The price of oil, having soared to an all-time high in July 2008
before plummeting by nearly 75 percent, is rising again and is
likely to climb ever higher as the economy recovers.
Of course, rational solutions, such as unlocking America's
restricted oil potential, appear to be off the table for the Obama
Administration and the current Congress.
Partially filling the policy void is a convenient scapegoat: oil
speculators. A recent statement by Commodities Futures Trading
Commission Chairman Gary Gensler and several pending
anti-speculation bills in Congress suggest yet another tired debate
on whether to crack down on such activities. However, oil
speculation is not the long-term cause of high or volatile oil
prices, and ill-advised market restrictions may well prove
counterproductive and a diversion from more sensible responses like
Oil Speculation: At Best a Marginal
and Temporary Cause of High Energy Prices
To some, there is something unseemly about making money by
betting on future outcomes. When we do this in the office pool,
well, that's acceptable. And when we do this by buying a share of
stock, a corporate bond, or a mutual fund, then we tell ourselves
that it's investing, not speculating. But in truth, if you are
taking on risk in the hopes of getting a higher return, then you
have joined the ranks of speculators.
Speculators are rewarded for accepting risk if they prove right,
and they lose money if they get it wrong. When oil prices began to
rise in 2008, some speculators bet that prices would rise further,
and they made a bundle. Others bet that prices would rise less or
fall, and they lost a bundle when prices jumped up rather than
down. The same process took place when prices collapsed, with some
speculators making money and others losing their shirts.
So speculators operate on both sides of a market when prices are
expected to go up and when they are expected to go down. They buy
what they do not need from someone wanting to lock in a sales
price, or they sell what they do not have by contracting with
someone wanting to lock in a purchase price.
Speculators are often easy targets because they seem to make
money without working for it, and sometimes they make a lot of
money. But professional speculators typically succeed by their
wits, the sum total of their research, training, and experience,
not luck. In so doing, they perform a vital role in financial
markets: Speculators accept risk that somebody else does not
For example, airlines have enormous demand for fuel, but they do
not want to bear the risk of higher oil prices. At the right price,
the speculator will take that risk. So the speculator contracts
with the airline to deliver an amount of oil (or jet fuel) at a
certain place and time and for a fixed price. The speculator, of
course, does not have the oil. Rather, at the appointed time, the
speculator buys the oil on the spot market for delivery. If the
spot price is then below the price contracted with the airline, the
speculator makes money. If not, the speculator loses. Either way,
the airline's future oil price is locked in today.
Without the speculator on the other side of the transaction, the
airline cannot hedge its risk. This is the first important lesson
about speculators: For every contract, there are two parties--in
this case, one party with risk it does not want and one party
willing to accept the risk at a price.
Suppose the airline does not hedge against a rise in the price
of oil. The airline has become the speculator, at risk of facing
higher oil prices than its competitors.
Speculators play a vital role in financial markets, facilitating
the price discovery process and improving the efficiency of
financial markets. Businesses of all kinds, and therefore their
customers and owners, benefit from the willingness of speculators
to take on risk for a price.
Under most circumstances, speculators move the market toward the
"right" price. On occasion, speculative activity seems to
contribute to a distorting of prices, especially when bubbles
appear as occurred in the dot-com bubble at the end of the last
decade, the real estate bubble, and last summer in the oil price
bubble. These asset price bubbles are troubling for many reasons
and are the subject of intense study and scrutiny. But bubbles are
relatively temporary, short-term phenomena.
Increased Domestic Production: A
Sensible Response to Oil Price Concerns
Oil speculation is, at most, a short-term contributor to price
swings. Long-term solutions to energy affordability lie
The anti-speculation fervor, if carried to fruition, could
diminish the effectiveness and competitiveness of America's
financial markets to the detriment of all concerned. Even more
worrisome, it could divert attention away from better means to
address oil price increases, namely increased domestic
Indeed, Washington's responses to price spikes have long
suffered from such red herrings. In the past, the favorite culprit
of price increases has been the major oil companies. The political
response has included congressional hearings featuring oil company
CEOs being harangued before the television cameras, endless Federal
Trade Commission investigations into industry "price gouging" that
invariably came up empty, and a number of anti-gouging bills.
However, at the height of $4 gas, the public was shouting
"drill, baby, drill" not "regulate, baby, regulate," and they were
on to something. According to government estimates, 19 billion
barrels of oil lie beneath restricted offshore areas--the
equivalent of over 30 years of current oil imports from Saudi
Arabia. And such initial estimates often prove to be low.
Last year, President Bush and Congress repealed the restrictions
on oil leasing in 85 percent of America's territorial waters that
had been off limits: the Atlantic and Pacific coasts and the
eastern Gulf of Mexico. The Department of the Interior is now
handling the process of actually leasing these new areas to energy
companies. Unfortunately, the Obama Administration has done a 180
on the issue and has thus far delayed any new leasing. It has also
revoked some onshore leases. Similarly, Congress has introduced a
number of measures to further reduce oil production via additional
regulations or higher taxes and fees.
Instead of clamping down on domestic oil supplies, bills like
the American Energy Innovation Act (H.R. 2828), the No Cost
Stimulus Act (S. 570 and H.R. 1431) and the American Energy Act
(H.R. 2846) seek to increase supplies. These bills expand and
expedite offshore leasing and open up promising onshore sites such
as Alaska's Arctic National Wildlife Refuge, a small portion of
which is believed to sit atop 10 billion barrels of oil.
Real Solutions Are Needed
At best oil speculation has a marginal and temporary impact on
prices. Targeting oil speculators for high and volatile prices,
much like targeting oil companies, is a political response that is
likely to do more long-term harm than good by undermining the vital
role speculators play in financial markets.
On the other hand, unlocking America's untapped oil potential is
a truly useful step towards affordable energy. Increased domestic
production would have a noticeable impact on supplies and prices
and is well worth doing, especially now that the latest drilling
technologies have greatly minimized the risk of oil spills and
other environmental damage. This pro-energy approach would clearly
help rather than hurt, something that cannot be said of
Lieberman is Senior Policy Analyst in Energy and the
Environment and J. D. Foster, Ph.D., is Norman B. Ture Senior
Fellow in the Economics of Fiscal Policy in the Thomas A. Roe
Institute for Economic Policy Studies at The Heritage
example, anti-price gouging legislation was included in the 2007
Energy Independence and Security Act, and a Federal Trade
Commission rule pursuant to this statute was recently promulgated.
This rule prohibits market manipulation in wholesale petroleum
markets--for example, attempts to distort prices by misstating
planned pricing or output decisions or false reporting of data. See
Federal Trade Commission, "New FTC Rule Prohibits Petroleum Market
Manipulation," August 6, 2009, at http://www.ftc.gov/opa/2009/08/mmr.shtm
(August 26, 2009).