What would you do if you were a senator? Explain to Americans that reducing the oil price will involve trading in that truck for a Mini? Or blame it all on “speculators” and promise a quick regulatory fix?
No prizes for guessing which way sentiment is leaning in Washington. Those blaming speculators for high crude prices reason that the marginal cost of producing a barrel is about $75. The current oil price is almost double that figure. Clearly, much money has gone into commodities recently. Therefore, speculation explains the “excess” and clamping down on it should push prices down.
This simplistic argument blithely ignores fundamental supply and demand issues. And the impact of passive investors on the oil market may be more subtle – and helpful – than senators think. An index-tracker typically buys, say, a futures contract three months out, sells it as it approaches maturity, and then reinvests in another three-month contract. Rolling this way earns a profit when the forward curve slopes downwards (“backwardation”). All that passive money, however, has supported the price of near-dated futures contracts, resulting in an upward slope (“contango”) at the near end of the curve and a general flattening. This affects spot prices indirectly. When futures enjoy a positive spread over the spot price, it can make sense to store oil now and sell it forward. In turn, those higher inventories dampen spot prices by allaying fears of immediate shortages.
Barring passive investors from the market, therefore, would help push the curve back into backwardation. Inventories would be liquidated as there is little point in storing crude in anticipation of lower prices. The eventual result? Even higher prices – perhaps $200, according to economist Philip Verleger. If active speculators also were curbed, volatility would spike as liquidity drained from the market. The irony is that by squeezing inventories and limiting the scope to manage market risk the crusade against “speculators” could increase the world’s dependence on important oil producers. Opec would surely applaud.