06 August 2008
Paper Oil and Wet Oil
It used to be that oil futures, like grain futures, were related to the risk that producers and users sustained in planning their deliveries in coming months. Those expectations, expressed in paper representing prices that would clear supply and demand when needed, determined the vagaries of the market. Now it is the other way around.
Of course, the market will never run out of paper (or electronic bits). But the negative feedback in the real market to the high prices caused by hedge fund speculation in the futures market has begun to worry the policemen on the hedge fund beat—the credit officers of those hedge funds and their banks. Liquidity and mutual trust are essential to smooth operation of the futures market. Fear of a collapse looms over the possibility that contracts will mature without sufficient wet oil to balance the expectations of buyers and sellers.
Hedge funds are little more than cosmetically sophisticated gambling schemes. They have distorted futures markets through the impact of the immense quantities of capital at their disposal. Perhaps limiting use of the futures market to the ultimate buyers and sellers of wet oil would help to dampen the volatility caused by financial speculation; but you know that smart speculators will always be able to find a way around such regulation. A slow shrinkage of the distance between oil products consumers (purchasers of gasoline, heating oil, etc.), grain consumers (everyone who eats)—the ultimate consumers of all commodities--will eventually result from the development of information technology. Until then, we will have a bumpy ride.
It used to be that oil futures, like grain futures, were related to the risk that producers and users sustained in planning their deliveries in coming months. Those expectations, expressed in paper representing prices that would clear supply and demand when needed, determined the vagaries of the market. Now it is the other way around.
Of course, the market will never run out of paper (or electronic bits). But the negative feedback in the real market to the high prices caused by hedge fund speculation in the futures market has begun to worry the policemen on the hedge fund beat—the credit officers of those hedge funds and their banks. Liquidity and mutual trust are essential to smooth operation of the futures market. Fear of a collapse looms over the possibility that contracts will mature without sufficient wet oil to balance the expectations of buyers and sellers.
Hedge funds are little more than cosmetically sophisticated gambling schemes. They have distorted futures markets through the impact of the immense quantities of capital at their disposal. Perhaps limiting use of the futures market to the ultimate buyers and sellers of wet oil would help to dampen the volatility caused by financial speculation; but you know that smart speculators will always be able to find a way around such regulation. A slow shrinkage of the distance between oil products consumers (purchasers of gasoline, heating oil, etc.), grain consumers (everyone who eats)—the ultimate consumers of all commodities--will eventually result from the development of information technology. Until then, we will have a bumpy ride.
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