More than one Congressional committee is investigating the role of speculators, who critics say have 'distorted' or artificially boosted oil's price -- driven it higher than a level the commodity would trade at if the price were based solely on supply and demand fundamentals.
New York Times columnist Paul Krugman, while not denying speculators have contributed to oil's record rise, nevertheless offers perhaps the strongest evidence regarding how a commodity's price can rise a great deal, without the influence of speculators. His evidence: iron ore.
Iron ore: no speculators, huge price rise
Iron ore, as Krugman astutely notes, isn't traded on a global exchange. Iron ore's price is set in direct deals between producers and consumers. As a result, there's no way to speculate on iron ore prices. No hedge funds diving into the market on a feverish afternoon to make a buy-side calculation. No institutional investors suddenly shifting large positions out of stock X and into Commodity Y.
So what has happened to the price of iron ore without speculators? Iron ore's price has surged in the past year. The price of China's steelmakers paid to Australian mines has increased 96% in the past year, Krugman noted. That's ninety-six percent -- a very large increase.
The reason for iron ore's price surge? Rising demand from strong, growing economies in emerging markets, Krugman noted -- the same factor that has driven oil's price to record highs.
Oil Analysis: A legitimate and telling point by Krugman. If speculators are the primary factors in commodity price rises, such as oil's, then their absence should have resulted in only a mild increase, but that hasn't been the case with iron ore. As argued in this space on several occasions, the biggest driver of oil prices is the more than 1 billion new consumers of oil (including businesses) being added to the market as a result of globalization. Paraphrasing George Allen, the former head coach of the Washington Redskins, "One billion new consumers can't be ignored." Thus far, global oil supply increases have not kept pace with demand increases, the world's safety cushion between oil supply and demand has decreased, and traders have bid up oil's price accordingly. Further, given the length of time it takes to increase oil production, the key factor determining whether prices cool off in the future will be demand decreases.
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Reader Comments (Page 1 of 1)
7-01-2008 @ 6:37PM
Lawrence Phoenix said...
You'd have to have iron ore in your head to believe this drivel Correct me if wrong, I believe it's 3 to 5 for accepting bribes are pushing futures you've invested in without disclosure...White hot speculation is driving oil prices and nothing else as 70% of futures are taken by people of have absolutlely no end use for crude oil..of course China's a huge market, that's true, but that's how you sell a lie, mix in the truth with the falsehood...
7-01-2008 @ 11:00PM
GoBoilers said...
Speculators have little to no impact on oil prices. http://www.beyondthemargin.net/2008/06/do-speculators-cause-oil-price.html
7-01-2008 @ 11:31PM
JP said...
Pricing power is different when it's direct to consumer from the maker.
What we're seeing here in oil is a middle man (indexed funds and investment banks) taking a cut. The way drug dealers take a cut by bullying local business owners in a neighborhood ghetto.
Is it right for the drug dealing mobster to bully the local business owner if he can get away with it?
It's funny they'd do that, they should be shorting the entire market instead of holding any positions because they're effectively destroying their entire investment portfolio (including the NASDAQ) by incrementally adding oil expenses to all of the companies they invest in.
Let's say AAPL uses FedEx to ship a laptop or iPhone, FedEx increases its rates on AAPL to compensate for their added fuel costs, then AAPL must pass it to the consumer. But it doesn't look like AAPL's prices are changing? Would that mean that, gasp, maybe AAPL is eating the rising shipping costs? 100% y2y rise in expense.
If oil doesn't give in, the rest of your portfolio most certainly will.
7-02-2008 @ 3:16AM
Coach said...
Demand for iron ore is up and there is obviously no surplus. You cannot compare apples and oranges. Demand for oil is up, but the big difference is supplies are adequate, (meeting the demands of the market), with reserve supplies available. Oil producers can increase output at any time. Saudi Arabia just did so twice in the last 2 months. Can anyone tell me how this is even remotely a fair comparison?
If Congress doesn't take action immediately to stop speculation on oil futures, America will lose the next world war without firing a shot. We are already in the middle of it, completely oblivious to the impact an economic crash will have until it's too late.
Vote every member of Congress out. They are failing to "protect America from all enemies, foreign and domestic" like they pledged to do when they took the oath of office.
Politicians are like diapers, they need changing often and for the same reason.
7-02-2008 @ 5:49PM
Pankaj said...
If anyone can explain to me this demand theory. I don't think demand has risen 100% in developing world and production has fallen 50% to result in this 100% increase.
How can there be so many consumers in last 6 months all around the world. It is just not practical.
At this rate we should be ready to see 500 dollar price soon.