Blame oil speculators?

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Are speculators contributing to higher oil prices? Sure, to some degree. How much? God only knows.

There's usually a moralizing subtext to critiques of speculation. But almost every economic activity under capitalism involves speculation. The creator of a new product is speculating that someone wants it. House buyers, if such creatures still exist, aren't just looking for places to live -- they're probably hoping to sell their homes at higher prices several years later.

So too with oil. If you're the oil minister for a member state of the Organization of the Petroleum Exporting Countries or the chief executive of an oil company, you have to decide how aggressively to pump out of your existing reserves and how much to spend on developing new oil fields. Such decisions depend on judgments about what oil will be selling for in 2010 and in 2020; these can be educated guesses, but they're still stabs in the dark. So even the most sober-seeming executive is a speculator.

Enough reframing the question. I suppose the issue is to decide how much the doubling of oil prices over the last year -- and their quadrupling over the last five years -- is the result of supply and demand and how much is the result of futures market participants with no tie to the oil industry other than driving a car. The standard explanation for high oil prices is that demand from developing nations has exploded, with China in the lead, while supply has stagnated.

Chinese oil demand has certainly grown strongly. But over the last five years, global oil consumption is up 8% and production is up 8.4%. For the five years ending in 1999, consumption was up 10% and production, 7.8% -- and oil cost $18 a barrel, about one-seventh what it costs today. In other words, production is keeping up with demand and current growth rates are hardly out of line with recent history, but prices have skyrocketed. And over the last three years, Chinese demand has grown at half the rate of the previous three. Putting it all together, I'd say that purely on the basis of fundamentals, high prices make some sense, but nowhere near this high.

What has changed in recent years is the explosion in commodity index funds, investment pools that hold a broad array of commodities. And as commodity prices rise, the funds buy more -- lots more. Over the last five years, they've bought -- on paper -- almost as much oil as the increase in Chinese demand over the same period. This is a very different game from more traditional futures speculation, where buyers and sellers are more or less in balance. It wouldn't take much to throw this whole process into reverse. We may not see $30 oil again, but $75 oil is a pretty reasonable possibility.

And I have to admit to mixed feelings about that. Averting a climate catastrophe requires us to burn a lot less oil, and nothing would encourage that more than high prices. I'd rather the proceeds go to alternative energy research and softening the blow to the poor than to Saudi Arabia and Big Oil. But I'd also be horrified to see SUVs come back into fashion.

Doug Henwood edits the Left Business Observer and is the host of "Behind the News," a weekly radio show in New York and Berkeley. His latest book is "After the New Economy" (New Press, 2004).

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Doug,

On Monday, you said that the average (I assume you meant median) household's real income is likely to be lower than it was in 1999. I can only assume you don't have a very clear memory of what 1999 was like. Do you remember the World Wide Web of 1999, where it took five minutes to download a family photo? There was no Wikipedia, Netflix was brand new, there was no such thing as buying an MP3 download -- which I suppose was just as well, because there was no such thing as an iPod. Meanwhile, Kodak had just released a 1.3 megapixel digital camera. You carried it on your shoulder and it cost $13,000.

All the changes since then count as economic growth, and not all of them are captured in the numbers you cited. Your measures of real income fail to fully account for improvements in quality and the appearance of entirely new products. Moreover, the benefits of that growth are distributed more widely than you admit. It's true that income growth has been concentrated among the rich. But it's also true that prices have dropped further and faster for goods that are bought by the poor and the middle class. The price of fine oak furniture is up, but the price of solid middle-class furniture is way down, and a similar pattern holds across other goods.

As for your ambivalence about cheaper housing, all I can say is that if you're going to complain about every price that goes up and also complain about every price that goes down, then I'm sure you'll always have plenty to complain about.

So much for Monday. Today, I mostly agree with you: It's very hard to guess what the price of oil would be in the absence of speculation, but it's also impossible to imagine what a world without speculation would look like.

I certainly agree with you that we have no good explanation of these prices. Certainly as an explanation by itself, "speculation" makes little sense. Speculators drive up prices only when they believe that future prices will be even higher. Why they'd believe that, I'm not sure.

I do think we should pause to note that if that's what's happening, then the speculators are doing our children a service by conserving oil for a time when it will be very scarce. In other words (if in fact that's what's happening), there are two reasons to applaud higher oil prices -- conservation and environmental issues. But speculators are unlikely to care about the latter. So no matter how high speculators push the price, they're unlikely to push it far enough.

Steven E. Landsburg is a professor of economics at the University of Rochester, a columnist for Slate and the author, most recently, of "More Sex Is Safer Sex: The Unconventional Wisdom of Economics."

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