Oil speculators leave giveaway print
By Thomas Palley
Over the past 18 months, oil prices have more than doubled, inflicting huge
costs on the global economy. Strong global demand, owing to emerging economies
like China, has undoubtedly fueled some of the price increase. But the scale of
the price spike exceeds normal demand and supply factors, pointing to the role
of speculation - and underscoring the need for policy action to clean up the
oil market.
Reflecting their faith in markets, most economists dismiss the idea that
speculation is responsible for the price rise. If speculation were really the
cause, they argue, there should be an increase in oil inventories, because
higher prices would reduce consumption, forcing speculators to accumulate oil.
The fact that inventories have not risen supposedly exonerates oil speculators.
But the picture is far more complicated because oil demand is
extremely price insensitive. In the short run, it is technically difficult to
adjust consumption. For instance, the fuel efficiency of every automobile and
truck is fixed, and most travel is nondiscretionary. Though higher airline
ticket prices may reduce purchases, airlines reduce oil consumption only when
they cancel flights.
This illustrates a fundamental point: in the short run, reduced economic
activity is the principle way of lowering oil demand. Thus, absent a recession,
demand has remained largely unchanged over the past year.
Moreover, it is relatively easy to postpone lowering oil consumption. Consumers
can reduce spending on other discretionary items and use the savings to pay
higher gasoline prices. Credit can also temporarily fill consumer budget gaps.
Although the housing boom in the United States - which helped in this regard -
ended in 2006, consumer debt continues to grow, and America's Federal Reserve
has been doing everything it can to encourage this. Consequently, for the time
being the US economy has been able to pay the oil tax imposed by speculators.
Unfortunately, proving that speculation is responsible for rising prices is
difficult because speculation tends to occur during booms, so that price
increases easily masquerade as a reflection of economic fundamentals. But,
contrary to economists' claims, oil inventories do reveal a footprint of
speculation.
Inventories are actually at historically normal levels and 10% higher than five
years ago. Furthermore, with oil prices up so much, inventories should have
fallen, owing to strong incentives to reduce holdings. Meanwhile, the Wall
Street Journal has reported that financial firms are increasingly involved in
leasing oil storage capacity.
The root problem is that financial markets can now mobilize tens of billions of
dollars for speculative purposes. This has enabled traders collectively to hit
on a strategy of buying oil and quickly re-selling it when end-users
accommodate higher prices - a situation that has been aggravated by the George
W Bush administration, which has persistently added oil supplies to the US
strategic reserve, further inflating demand and providing additional storage
capacity.
Absent a change in trader beliefs, the current oil price spike will be broken
only by a recession that exhausts consumers' capacity to buffer higher prices,
or when the slow process of substitution away from oil kicks in. Thus, economic
fundamentals will eventually trump speculation, but in the meantime society
will have paid a high price.
Whereas oil speculators have gained, both the US and global economies have
suffered and been pushed closer to recession. In the case of the United States,
heavy dependence on imported oil has worsened the trade deficit and further
weakened the dollar.
This sobering picture calls for new licensing regulations limiting oil-market
participation, limits on permissible trading positions, and high margin
requirements where feasible. Sadly, given the conventional economic wisdom,
implementing such measures will be an uphill struggle.
But some unilateral populist action is possible. A major form of gasoline
storage is the tanks in cars. If people would stop filling up and instead make
do with half a tank, they would immediately lower gasoline demand. Given lack
of storage capacity, this could quickly lower prices and burn speculators.
Thomas I Palley is the founder of the Economics for Democratic and Open
Societies Project.
(Copyright 2008 Project Syndicate. Published with permission of the
Global Policy Innovations program at the Carnegie Council for Ethics in
International Affairs.)
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