• by Christopher Knittel and Robert Pindyck
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Angel Gonzalez, a gas attendant at a station in North Brunswick, N.J., pumps gas at the station, Wednesday, Oct. 17, 2007. (Mike Derer/AP)

Americans are spending more money at the pump than ever before. According to a recent estimate by the Energy Department, the average U.S. household spent nearly $3,000 on gasoline last year. Earlier this month, the U.S. Energy Information Administration forecast that the price for regular gasoline will average $3.63 a gallon this summer — a slight decline from last summer, not far from the record levels set in 2008. Why do oil prices remain so stubbornly high?

According to some in Washington, the blame lies with “speculators” — investors who buy and sell oil futures contracts to bet on the price of oil. As they see it, these scheming speculators — which may be individuals, but can also be mutual funds, hedge funds, or other investment institutions — inject billions of dollars into commodity exchanges in pursuit of a limited number of barrels, which in turn drives up the price of oil. Speculators, critics say, rake in piles of money at the expense of ordinary people who are going broke fueling their cars and heating their homes.

More than other commodities, sharp increases in oil prices are often blamed, at least in part, on speculators.

President Obama has called for restrictions on oil speculation, as have other influential figures in the policy and business community. In an op-ed in The New York Times last year, Joe Kennedy II, a former Massachusetts congressman who is the founder of Citizens Energy Corporation, said that speculators “should be banned from the world’s commodity exchanges.”

The problem with this view is that it ignores other important long-term shifts in economic fundamentals that contribute to the supply and demand — and therefore the price — of oil. Chief among them: the rise of China and India, whose growing thirst for petroleum drives up the price. Consider this: In the late 1960s, the U.S. used a third of the oil consumed in the world, while China consumed less than 1 percent, according to the International Energy Agency (IEA). In 2011, the U.S. accounted for less than 22 percent of world oil consumption, while China’s share was 11 percent.

This increase in demand has already had a big impact on the price of oil. Until mid-2004, the price of crude oil in the U.S. had never exceeded $40 per barrel. By 2006, it reached $70 per barrel, and in July 2008 — when the economy was going gangbusters and China and India were the two fastest-growing countries in the world — it reached a peak of $145. By the end of 2008, the beginning of the global financial meltdown, the price had plummeted to about $30. The price of oil reached about $110 in 2011, and today it hovers around $90.

Back to those pesky speculators for a moment: surely their bets on oil have had at least some effect on prices?

According to our latest research, the answer is: not really. In our recent paper, we explore the link between speculation and inventory changes. We calculate a series of speculation-free prices by creating a stable inventory of oil, providing us with a picture of what the market might look like in the absence of speculation. We focus on inventory for a simple reason: If oil prices are changing because of speculators, then there would have to be commensurate changes to inventories — a build-up when prices are increasing, and a draw-down when prices are falling.

But when the economy was strong and oil prices were increasing, we didn’t see large increases in inventories. In fact, they fell somewhat. This means that peak prices would have actually been higher if you take away any effects of speculation.

Investors buying oil contracts, the so-called speculators, are simply making a bet on supply and demand conditions in the future. And they are just as likely to be wrong as they are to be right.

More than other commodities, sharp increases in oil prices are often blamed, at least in part, on speculators. (Interestingly, however, speculators are rarely blamed for sharp decreases.) But they are not actually at fault. Oil price speculation is just an investment designed to pay off if the price of oil goes up (or alternatively, if it goes down), but it can do little or nothing to affect global prices.

Investors buying oil contracts, the so-called speculators, are simply making a bet on supply and demand conditions in the future. And they are just as likely to be wrong as they are to be right. Those who profit are either very lucky or they have better information than the market does. (They may have a better model for forecasting Chinese growth, or more reliable predictions about Middle East supply disruptions.) Either way, their activities will have little effect, if any, on prices and volatility.

This piece was co-authored by Robert Pindyck, Bank of Tokyo-Mitsubishi Ltd. professor in finance and economics and a professor of applied economics at the MIT Sloan School of Management.


Tags: Barack Obama, Middle East

The views and opinions expressed in this piece are solely those of the writer and do not in any way reflect the views of WBUR management or its employees.

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  • John Getsinger

    The thing not to bet on is the conclusion of the authors. The cited paper focuses solely on West Texas Intermediate crude oil, making an argument for ignoring the world oil market that’s roughly equivalent to looking for your wallet where there’s light instead of where you think you dropped it. The term “speculator” is defined so as to exclude institutional players like the Russians or the Saudis. There is only a single mention of the US Strategic Petroleum Reserve, which treats it as a minor player whose stocks and moves are transparently known, which doesn’t match up with the stovepipe secrecy mindset of the feds at all. Over the period studied, the US dollar has taken a beating, but the paper fails to address the rubber yardstick issue. In a sort of self-lampoon, the principal author has given pride of place at the top of his own MIT webpage to a Rush Limbaugh quote. Alas, I dearly would like to learn more about oil speculation; maybe another time. The article seems a lot more like another ginning up another citation for the CV than serious scholarship.

  • EarlRichards

    The financial speculators and the oil traders control and manipulate the oil price, the oil supply chain and the oil markets. Google the “$2.5 Trillion Oil Scam – slideshare” and google the “Global Oil Scam.” The US is a victim of this scam. Plug your Tesla S, electric car into your household, solar array.

  • TonyMac63

    Financial speculators are the big problem; this article fail to bring up a few things. 1. Our on hand supply of # of barrels of oil is at the largest it has been since the early 90’s and growing. This supply has been growing for months. 2. As John said below the Strategic Reserves are nearly full and that supply is transparent. 3. Our production of oil is growing as well as other world suppliers. There is more than enough supply to meet the world needs for some time to come and if “we” should have a embargo. Our own production is nearly enough to supply half the oil our refineries need and then factor in the on hand supply for the other half. 397 million barrels will last about 50 days before we will need to touch the strategic reserves which has about 698 million barrels.

    Now, I know the type of oil comes into play, but during a crisis our county will make due with what we have, as we have always done.