Dumb Comments On Energy Prices And Manipulation

There are so many silly assertions and so little time!

One of our missions at “A Dash” is to identify strong sources of information and analysis.  Even the most intelligent reader needs some expertise to make the key distinctions.  Let us consider some examples.

Oil Demand and Price

The Statement:  One of the CNBC talking heads repeatedly stated that oil prices fell by 80% but demand did not drop that much.  To her, this was evidence of an inaccurate market.  None of the many CNBC panelists contradicted her.

The Reality:  Introductory Econ classes start with how markets clear, showing a supply function (a curve) and a demand function (also a curve).  The markets clear at the intersection of the two curves.  A lecture or two later there is a discussion of elasticity — how much demand (or supply) changes with a unit change in price.  There are examples of inelastic demand (insulin is a favorite) and more responsive demand.

The Conclusion: It is not proportional or linear.  It is another case of pop economics intuition leading one astray.  Let us suppose that the oil market is near a tipping point.  A demand curve intersecting slightly above the production capacity leads to a price spike.  At a slightly lower point, producers may still want to generate some revenue.  It is all about the shape of the supply and demand curves.

Oil and Stock Correlation

The Statement: An expert says that stocks are trading based upon oil.  There is a chart showing a correspondence between stock prices and energy prices.

The Reality: The relationship between energy prices and stock prices is situationally dependent.  In general, high energy prices are a tax on the consumer.  There is no reason for higher oil prices to cause higher stock prices.

The Conclusion: This is a classic case of a spurious relationship.  This is a technical statistics term meaning that Factor A (in this case perceptions about the economy) is driving the behavior of both Factors B and C.  The apparent relationship is not causal.  In addition, this would make sense only if stock traders thought that energy prices were a more accurate read of the economic prospects.

Rogue Trading and Energy Manipulation

The Statement: There are some rogue energy traders who made drunken or mistaken trades.  These needed to be unwound.  This shows manipulation of the energy markets.

The Reality: Mistakes are discovered and corrected.  It is not manipulation.

The Conclusion: It has no lasting impact on prices, despite the media hype.

Speculation drives Energy Prices

The Statement: Speculators have exacerbated price swings in energy.  Some government officials in several countries want to hold hearings and consider legislation to curb speculation.

The Reality: Speculators are trying to make profits.  They add liquidity to the market, acting based upon many sources of information about all conditions.  Think “The Wisdom of Crowds.”

The Conclusion: There is very good evidence on this point, from some excellent sources.  Astute economist James Hamilton took a close look at this when energy prices spiked, and wrote as follows:

I personally do accept the view that the “paper oil” speculation has made a contribution in recent months to the increase in the price of physical oil. I believe that this speculation has resulted in a slight decrease in the quantity demanded that has required some modest supply reductions or accumulation of inventory by producers. But I expect that producers will find these changes not to be in their best interests as the demand adjustments become more prominent, at which point the price must return to that governed by the underlying physical fundamentals.

Ultimately, the price must be such that the quantity of physical oil demanded at that price is equal to the quantity of physical oil supplied. Any speculator who promises on paper to buy oil for more than the physical stuff is actually selling for will find themselves at that point with a big, fat paper loss.

Here is another take from noted investment advisor Dr. Stephen Leeb:

The real force at work behind last year’s run-up in prices, the subsequent decline and the rebound that has followed is the market’s invisible hand. In other words, good old fashioned supply and demand was the culprit. Unprecedented synchronized global growth between 2005 and early 2008 caused demand to soar, yet producers were unable to meet the call to increase production by anything more than a token amount.

Readers should check out his entire review of the history and his argument.  Government intervention to distort markets is the last thing we need.

Our Overall Take

There is an active market in conspiracies and manipulation.  It makes an ideal media story, whatever the reality.  Commentators also seem to have a bias toward the legitimacy of equity markets and against futures markets, often citing off-hours trading.  Perhaps those of us with more “Chicago” experience better appreciate the depth and liquidity of futures trading.

Those doing “pop economics” have a field day.  It takes careful analysis to sort out the reality.

Subscribe by RSS Subscribe by Email