Speculate this

Nothing seems to bring the wing-nuts or populists out in force so much as high oil prices. Over on BusinessWeek’s website, Texas-based journalist Ed Wallace last week posted a provocative essay questioning the veracity of the supply-demand explanation for high oil prices, preferring instead to insinuate that speculators play a much larger role than official D.C. bureaucrats wish to believe or admit. This led to an indignant response from Jeffrey Sprecher, chairman and CEO of IntercontinentalExchange, a futures and derivatives exchange.

When we really examine Wallace’s main claim, it’s not all that outrageous. Of course speculation has played a role in the run-up! Oil is a fungible commodity traded globally, and all such commodities are vulnerable to arbitrage. This seems like a fairly commonsensical statement, benign even – that is, until Wallace injects the premise with the shrill-sounding pitter-patter of a conspiracy theorist who’s just “connected the dots” for the first time.

The current events cut-and-paste job that he performs in order to demonstrate that demand is not outpacing supply is a fun exercise, but doesn’t really prove his point, either. Daily global consumption of oil is somewhere in the neighborhood of 80 to 90 million barrels. I’m not sure how it is that Wallace’s slapdash exercise, accounting for 2 or 3 million barrels per day, moves the needle much. Further, some of the events he seeks to figure into his calculations have either just occurred or are yet to occur; in other words, they haven’t had a chance to move the market yet, assuming that they could in the first place.

The user comments following the article are downright zany. For that we can’t blame Wallace directly, but the innuendos in his essay are unmistakable, from allusions to Dick Cheney and Enron to the ominous market movements of Goldman Sachs. And so, while the substance of Wallace’s actual claims regarding the role of speculation are normative, it’s his attitude and innuendo that the wing-nuts and ultra-populists latch onto.

I was beginning to think the folks at BusinessWeek had gone over the edge, until today, when Economics Editor Peter Coy responded to Wallace’s essay with an opinion piece that puts the speculation story in perspective. He concludes by reporting:

Now, unlike some doctrinaire believers in market efficiency, I’m perfectly happy to stipulate that speculation is responsible for big day-to-day movements in oil and gasoline prices. But who cares? That’s how markets work. People bet whether oil prices should be higher or lower based on their best assessment of all the latest data, which is almost always incomplete and contradictory….For every piece of data you produce showing that supply seems to be exceeding demand, I could come up with a matching one for why people worry that demand will exceed supply.

There is a Queen Mary element to oil consumption. Patterns of usage don’t change overnight. My earliest memories of television involve commercials for sub-compact automobiles that routinely got 50 miles per gallon (MPG). I just saw a commercial this weekend that touted 32 MPG (that’s all?). That was supposed to be a selling point…it struck me as just lame. Likewise, there are myriad behaviors linked to consumption that will take some time to alter. On top of that, the long term trend has been toward greater consumption. Globally, we use 13% more oil than we did ten years ago, according to BP's annual Statistical Review.

The upshot from all of this is just about what Coy claims – a massive correction is in the offing, and that correction will punish speculators whose greed exceeds their caution. Likewise, as noted at Seeking Alpha, it might be time to take a good look at the refining industry if you’re a stock picker. The whole industry has been battered, and a decrease in oil prices will signal better days ahead. On the whole, The Economist gets in about right with last week’s leader, but kudos to BusinessWeek for the give and take.