Next Generation Energy is managed and written entirely by Seed editors and expert guest bloggers. Read more about them Commodities account for the goods that feed us, heat our homes, get our cars cruising, and provide the basic materials we need everyday... and the commodities market recently nearly doubled in price in about a year. So what's up?
They say, it was a bubble actually. Of global magnitude.
You see, the high prices of fuel have led to inflated costs in other sectors, and in recent months, the boom got particularly ugly as the UN reported an additional 50 million people around the world suffer health problems because they can't afford food. (This seems like a low estimate as over a billion people live on less than a dollar a day).
But what's this got to do with energy? Oil... and oil markets.
The trouble is financial speculators. The world's growing middle class is buying more food and oil and investing in large institutional commodity markets. In other words, traders are betting on rising prices.
After the collapse of technology stocks in the sunset of the Clinton Administration and the recent burst of the housing bubble, investors were looking for another market to turn out some quick greenbacks. Increased demand in Asia coupled with lower commodity supplies and what looked like a bad year for grain (now projected to be a bumper crop), drove an increased frenzy of investment in 2008.
In five years, the total value of institutional investors' holdings in commodity index funds rose from $13 billion to $260 billion and the price of the commodities tracked in them rose nearly 200 percent. And keep in mind, investors compete with people who need these commodities for the operation of their businesses, yet over 71 percent of the commodity futures contracts are owned by speculators, up from 37 percent in 2000.
So don't look to ANWR and offshore drilling as the solution to high oil prices. Look to the traders who do not pass price fall benefits to the consumer. The trend has not gone unnoticed in the US and the Senate is now considering legislation aimed at cutting the cost of petrol and heating oil by ending excessive speculation in oil futures driving up prices.
According to the NYTimes, we experienced a near 20 percent decrease in all commodities prices over the last month, representative of slowing global growth and reduced demand for oil in the short term. Key word here: Short. Remember, inadequate production to meet growing consumption demand raises oil prices, which climaxed higher than ever this year.
So yes, the assault on your wallet appears to be weakening, but don't get too comfortable. Developing Asian economies will necessitate future supplies, which are anticipated to become increasingly hard to come by. The big take home message for today is:
The spike in commodity prices, no matter what the cause is giving us a taste of the future.
This should be the kick in the pants we need to act to develop alternative energy technologies now. We can't sit around and wait over the next couple years for prices to climb back up again. And be assured. They will.
Environment
Comments
Miss Sheril,
You are probably right, but I don't think it will matter for two reasons. First, while many middle and upper income folks are likely in to commodities future, most of them are not direct investors. They do it through funds of various kinds, so individual investors don't see how their money is playing in this. So they won't put pressure on the fund managers or the futures traders.
Second, humans are just not built for a clear understanding long term impacts and long term risk analysis. The SUV drivers of thew world don't care about supply and demand presently, much less 5 or 10 years down the road. they just want gas prices to go down now, and its cognatively easier to blame someone else. While $4 a gallon gas has had some positive effects in terms of getting people to consider not driving, I don't see it causing folks to understand these large forces.
All of which is to say we're along way from most Americans really putting political or economic pressure into the world to do things that will be goo din the long term.
Posted by: Philip H. | August 20, 2008 11:46 AM
I'm a little confused by the attribution to speculation... Surely speculation is ultimately a zero-sum game - if you're not actually taking delivery when the contract comes due, then you must, by definition, sell as much as you buy. Secondly, the price of futures is limited by the "arbitrage cap" - the point at which it becomes profitable to buy on the spot, sell on a future, and pay the cost of carry.
At the end of the day, futures prices can only go so far into contango, so the future price is limited by the spot price - which is set by people actually taking delivery of physical commodities. Somebody is taking delivery at those prices.
I can see an argument that arbitrage can pull up the spot price, but only if there's significant quantities of storage available at attractive prices. I'm not convinced that this is the case with oil. Speculators aren't building tank farms in their yards, and there's only so many tankers out there...
I can also see an argument that speculation increases volatility (in both directions). I just don't see how it can really drive prices over the medium to long term.
Posted by: Dunc | August 20, 2008 12:17 PM
Oh, and there's also the point that the bulk of speculation is by day traders (who play both ends of the market, short and long) rather than by long-term investors (who pick a position and stick with it).
Posted by: Dunc | August 20, 2008 12:21 PM
There's more than one kind of "speculation", and there's very little evidence to suggest that the bad kind, bandwagon speculation - the kind that creates speculative bubbles in the prices of tulips, dot.com stocks, and craptastic McMansions, is to blame for the current run up in commodity prices. See, e.g.:
Jeff Frankel at Harvard:
http://tinyurl.com/5buf4l
Paul Krugman at the NYT:
http://tinyurl.com/5cg6ab
Mark Thoma at the University of Oregon:
http://tinyurl.com/6sy739
and a forest of links from those articles to other parts of the discussion.
The people blaming "speculators" are either A) politicians looking for a scapegoat so they themselves don't have to be somehow responsible for $4 gas, or B) liberals who want the public to support more stringent regulation of the finance industry, and are trying to leverage the $4 gas to their cause.
The finance industry is, indeed, a wonderful scapegoat at the moment, and I heartily agree that it deserves to be kicked while it's down. I hope we get a lot more transparency and sensible regulation out of our current crises. But I really don't see anything that indicates they are responsible for the dramatic run up in commodity prices, and making spurious claims like that doesn't, I think, help the long term argument that they should be better regulated.
And in fact, your own post seems to suggest that you don't really believe it's their fault either. If the price increases were just due to speculation, why would this just be a taste of the future? You clearly believe that prices will continue upwards, as global demand continues to increase, and global supply of commodities stagnates (at some point) because they are all ultimately finite resources.
Posted by: Zane Selvans | August 20, 2008 1:44 PM
World oil production has not increased since 2005 while the world economy has grown. This is quite sufficent to explain increases in oil prices since then without bringing speculation into it.
There is a random element in the price of oil and other commodities that results from people not knowing what will happen in the future. As a result people guess, or as it is often called, specualte. Sometimes people guess wrong, but this is self correcting. If the price of oil is pushed too high then not all the oil coming to market will be sold and inventories will increase. As it costs money to store oil this will cause prices to drop. It is possible that oil producing countries are reducing production because they think oil will be even more expensive in the future and they will be able to sell it for even larger profits then, but there doesn't seem to be a lot of evidence that this is occurring, although admittedly we can't be sure.
For commodities that are easier to store than oil, such as copper, it can be easier for speculation to affect the price. However, the increase in oil and other commodity prices appears to simply be a result of people being willing to pay higher prices for them before they are willing to do with less.
Posted by: Ronald Brak | August 20, 2008 9:54 PM
How about a top level topic on geopolitical ramifications of alternative energy. The Russia / Georgia thing is the just the latest in a long list, but seeing the EU (despite all their green talk) unable to do anything against their biggest petro supplier is pretty telling.
Posted by: travc | August 20, 2008 11:26 PM
Dunc is correct. Speculators can only increase prices if they are actually buying and hoarding the commodity. If they are buying futures they’re just placing a bet. And quote obviously, someone else must be taking that bet – ie betting that prices will go the other way.
Posted by: Skeptico | August 21, 2008 1:10 AM
While the premise of some of these comments is indeed correct, in that speculators must eventually sell what they buy, it is certain that increased speculation raises the prices on many commodities. They are, after all, making money; this money must come from somewhere, and it isn't the producer of the commodity.
The consumers pay, as always. And consumers will pay what they must for what they need (or think they need).
In the modern world, we live in a consumer-driven artificial economy, where people work very hard for things they don't need. Just one example: the majority of cigarette production in this country is consumed by people who earn below the poverty line. The segment of the population that receives the most governmental finacial aid spend large amounts of money they can't afford on an item that is intrinsically as much a luxury consumable as champagne and caviar.
The end result of such a system is inevitable. Energy costs will continue to rise as our self-promulgating, self-indulgent inefficiencies swamp global production. The narod, the masses, will bear the heaviest burden, and the good of the environment will be sacrificed on the altar - not of profit, but of gluttony, of short-sighted and self-indulgent wilful waste.
Energy is cheap and plentiful. We live very near a massive natural nuclear reactor called "the sun", and we've had the technology to harvest it for centuries. That's known as "farming". Secondary methods have been with us almost as long; the water-wheel and the windmill are hardly recent technology.
We need to live on less. Over a billion people survive on under a dollar a day. Americans that consume fifty times that amount are considered impoverished.
And most of us don't think we have the power to fix any of what's wrong with the world. Go figure.
Posted by: John the Gnerphk | August 21, 2008 2:57 AM
Sorry, but this is complete nonsense. As has been pointed out, speculators don't take possession of anything. And it's not easy money, since prices can fall as easily as rise. It's a high-risk game, and where some can win big, many others can lose big. After all, for every buy, someone else must be selling. (And from what I hear, inventories aren't even rising, which you'd certainly expect if everyone thought prices would be higher later.)
However, speculators make the PERFECT scapegoat. Who can love a 'speculator,' after all? Politicians, in particular, are desperate to pass the blame on to 'speculators.' But they're not the only ones. We all love to blame speculators to excuse our own failings. Every time you see someone blame speculators, just ask yourself what advantage they'd have in passing the blame to someone else.
Well, I hate to break it to you, but this is OUR fault! We had the first oil shock in the 1970's, and apparently we learned nothing from it. And we elected the worse president in U.S. history, just to ensure that things would get as bad as possible. Don't blame speculators. Put the blame where it really belongs, on all of US!
Posted by: WCG | August 21, 2008 9:27 AM
Then how do you all respond to this Washington Post story? Sure looks like speculators, who are not taking delivery, are part of the picture. Most troubling to me is that they are being allowed by the federal regulatory agencies to trade electronically on platforms that the feds do not want to control. Fox and hen house, perhaps?
Posted by: Philip H. | August 21, 2008 11:56 AM
Large companies spend huge amounts of money on oil futures according to the Washington Post? I am somewhat underwhelmed by this news. I am also rather unphased by the suggestion that US financial markets are poorly regulated. We're already rather familiar with the state of US financial regulation. But let's just say that speculators are consistantly pushing the price of oil above the market clearing rate instead of just bouncing around it as I'd expect them to. If this were the case then inventories would increase and prices would drop in the future, so it isn't something I'm particularly worried about.
Posted by: Ronald Brak | August 21, 2008 9:07 PM
You mean this: "Some lawmakers have blamed these firms for the volatility of oil prices" [my emphasis].
Nobody is arguing that speculation doesn't increase volatility - if you look up-thread, you'll see that I specifically said that it does. But volatility operates in both directions, not just upwards. The author is conflating short-term volatility with medium-to-long term sustained price rises - they're quite different things.
Posted by: Dunc | August 22, 2008 5:14 AM
Dunc is quite right - speculators who do not take delivery cannot affect market price that much. They follow the market - they don't push it. In many cases significant numbers of speculators are actually beneficial in a market. They are beneficial because they add liquidity - i.e. they increase the numbers of buyers and sellers, so that people can buy in and sell out of the market when they need to. The more buyers and sellers in a market, the less the movement of a single large player matters. With a lot of speculators, it's less likely a hedge fund needing to sell a huge position will push the market down just by the fact of its selling, for example.
Congress's fixation on "speculation" and a "bubble" is just the search for a scapegoat and has no relation to reality. Reality is that growing demand from China, Indonesia, India, etc., and growing belligerence from major suppliers (Russia, Iran, Venezuela) is increasing risk and raising prices. Notice how oil jumped $5 yesterday when it looked like tensions were rising between Russia and NATO? That's reality. Speculators are just trying to ride it.
Posted by: Ms. Krieger | August 22, 2008 12:29 PM
Why is there so much resistance to the idea of speculation being the man cause of the price rises of 2008? It is a fact that the sheer numbers of speculators was higher than ever before. All commodities are finite and the more that is purchased the less is available hence the price increases especially when speculators are not users but holders.
Another factor worth noting is how the general population responded. Most people stayed home quite a lot this summer, which resulted in what now cold be termed a surplus because so much less was purchased than what was expected. This "power of the people" event was quite accidental but could not have been much better than if it had been planned and organized. Demand fell, prices are now falling and the fallout has just begun. Sure many speculators will lose but the damage they have done is yet to be readily understood.
The results:
• People stayed home and the prices are falling. Good
• People stayed home and there is an epidemic of store closings Bad
• People stayed home and due to falling prices, local gas stations are close to selling gas for less than what they paid for it. Bad
• People stayed home and more fallout to come. Bad
The people united accidentally and leveraged some real power over the market. It never needed to happen and it shows how fragile our economy has become. Public ownership of companies has made them vulnerable to every little spot of bad news. The entire stock market has become so volatile due to at least 2 major changes of public life, news coverage and the ability of so many to trade stocks so quickly have contributed to this volatility.
Through cause and effect it is easy to see how the chain reaction started and much harder to see where it will end. Most people will disagree because they can only see what affects them immediately and do not wish to see ahead to the effects. We need to get our best minds to work on the problem, No not the oil problem that is just one tiny piece of the greater economic problem looming on the horizon. The real problem is market volatility and if it is not dealt with soon, we are in for a far greater crash than oil alone could cause.
Side note about Oil: We should not get off oil because of high prices, or energy independence or global warming etc. We must get off oil because it is limited, it is a commodity (volatile) and because the alternatives offer freedom from burdens on our incomes and a better quality of life.
Posted by: Rollin Shultz | August 27, 2008 9:44 AM