I’ve been following the rise of oil, personally and professionally.  Oil prices affect me a lot more professionally than they do me personally. I don’t drive enough that the price of gas makes a substantial impact on my budget.  The fact is that rising oil prices have been good for me professionally.  Yes, I’m in the “evil” energy business.  I’m one those “speculators” driving up oil prices.

That’s not quite true. I don’t trade oil, but oil does have a substantial but indirect impact on the electricity market that I’m in. I also don’t believe that rising oil prices can be squarely blamed on financial speculators.  This is not to say that traders do not affect or profit from rising oil prices. However, it’s simplistic to think traders can make oil go from $60 to $120 and keep it there all on their own.

When an oil trader bids up oil by buying oil futures in the “shadow” financial economy, there is still a day of reckoning in the real economy. There’s no question that a speculator can raise the price of futures by merely buying.  Futures are contracts to buy or sell at a future date.  If I sold a one year future contract for $100/barrel, I’m obligated in one year to deliver oil for $100/barrel.  For instance let’s say I wanted to raise oil prices, I could buy future contracts settling a year out for $200 when oil is only trading $100 today in the spot market.  The spot market is the real world actual time economy.  The spot market and the futures market however do move together.  If someone is willing to buy oil for $200 in year, but oil is only $100 today, there’s a clear profit opportunity. I can buy oil today, store it for something less than $100/barrel, and sell the future contract.  Instant profit of a $100.  As a result spot markets and futures markets tend to track.

However for the same reason that speculators can affect the real world spot market, the real world spot market has impact of the shadow economy.  If speculators are willing to buy $200 oil in on year’s time, but inherent supply and demand implies oil should be $100 today and tomorrow, then there should be other traders who would gladly take the other side of that trade.  That trader knows he or she should be able to procure oil for less than $200/barrel.  Ultimately what really prevents speculators from affecting actual prices in the long term is that for every deal there is someone just as canny on the other side.

I’m not naive enough to believer that speculators have not had an impact on oil prices. They have, and were the movement in oil prices short lived, I would put more blame on speculators. However, high oil prices have been sustained and for that I believe there have been actual supply and demand changes. Speculators can only keep prices high only for so long as it takes ever more capital to keep prices high.  For example let’s say I’ve brought $200 oil last year, I’m out $200 already, and if I were want to keep prices high I need to come up with more capital to buy more without raising capital by selling.  It certainly wouldn’t be the first time that speculators have tried to corner the market.

Sadly enough, rising oil prices if they persist are being caused by long term change.  Rising demand in developing nations such as China and diminishing supplies have fueled the rise in oil.  I don’t believe necessarily that we will run out of oil in the next decade, but it is a matter of time.  Oil and other fossil fuels are a limited resources.  It’s not a question if we’ll run out, but when.  In this regard, high prices are the answer to the long term problem. Higher prices will force us to rethink where we get our energy and how we use it.