the very poor state of the world’s currencies and the credit crunch. More here.

  • Phillip Huggan

    The main cause of the oil price rise from $8 a barrel ten years ago to $135 now, is that there are credit forces that case oil prices to rise too much and fall too much, and that this whipsawing does not also occur in planning oil refineries. When prices were $8, no one built refineries. No there are no refineries.
    I know the real concern here is over the last two years. But the Netherlands have $10/gallon oil (they pay the social costs of pollution) yet enjoy a much higher standard-of-living than Americans. So I think the recent ruckus is just politicians trying to gain brownie points; is a non-issue to me.

    I agree there is no manipulation, but I don’t see why CFTC shouldn’t regulate commodity markets. Without controls on how credit can interface with traditional capital, you get hedge funds tanking price signals in the long-term. You give credit to rich actors on the assumtion it will help them create even more wealth using the same processes that assumingly allowed them to get rich in the first place. But these actors are using novel processes to “invest” their credit in ways they clearly don’t understand as well as they understood their traditional capital field that got them rich.

  • If you follow the link nick (Nick Szabo) gave, you will read that the biggest of the recent investors in commodities have been pension funds, which hold the savings of ordinary people — most of which do not belong to the “rich actors” that Phillip Huggan seems to want to pin the blame on.

    Also, can Phillip document his implication that if credit were unavailable for the purpose, then investors would not have run up commodity prices in recent months and years? Yes, I know that historically professional commodity traders have made heavy use of credit: it seems though that the recent flight to commodities is the doings of investors other than commodity traders as traditionally conceived.