Sunday, January 11, 2015

A Comment about the Price of Oil and Futures Markets

Every time there is a big increase in the price of oil, people are quick to blame speculators in the futures markets. Funny, though, now that there has been a large and rapid fall in the oil price, I haven't seen anything blaming the speculators. At some point, though, the price of oil will increase. Look for speculators to be blamed.
A few things to remember about futures markets:

For every long position there is a short position. The futures markets are a zero sum game (except for things like commissions.) The gains and losses offset each other.
Very few futures contracts are held to maturity and result in delivery of the underlying commodity. It is the threat of delivery that causes the cash and futures prices to converge as maturity approaches.

To make the case that the futures market is affecting the cash market price, one has to make the case that some development in the futures market is affecting the underlying supply and demand conditions for the commodity in a way that would not happen if the futures market did not exist.
Despite the foregoing, I actually think that financial institutions are often not subject to enough regulation or supervision, resulting in imprudent risk taking that can ultimately cost the government and/or society. However, those in favor of better regulation should not use market developments that they know are unpopular (e.g., a stock market decline or an increase in the price of oil) to make the case for more regulation unless they have a good reason to believe that the development is due to lax regulation. Often, they do not have a good case, and this hurts their credibility with people who have some knowledge of the markets in question.

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