Oil speculation is back in the political spotlight again, and with oil back at more than $100 a barrel after a short reprieve, it's sure to stay there. As usual, when oil rises Congress and the president take the opportunity to blame the nameless, faceless "speculators" that trade oil.
We saw the same action in 2008 when oil was sprinting toward $140 a barrel. If energy prices are rising, it must be someone's fault, and speculators are the easiest to blame. But should they really be the targets of our ire?
Silver as our guide
Perhaps we can learn something from the recent fall of silver prices. As the CME Group
But there are some significant differences between how precious metals futures trade and how oil futures trade.
In general, when futures contracts are settled, the buyer of the contract must take delivery of the underlying commodity to complete the contract. In the case of silver, even if you aren't a big time hedge fund, that isn't terribly hard. The CME states that silver can be delivered to any "Licensed Depository designated by the Exchange." Or worst-case scenario, a bar of silver would serve as a nice paperweight in your cubicle.
Therefore, delivery of silver is a relatively easy proposition, suggesting that even if you're speculating in the metal, there is no reason for the price to move dramatically at contract close to clear out speculators and restore supply/demand balance. Oil however is a different story.
At the close of a crude oil futures contract, a buyer must take delivery of the oil. And it's a lot of oil. A crude oil futures contract on NYMEX is for 1,000 barrels -- or 42,000 gallons. I don't know about you, but I don't have a place to store 42,000 gallons of oil in my house, much less a way to transport it from the delivery location.
Therefore, at the end of oil futures contracts, speculators have to leave the market, leaving a balance of supply and demand. If, for example, there were excess speculation that oil prices would rise when delivery date nears, the holders of these contracts would have to sell, flooding the market and dropping price rapidly. But moves like that haven't been common until late last week when oil dropped nearly 10% in one day alone. And that was a fundamentally driven move that has partially corrected itself.
The value of speculation
Many who are calling for them to leave the market also don't understand the value of speculators in the market. Speculators play a key role in what is called price discovery and can reduce operational volatility for companies.
For example, oil refiner Valero Energy
Oil producers like Kodiak Oil & Gas
Investment banks like Goldman Sachs
300-pound gorilla in the room
If you're wondering who's really driving higher oil and gas prices you may want to ponder that the next time you fill your gas tank. As a country, we have shown over decades that we aren't quick to change our energy habits when costs go up. And as economies like China, India and Brazil grow, they need more energy, putting more pressure on prices.
We may slowly be learning a lesson as Ford's
It's much more likely that those demand sources are driving energy prices than speculators in the market.
Foolish bottom line
Speculators aren't the problem in energy markets. You may not like what they do or how they make money, but the real problem is closer to home. It's our insatiable thirst for energy at any cost and our willingness to blame others when that demand drives up prices.
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