Join Us for a Free Webinar on Finding Great Companies and Invite a Guest!

Click Here

                                 

Bookmark and Share




Search     

Printer Friendly Version


In Praise of Speculators


Hoarded Oil Could Provide Insurance



Politicians are blaming speculators for the recent rapid rise in the price of gasoline. Speculators may indeed be raising oil’s price, but I’m not sure. If they are, however, they deserve our praise.

Imagine you run a hedge fund and think the price of oil will increase by considerably more than the interest rate will over the next year. You should borrow money at the current interest rate, use these funds to purchase oil and store it somewhere. Your actions will reduce the amount of oil on hand for sale now and so raise today’s price.
   
But you’re buying oil today only because you intend to sell it in a year — when you’ll increase the available quantity and so lower its price. If you’re correct about oil’s price being higher a year from now than it is today, your actions will push up the price when it’s relatively low and decrease it when it’s relatively high. Your speculation, therefore, will even out the price of oil over time.
   
Some politicians are seeking to stop such ventures. If they succeed they will at best accomplish nothing and at worst increase the oil market’s volatility and therefore increase the cost to businesses and consumers of responding to price changes.
   
So are speculators doing this? I haven’t read any hard evidence of people storing large quantities of oil. But oil can be hidden anywhere, so it might be happening.
   
Expectations of an Iran-Israel war might be motivating speculators to bet on oil’s future price rise. If Iran is trying to build atomic weapons, it might be doing so in an effort to destroy Israel. Israel’s fear of Iran’s intentions might soon cause it to launch an airstrike against Iran’s nuclear facilities.
   
Iran has threatened to retaliate against such an attack in part by closing the Strait of Hormuz, a waterway bordering its country through which about 40 percent of globally traded oil passes. Iran doesn’t have a navy that’s anywhere near strong enough to take control of the strait, but it could mine the waterway or sink large ships, making the strait temporarily unnavigable.
   
By closing the strait, Iran would induce the mother of all oil shocks. The U.S. Navy would quickly work to reopen it, but this would take at least a few months. And if Iran weren’t conquered or bombed out of the Industrial Age, it would likely maintain the capacity to fire missiles at oil tankers crossing the waterway.
   
My guess is if speculators are hoarding oil, they’re doing so mostly with the thought that Iran might close the strait, which would cause oil prices to skyrocket. Such a gamble would essentially be providing the world with insurance against the strait’s closure, because if it does close, speculation will cause the oil supply to be higher than it otherwise would’ve been.
   
A closure would devastate the stock market. Indeed, I suspect the midyear market fall was partly out of fears that the Strait of Hormuz might be shut down. This means if the market comes to believe Israel won’t strike Iran, or if Israel does strike Iran and Iran is unable to close the strait, the market might rebound.


James D. Miller is an associate professor of economics at Smith College in Northampton, Mass. His latest book is Singularity Rising: Sur­viv­ing and Thriving in a Smarter, Richer and More Dang­erous World (BenBella Books), on sale in October.


Learning Events Near You:

Find a Chapter Near You

Corporate Partners

Learn more about

companies supporting

BetterInvesting's mission