Speculators provide a service
A shortened version was published in The Tennessean,
Sunday, April 3, 2011
Speculators provide a service
by Richard J. Grant
French consumers import significantly more Libyan oil than do American consumers. Knowing this, many Americans believe that a disruption of Libyan oil production would not have much effect on our price of oil. It would appear that the French would bear the brunt of the sudden scarcity and the consequential price increases.
That might be true in the very short term, but then what? As French consumers quickly bid up the price for remaining supplies of oil, their willingness to pay higher prices would attract supplies that might otherwise have gone to other parts of the world. That includes oil that might have come to us, whether produced in the US or abroad.
A characteristic that oil shares with money is that both are fungible. This means that one barrel of a given grade of oil is a substitute for any other -- just as one dollar bill seems the same as any other. With a sudden increase in scarcity, remaining supplies would be directed to their most-valued uses, as signaled by the rising prices. There would also be a tendency to conserve oil.
Higher prices encourage other suppliers to produce more. Each barrel sold brings in more revenue than before, but there are also political considerations. Saudi Arabia has already demonstrated a willingness to produce more oil to dampen the recent price rises. The Saudi government needs more revenue to buy domestic social peace, and its dampening of price rises will also dampen the ire of its customers and strategic allies.
Such ire that remains is often directed toward “speculators.” It is widely imagined that there is no good reason for the oil price to be over $100, given current supply and demand conditions. But business is not a prisoner of the moment. We must always look forward, and that is what speculators do.
Each of us plans for the future. Whatever supplies we expect to need, we buy before we need them. In so doing, we do our small part to keep the prices of the goods we buy higher than they would have been. We are acting as speculators, and in so doing we encourage suppliers to put more resources into the production of those goods that we expect to need.
Countries in the Middle East and North Africa face considerable political uncertainty at this time. It is unlikely that this will result in a long-term disruption of oil supplies. Business is business. But the new regimes could surprise us.
This is the reality that speculators face. When they bid up the price of oil, whether in the spot market or the futures market, they are acting on their belief that market conditions are likely to cause prices to be higher in some future period. If they are correct, they will profit, and in the process will have helped to conserve oil and to encourage future production.
If they are wrong, they will lose. And anyone who believes that they are wrong is free to speculate against them by taking an opposite position in the market.
Speculators serve society by thinking about the future and acting on their thoughts. In that sense, we are all speculators. The opportunity to create a profit encourages us to think harder about how best to employ our resources. And we let government interfere with this at our peril.
Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com
Copyright © Richard J Grant 2011
Sunday, April 3, 2011
Speculators provide a service
by Richard J. Grant
French consumers import significantly more Libyan oil than do American consumers. Knowing this, many Americans believe that a disruption of Libyan oil production would not have much effect on our price of oil. It would appear that the French would bear the brunt of the sudden scarcity and the consequential price increases.
That might be true in the very short term, but then what? As French consumers quickly bid up the price for remaining supplies of oil, their willingness to pay higher prices would attract supplies that might otherwise have gone to other parts of the world. That includes oil that might have come to us, whether produced in the US or abroad.
A characteristic that oil shares with money is that both are fungible. This means that one barrel of a given grade of oil is a substitute for any other -- just as one dollar bill seems the same as any other. With a sudden increase in scarcity, remaining supplies would be directed to their most-valued uses, as signaled by the rising prices. There would also be a tendency to conserve oil.
Higher prices encourage other suppliers to produce more. Each barrel sold brings in more revenue than before, but there are also political considerations. Saudi Arabia has already demonstrated a willingness to produce more oil to dampen the recent price rises. The Saudi government needs more revenue to buy domestic social peace, and its dampening of price rises will also dampen the ire of its customers and strategic allies.
Such ire that remains is often directed toward “speculators.” It is widely imagined that there is no good reason for the oil price to be over $100, given current supply and demand conditions. But business is not a prisoner of the moment. We must always look forward, and that is what speculators do.
Each of us plans for the future. Whatever supplies we expect to need, we buy before we need them. In so doing, we do our small part to keep the prices of the goods we buy higher than they would have been. We are acting as speculators, and in so doing we encourage suppliers to put more resources into the production of those goods that we expect to need.
Countries in the Middle East and North Africa face considerable political uncertainty at this time. It is unlikely that this will result in a long-term disruption of oil supplies. Business is business. But the new regimes could surprise us.
This is the reality that speculators face. When they bid up the price of oil, whether in the spot market or the futures market, they are acting on their belief that market conditions are likely to cause prices to be higher in some future period. If they are correct, they will profit, and in the process will have helped to conserve oil and to encourage future production.
If they are wrong, they will lose. And anyone who believes that they are wrong is free to speculate against them by taking an opposite position in the market.
Speculators serve society by thinking about the future and acting on their thoughts. In that sense, we are all speculators. The opportunity to create a profit encourages us to think harder about how best to employ our resources. And we let government interfere with this at our peril.
Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com
Copyright © Richard J Grant 2011