Are Speculators to Blame for High Oil Prices?

The issue du jour, at least until last night’s excellent news, was high gasoline and oil prices. Central to that discussion was a fight over whether speculators were to blame. The public debate has been disappointingly uninformed. For one side, speculators are obviously to blame; for the other side, they can do no wrong. Ezra Klein has admirably turned to a couple top flight economists for help in sorting through the muddle. His conclusion: “Speculators probably aren’t the problem.” They’re right in substantial part, but they’re also missing some important things about how real oil markets work, which make it much harder to dismiss speculators’ influence. This is as good a time as any to try and set a few things straight.

Klein reports a standard economists’ line, which is at the core of his analysis:

“Speculators make money by pulling oil off the market, putting it in inventory, and selling it later,” Greenstone continues. So if you’re seeing speculation, you should be seeing a massive run-up in inventory. And we are seeing a bit of an inventory bump, particularly in recent weeks. But not enough of one.

This confuses global inventory figures with U.S. ones (Klein’s original post links to news on U.S. inventories). There is no good data on global oil inventories, which makes these sort of arguments invariably unsound. Moreover, inventories are often carried by doing things like storing oil in tankers at sea (or, equivalently, moving those tankers to their destinations slowly). Once again, the official U.S. inventory numbers miss this.

It also misses a critical way that oil can be pulled off the market without inflating inventories: producers can cut back on supply. Indeed many suspect that that is precisely what’s happening. Futures markets bid up prices; Saudi Arabia and other OPEC members set the price at which they offer their oil by indexing to those futures markets; people don’t want to buy all that much oil at such high prices; Saudi Arabia et al thus curtail production. Markets balance, prices are higher, and inventories don’t build up.

That said, I’m with Klein (and Jim Hamilton, the second source of his analysis) in pinning most oil market skittishness to the decline of Saudi spare capacity at a time of surging Asian demand. (Stay tuned for more on that in a few weeks.) But one needen’t pick between the two explanations: a mix of physical and financial factors are undoubtedly at work.