The response to OIL speculators

For many this will be a controversial position so I only ask that you hear me out before ....you know...

We all remember the Enron speculation induced power crisis from a few years back. We are now seeing an oil price spike and some here are tempted to place the blame again on speculators.

Yes, speculators have a role in the oil price spike but there are reasons that they have been able to play the market, and ways that we can "beat" them.

Let's start with OPEC.

OPEC for years has controlled the price of oil. How? By controlling supply. If the price got too low they could throttle back production and balance supply with demand to get their desired price. Now of course it didn't always work as some members would try to cheat and supply more to the market to scam some extra gain, but at least in theory this is how it worked.

Although OPEC could have kept prices even higher it did not so so because it was afraid that high prices would lead to the development of alternative fuels, thereby reducing the demand for their product. So they tried ot keep a balance, a price high enough that they made good money on and a price low enough that discouraged alternatives.
 

A little basic business:

I want to interject here with a little business theory on pricing a product. For many companies it is one of the most important decisions they make as some of their customers are willing to pay more for their product and some less, but they can only have one price.

So if you are a bakery that makes chocolate cakes that you price at $20, you know that some customers would pay $30 and that you are losing some customers who would only buy at $15. But if the cakes cost you $15 to make then selling them at $15 won't make you any money. Now if your cakes are amazing and you could sell all you make at $50, why would you sell at $30. That would be stupid. The idea is to get from your customer the highest margin you can get (of course also considering volume.

You will also notice in business that many of the most profitable and popular products (especially food related) are products that cost nothing to make, but for which people will pay high prices. Things like bottled water, cola (sugar and water), french fries (compare the price of potatoes to the price of fries!), potato chips, etc. These companies have been lucky/smart enough to find a product that costs little but sells for much.
 

Back to Oil:

You may already see where I am going with this. If you are an oil producer how much should you sell your oil for? Answer: the highest price you can get (except if you were Opec and worried about alternatives) as long as you make more than it costs to take it out of the ground and get it to market. The problem is that other oil producers also want to sell their oil and all oil is more or less the same (okay not really, but for our purposes stay with me). That means I also have to watch what the other producers area selling for.

OPEC has been able to control the market because it was usually the lowest cost producer. (Saudi Arabia could produce oil for about $2 a barrel in the past.). It could therefore undercut any other producer, so usually no one wanted to get into a price war with Saudi Arabia (or OPEC).

Speculators, looking at this situation, have not seen much of a way to make money. If they push prices too high Saudi Arabia would turn on the price and squash them. That is what Saudi did when OPEC was maintaining a price band. If it went above the band OPEC threatened to increase production and prices would drop, speculators would get hit. It was na d is a game and everyone knew their rules. Speculators could make some money, but they knew not to push their luck.
 

The Current Situation:

We have gotten to a point where demand has grown faster than supply. In fact, due to Peak Oil, supply is basically plateauing at about 87 million barrels a day while demand continues to increase, especially in Asia.

Speculators saw that OPEC was basically maxed out in its production. They saw other producers maxed out, and they saw prices creeping up, and most importantly they saw demand was not dropping, in fact it was continuing to increase.

This was a green light to speculators that there was a pricing mismatch. Producers were not charging enough for their oil. Consumers were willing and able to pay more.

So speculators being what they are - opportunists - took advantage of an existing mis pricing in the market. They did not create the mismatch, they merely sought to exploit it, and they have. In fact they have probably been surprised by their success and by the unwillingness of buyers to cut consumption.
 

Breaking speculation:

Going back to the power crisis for a moment. I never understood why the Governor of California did not go on the news each night, or use air time to dramatically call for massive conservation efforts.

I remember mt friend telling me about a similar situation in Alberta. Someone from the government had the news crews show up at the central monitoring station and from there he asked all citizens to turn off all unnecessary appliances etc and showed, in real time, how that dropped demand. You could see that as people got up from watching the news to turn off stuff, power demand dropped.  

The point here is that while speculators can control/limit supply, consumers control end demand. If consumers show that they can collectively influence demand the speculator can't push the price higher, or at least may be scared to do so, because he does not know if he will be successful, or whether he will get squashed.

The same is true for the OIL PRICE.

If the President showed leadership and went on TV and said, we need to conserve NOW. And if he coordinated with other leading consuming nations and made it clear that demand would be curtailed NOW, then the crude oil price would plummet immediately because speculators would be afraid that no one would buy their $130 oil.

Of course this does not solve the underlying problem but it has the potential to buy some time to work on alternatives.
 

Wrap up:

Speculators have done us a favor by pointing out the reality of Peak Oil. But we do not have to be victims of speculators. It is possible to "beat" speculators by showing that we do not desperately need what they have to sell. Of course that does require changing behavior - and like it or not that is something we will have to do, either voluntarily, or through higher prices impacting our spending decisions.