Keeping Some Speculators out of the Oil Market May Lead to Higher Oil Prices

Michael Giberson

From Fortune-Investor Daily:

If Congress or the CFTC forces through stiff curbs on futures trading by so-called “speculators” — i.e. investors who use futures to bet on future price movements but don’t buy actual oil — it may lead to higher, not lower, oil prices over the long term.

Why? Imagine you’re an oil company CEO thinking about drilling a new oil well that won’t produce until 2011. Given the high upfront costs of drilling, you’re going to be more likely to undertake the project if you can use the futures market to lock in oil prices in 2011 that will justify your drilling costs. The buyer on the other end of your futures trade is probably an investor — someone who will commit to paying you $75 a barrel for oil in 2011 because he believes actual price in 2011 will be even higher.

However, if fewer investors are allowed to take the other side of your trade, you will have a harder time locking in a good price for your 2011 oil. That could make it harder for you to justify the upfront cost of building the new well. Less investment in new oil wells means less future supply, and less supply means higher oil prices.

2 thoughts on “Keeping Some Speculators out of the Oil Market May Lead to Higher Oil Prices

  1. Michael–

    I made a similar point in my Congressional testimony last summer. Not like it made any difference; nor will the Fortune piece. The idea of equilibrium responses is well beyond what Richard Posner once called “the Congressional intellect” can grasp.

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