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Much to my chagrin, there isn't a whole lot of back-and-forth on my blog (though I'm surely at fault for that with my unreliable posting schedule), but there was a great response to my blog post yesterday about oil prices and I wanted to make sure to highlight it and respond.

I'm not going to pretend that a big part of the reason that I like the response isn't because it happens to agree with my own view. However, I think it does really underscore some of my own thinking. Here's what Michael over at The Macro & Micro has to say:

To answer your question - well you seem to have already done so - S/D have not changed that much... it is the speculation that has changed. While the economist suggests we not 'blame the speculators' (http://www.economist.com/opinion/displayStory.cfm?source=most_read&story_id=11670357), I still find myself disagreeing.

One line in the article "But they do so based on their expectations of future trends in supply and demand, not on whims." is frankly not true. Often speculator 'expectations' may be 'educated whims' - that are wrong. The index funds and the smarter players make a move and everyone else who knows nothing follows - typical herd mentallity.

For example:

1. "On January 17, 2006 crude oil for February delivery rose by USD 2.38 (3.7%) to USD 66.30 a barrel. This was the highest increase since early October 2005." (http://en.wikipedia.org/wiki/Oil_price_increases_of_2004-2006)

2. This jump was a futures market response to the Nigerian violence... in which a temporary 250,000 barrels per day was not produced from Nigeria.

3. According to the 'profit fromthe peak' front flap (I'm seriously considering this book), oil consumption is 86m barrels a day. 250,000 is not even 1 percent of that.. its like .3% - however oil prices rose 3%. less than .5% is barely a drop in the bucket, but the price raise was hardly warranted. It was speculation.


Can I say I couldn't agree more? One of the things I've tried to do is actually sit down and put together some sort of supply and demand curve (the stuff of Econ 101) for oil. Now I understand that it's hard to substitute in many of the places where oil is used, but frankly I couldn't come up with a reasonable graph that would explain the change in the price of oil over the past few years.

As for The Economist, yeah, that was pretty disappointing for me to read. The Economist is easily my single favorite publication ever and I can't help but think they missed the boat on this one. Is all the price action due to speculators? No. But I think there's a healthy margin that is. And as Michael pointed out, it's wrong to assume that all those buying and selling oil futures are fundamental driven investors looking at oil consumption and production statistics. You've got plenty of technical analysts and trend followers out there who are going to be basing their trading on price action and chart patters, not real supply and demand.

So, as I said before, I welcome responses and thoughts -- even if they differ from my own. We're talking about a huge global market here and so I certainly can't claim to have all the answers.

-AvgJoe

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