And a Thirty Aught Six

Tuesday, April 25, 2006

Gas problems that aren't caused by beans for $200, Alex.

Jay Tea, over at Wizbang, discusses the current increases in gas prices. In it he expresses his wish that the oil traders (speculators), who neither consume nor produce oil but rather just buy and sell, take one in the shorts for driving up prices.

I left the following comment there (a couple of typos fixed from original comment):

Speculators perform a valuable service: They incur risk that other market participants don't want to bear. Many companies not in the oil/gas industry have oil or natural gas as a large portion of their costs. They want to have some kind of assurance that if the price spikes, they don't go out of business. So, they buy futures, often from speculators who bear the risk (I'll deliver X barrels of oil to you in Y months at Z price, regardless of the market price in Y months.) The company reduces its risk, and the speculator expects to make a profit. Both players in the market get something they want: the speculator a chance at a profit, the company reduces risk.

Full disclosure: I once worked at a division of a power company (electricity generation) that bought coal and sold electricity on (relatively) open markets in large part on the futures markets. Such markets would not exist without these speculators.

I don't mean to imply that there would be no long-term contracts without speculators. Rather, the market is more liquid with them and sellers and buyers are offered more choices in their methods to reduce their risk.

For interesting reading that I don't have the time to comment on: That 70s energy policy, a few articles from Tech Central Station on proposed oil policies that were tried in the 70s, and the effects of those polices.

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