Saturday, July 12, 2008

Bob Murphy On My Speculator Article

I now see that Bob Murphy commented my LRC article on speculators and oil on the "Crash Landing blog".

There seems to be two problems he had with my article. The first was his assert was with my argument that speculators can lower as well as raise futures prices depending on whether they have a net short or long position. He then presents a long argument involving speculation that Iranian president Abema-dinobots [?!?] meeting with an "accident" in June 2009, something which raise the futures price from $145 to $350. Then he says that some speculators who believe the "accident" with Abema-dinobots will only raise it to $300 will at that point take short positions, and that this proves speculators can move prices in one direction even if some take positions in the opposite direction.

But this mixes up the categories. Sure there can be speculators who want to short at such a position even as speculators move it up. But what this will do is not to eliminate the net long position of speculators but to expand the number of contracts. But the increase in the number of contracts will not change the fact that speculators have net long positions while traditional hedgers have net short positions.

In the end he writes:
One final thing: In his defense, maybe Karlsson had the following in mind. Suppose we are at an initial equilibrium, where a futures price is determined only by traditional hedgers, such as oil companies and airlines. Now a bunch of speculators come on the scene. If their activity leads to a higher futures price, then that will cause the original hedgers (the fundamental traders) to become net short, as they "export" some of their contracts to the Nation of Speculators. But that means the Nation of Speculators must be net long.

And vice versa is true: If the Nation of Speculators ends up causing a financial-world (i.e. market) futures price to be lower than it would be without trade with the speculators, then the Nation of Hedgers will import futures contracts from them at their cheaper price, and become net long. That means the Nation of Speculators is net short.

OK I guess I will give Karlsson the benefit of the doubt, and assume this is what he had in mind."

Yeah, that's exactly what I had in mind, and I don't think I wrote anything different, so I don't see what the fuss is about.

As for his other point, that futures prices can move spot prices, let's say in the aforementioned scenario with Abema-dinobots' "accident" that the accident won't occur. Well, then at a price of $300 or $350, the price will be far too high. A massive surplus will then occur, and unless speculators are willing to accumulate massive inventories, they will lose big as they will be forced to sell at the goods market equilibrium of $145, the same it would have been without the Abema-dinobot speculation. If on the other hand Abema-dinobot really meets with the "accident" and this "accident" really does result in massive supply disruptions, then the goods market equilibrium will move to $300-$350, and the speculators will be vindicated. But this movement would have occurred even if the speculation hadn't taken place, and so again speculators won't raise the price.

The only way in which this could have effect on the price would be if either speculators start to accumulate physical inventories or if it makes producers, wholesalers or retailers start to accumulate inventories (or in the case of producers, cut back production temporarily) in anticipation of such an event. Then it would raise current prices while lowering the price in June 2009. However, this would only imply a temporal shift in price and not a permanent increase and it doesn't change the fact that only speculation in physical inventories can affect the spot price, not pure futures price speculation.


Anonymous newson said...

yes, i'm always amazed at the number of supposedly very savvy people who still don't get it - that spot is the real direction trendsetter, not the derivatives, which absorb a lot of the trading noise.

as you say, to buoy the oil price over time, you're going to need a lot of storage tanks, and impossibly deep pockets.

5:48 PM  
Blogger VVi11y said...

Not my area of expertise, but here is one guy who makes a case that futures are affecting spot prices:

Could he be onto something?

6:07 PM  

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