Oil Speculation

The Rational-Choice Model, often used by political scientists, states that in order to understand a decision such as regulating speculations, it is important to scrutinize the decision-makers. Federal officials have a very vulnerable career, balancing the noble goal of making good public policy and ensuring their own “job stability”. To accomplish the first goal, however, the officials must be certain to build up power and influence and be certain to be re-elected. The government, senators, and house representatives may make choices that may have negative short-term effects but may get them re-elected. It is therefore our duty, as United States constituents, to take long-term effects of the decisions into consideration when assessing whether these policies serve us well. By considering these outcomes and sharing our views with our local representatives on Capitol Hill and national representative in the White House, we may be able to reconcile the short-term and long-term conflicts. In order to decide whether there should be regulation in place reigning in oil speculation or not, responsible citizens must decide what the short-term consequences of speculation regulation may be, what the long-term effects may be, and what are the factors influencing the decision-makers.

The oil market functions based, in part, on the forces of supply and demand, as all other markets do. The equilibrium price and quantity as set by actual users of oil maximizes producers’ profits while maximizing consumers’ utility. If the price is above the level at which the demand is equal to the production of oil, there is an excess supply. Although buying a futures contract does not directly reduce the supply of oil to consumers, it is possible that speculators, i.e. buyers and sellers who will never take actual delivery of the commodity drive up prices of oil directly. They may encourage producers and other players to store oil rather than to make it available for use. Because the oil market is not based solely on the forces of supply and demand of oil users but speculators play a role in raising and dropping the prices, the oil market is extremely unstable. Oil speculators drive prices up and down, rather than stabilize commodities prices over the long-run. Oil producers, trying to maximize their profits by increasing the value of the company through speculators, claim that “speculators play a crucial role in the futures market by providing liquidity to hedgers (WSJ)”. The Wall Street Journal article “Oil Speculators Under Fire,” by Alistair MacDonald, Guy Chazan and Carolyn Cui makes a basic assumption that market speculators are driving up prices of oil. Certain Senators blamed speculators for high prices of commodities and, according to the Wall Street Journal, “political momentum is building to stop them.” The Commodity Futures Trading Commissions, seemingly believing that oil speculators drive gas prices up despite the low demand, is considering tougher regulation of oil-futures markets.
It is possible, however, that oil speculators may not be entirely responsible for the rising oil prices. New York Times op-ed columnist Paul Krugman believes that “growing demand from emerging economies, not speculation, is the real story behind rising prices of raw materials, oil included.” Some economists perceive the sudden legislative momentum as an attempt to distract the public from “the real issue”: although oil prices may fluctuate in the coming years, the long-term trend is sloping upward and regulating futures markets is not going to bring back the days of cheap oil. The public must adjust to the higher oil prices, and the government may help them do so by helping develop alternative-energy technologies.

The question “should oil market speculators be allowed to drive up prices of oil, regardless of current supply and demand” may be answered fiscally and economically or environmentally and socially. In order to answer this question, we will assume that speculators are driving up gas prices. Economically, it is certain that these speculations are creating an excess demand which may in turn be causing inefficiencies in the oil market. Speculations, considering this approach only, should be regulated. However, the social aspect of this matter must be taken into the decision-making process. Allowing speculators to drive up oil prices may decrease oil demand even further. This may have a long-term positive effect on our society as it may increase the demand and production of fuel-efficient cars and add to the importance of finding alternative-energy technologies. From an environmental prospective, the rising prices, whether the credit or the blame for them is given to speculators or to developing economies, may be saving the planet. Regulating oil speculation so that oil markets more accurately reflect free-market conditions may solve the short-term problem of high gas prices, but it would prolong the long-term environmental problem. Energy traders admit their concern in the Wall Street Journal, stating that “regulation could stunt trade, increase costs in the marketplace and potentially scare away some players from the oil-drilling business.” Although this may be a concern for energy traders and oil companies seeking to protect their profits, it should relieve the responsible United States citizens. We may, finally, be forced to reform our economic system in order to preserve our planet.

http://online.wsj.com/article/SB124700398437207969.html