Oil Speculators Can Go Both Ways

Oil speculators in the commodities market have been at least partially responsible for the inflated runup in oil prices in recent weeks and months. The psychology of oil speculators--their beliefs concerning current and future supply and demand (S&D) and real world events that may impact on S&D--determines how far they will go in driving prices, often erratically.

Larry Kudlow offers his support to the beleaguered oil speculator, and suggests that the best way to get the speculator to influence prices downward is to project a "reality" of increased supply into the future:

The Democratic argument — which I heard again last night on my show from Robert Reich — is that it will take ten years to lift new oil, which will never help today’s price problem. Obama says exactly the same thing, as do Harry Reid, Nancy Pelosi, and all the rest. But they’re forgetting the role of oil traders.

Oil futures markets have contracts that run out five years and beyond. If these traders — or “speculators” — believe new oil supplies are on the way in the future, they will sell those out-year contracts. And before long market arbitragers will backward-ize those price drops toward the spot market, bringing prices down there as well.

In other words, trader/speculators can be very handy instruments of energy (and economic) policies. If demand exceeds supply they are buyers. But a prospective future supply increase makes them sellers. In a free market prices move both ways. And if Sen. McCain would take the time to learn this he could respond accordingly to Obama’s silly criticism that we shouldn’t drill because it will “take too long.” __RealClearMarkets

So it is not really necessary to have more supply than demand, or more demand than supply. It is only necessary that speculators believe that S&D are in a particular configuration, or will be in the future. Those who can influence the beliefs of speculators may be the ultimate puppet-masters, if they can act without detection, and reap profits without ruining a good thing.