April 25, 2012
More on speculation
In addition to my discussion last week on the role of speculation in oil markets, let me call attention to commentary from some of my academic colleagues on the same topic:
Posted by James Hamilton at April 25, 2012 11:03 AMdigg this | reddit
Speculation is a demand-side phenomenon arising from price-inelasticity (most of the time). If you believe in price inelastic demand, then you believe in oil prices above their long-term sustainable levels as well. The relationship is not causal, it's definitional.
Also, China's carrying capacity for oil consumption is now greater than that of the US. In 2010, we and BoA/ML estimated the difference at $10-15, ie the Chinese could handle an oil price $10-15 higher than the US.
This past week, a senior BoA/ML analyst (in an email to me) suggested the Chinese economy might handle as much as $130 Brent. Given that our consumption started to fall at $85 and that I estimate our carrying capacity at not greater than $95, this implies China is now able to carry an oil price as much as $30-40 more than the US. Personally, I think the difference is probably on the order of $25-30, but even this is twice what we estimated just a couple of years ago. (It is, however, consistent with our forecasts and analysis from both then and now. This is an opening wedge.)
So China is putting the squeeze on us, with the result that the US will be hemorrhaging oil consumption for the indefinite future.
Posted by: Steven Kopits at April 25, 2012 12:18 PM
I've was thinking quickly on GNE and the Iraq war.
How did mideasterners respond the demise of the Iraq regime?
I know in Kuwait, they began building relentlessly (no longer afraid that their property would be destroyed or stolen). Was this a major trigger for greater consumption/non-oil-producing economic activity in the region? Did this demand help shift us to a new supply/demand equalibrium?
Posted by: aaron at April 25, 2012 12:58 PM
It is political, not economic. Enough said. The post WWI era was the scariest, though the Carter wheat issue was also scary. Speculation is the grease in the wheels. If Goldman Sachs says the price is 25% driven by speculation, that is weird, it means, I suppose, that the speculators are losing their shirt? They have pushed the price 25% above long run equilibrium? Wow. So the price should be expected to fall? Traditionally it is the hedging demand which pushes price, and speculators actually get a premium to supply liquidity. Need some educating in that congress. Good job.
Posted by: pete at April 25, 2012 01:04 PM
You can also add:
Posted by: Bruce Hall at April 25, 2012 04:01 PM
Unfortunately, some basic economic fallacies have to be countered over and over.
Posted by: Rich Berger at April 26, 2012 06:35 AM
So are you saying that our president and Treasury Secretary are not the brightest bulbs in the room on this issue - not to mention Kennedy?
Posted by: Ricardo at April 26, 2012 08:10 AM
Steven: Thanks for sharing.
You wrote: So China is putting the squeeze on us, with the result that the US will be hemorrhaging oil consumption for the indefinite future.
I have one question and one comment. How is that oil price tolerance threshold estimated for China? Is it based domestic oil consumption as a percentage of GDP?
There is absolutely nothing wrong with the US "haemorrhaging oil consumption". But there is something wrong with the US passing up on policy that would help accelerate that process such as steep excise taxes on dirty fossil fuels. In the background, the USA is regarded as the premier terrorist organization, which objectively it is, and that the USA terrorizes people in the Mid and Near-East in the pursuit of secure oil. That perception is not at all accurate but the damage that perception does to contemporary US interests is undeniable.
To paraphrase Nancy Reagan: Just say NO to cheap energy.
Posted by: westslope at April 26, 2012 04:05 PM
Oil price tolerance--"carrying capacity" is the phrase I use--is indeed calculated as crude oil consumption as a pct of GDP. It is cross-checked against consumption trends, allowing for lags. It is some art, some science. Right now, China's tolerance looks to be about 6.2% of GDP, a bit down from earlier estimates. (We would expect this number to decline over time, by the way.)
Whether oil matters or not is a function of the response to higher energy prices (or lower consumption, if you prefer). There are four possible responses:
- greater efficiency, eg, higher mileage cars
- social reorganization with activities not requiring fuel (or less fuel), eg, internet-based social and commercial activities
- conservation, eg doubling up on trips to Wal-Mart
- decline in economic activity, eg, we are missing one aircraft departure in three compared to trend
So, we see evidence of all four of these, but no one has yet made any attempt to quantify them. Whether they matter depends on whether you think prosperity is important.
Posted by: Steven Kopits at April 27, 2012 09:53 AM
Here's a summary of an empirical study demonstrating a strong relationship between speculation and gas prices.
Posted by: Michael C. Morrison at May 1, 2012 08:18 AM
For the sake of argument, let's stipulate the rascally oil traders "decided" to cause annual (Brent) crude oil prices to double from $55 in 2005 to $111 in 2011 (while at the same time deciding that US natural gas prices should fall).
Here's the question: Given a doubling in annual crude oil prices, why has annual global crude oil production been flat since 2005 (EIA) and why have seen a measurable decline in Global Net Exports of oil?
Posted by: Jeffrey J. Brown at May 1, 2012 07:15 PM