By Hilton Price
I remember being a smoker very well. I remember the anticipation of my next cigarette break, especially if it meant getting away from my daily workload for a few minutes. I remember the soothing feeling nicotine had on me, truly a sign of my (at the time) serious addiction. Most of all, I remember how I always knew how bad those little sticks were for my health, and how I smoked them (sometimes eagerly and happily) despite this knowledge.
I bring all this up because in learning about the oil & gas industry, I have been reminded my former tenure with cigarettes. Smoking cigarettes is a lot like oil price speculation. If my new eyes on an old industry understand this right, neither makes any logical sense and seems to only cause harm, yet the practice continues largely unabated every single day.
The process of speculation is headache-inducing due to its complete lack of regard for supply and demand. Oil pricing revolves around futures, essentially a pre-set price for a delivery sometime down the road, making the classic supply/demand model no longer applicable. Now, oil sellers need only offer a price that they believe the buyer will agree to, no matter how the price is determined. The final price could be determined by a gust of wind, conjured from animal bones, or simply
pulled from the ether by the imagination of an inebriated hobo. As long as the
buyer agrees, congratulations! You just set the price for oil!
It’s a wonder every business across the globe hasn’t adopted this approach to pricing. If they could, I’m sure every store at my local mall would love to implement this. Instead of paying $120 for a pair of jeans today, shoppers would now agree to buy a $500 pair of jeans in 5 years. Denim futures would create a whole new generation of millionaires. Personally, I think having to sign promissory notes would make the whole shopping mall experience a lot more interesting. And don’t get me started on the food court. Panda Express would be the new high-water mark in upscale dining, with reservations made 3 years in advance.
Smoking (and exaggeration) wasn’t my only pointless habit. I’ve also always been a bit of a collector (trading cards, comics, games,) so I understand that sometimes things are priced excessively high. Every comic book store has a few books hanging behind the counter because they are “collectible.” The demand may not be obvious and immediate, but since the book is rare, it can demand a higher price than others.
But we’re not talking about some niche collector market. This isn’t baseball rookie cards or obscure comic books from the 50s. This is the one commodity, besides food, that nearly everyone in every industrialized nation is using. So, we’re essentially ignoring the demand on one of the few items that will always have demand. The growing interest and shrinking cost of renewables means demand for oil will one day be replaced by demand for something else. So, not only are we ignoring the massive demand for oil, we’re failing to take advantage of that demand while it exists! Save the futures and speculator nonsense for 100 years from now, when every home has solar panels and our cars are powered by canola oil. That will be the time to charge prices
pulled from thin air. That will be the time to sucker buyers with talk of
future pricing. Today is not the time for imagination in pricing. Today is the
time to sell the oil to the people that want it for a reasonable price.
But, instead, the success of our speculator market has other countries interested in their own game of financial make-believe. Much like younger friends I had who once considered smoking because they saw me do it, now other countries are considering picking up our bad financial habit. Although, the U.S. is younger than China, so the metaphor is getting a little shaky. Point is, speculation has been successful for some, and now others want in. Meanwhile, there may be a chance that rational thinking could one day return to our own markets.
President Obama, always a favorite topic around the office, announced plans to crack down on speculation. At least, I think I saw that somewhere. As the 24-hour news cycle does, it was soon replaced with other stories. But I swear he said that, and whether it’s a political ploy or a real concern for the man, it’s very much needed. People are getting rich making stuff up, and not in a cool way like Stephen King or DEVO or those guys behind LOST. Their making up pricing, and we’re playing along because we think there’s no other way.
I remember another time I felt like I did something because there was no other way. I smoked cigarettes. Why? Because I had smoked for years, and I was addicted, and it was just part of who I was. Well, then I quit. Now, I don’t smoke. It’s dumb and dangerous and I don’t want any part of that. Speculation is the same. Together, as a planet, we need to quit, and keep our friends, the other countries, from starting. It’s dumb and dangerous and trust me, we don’t want any part of it.
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One of the basic treatises in economics is that prices are set, and value is determined not by the labor pool, not by the government and not by the sellers; but by the buyers. In the futures market, as in any other market, you are free to your price wherever you want, but the value is not set until the market, not one or two knuckleheads, does its price discovery and proves the price.
ReplyDeleteI can ask $22,000 for my well-maintained 2003 Durango or $750,000 for my modest home in the Westbury subdivision of Houston all day long, but the price I set doesn't determine the value. Even if some poor jackalope would accidentally buy my truck for $22,000, that wouldn't mean every six-figure mileage 2003 Durango would be worth $22k. The other buyers would shake their heads, or point and laugh, but nobody else is obligated to pay that price.
Buyers are by and large traders - traders tend to be pretty saavy about the market and can do advanced math. Think about somebody who buys fuel to hedge one of the major airlines - just how stupid do you think these people are?
Even if the prices were miraculously rise to the level that any Joe puts out there, there is another band of heartless warrior-vampire traders out there called arbitrageurs who would suck the blood out of any firm stupid enough to trade on that "make-believe" speculative scenario you lay out.
But, yeah, okay... it's the greedy, heartless speculators driving oil prices needlessly higher. Whatever. What mystifies me is how anybody in our business could buy that argument and join that particular chorus... you know they think they same thing about us, right?
I think you unecessarily denegrate the professional traders. Most still operate within the traditional parameters that are bound by the time value of money and place, anchored in the realities of the current market.
ReplyDeleteThe reality of pure financial trading, as the speculators almost all are, need to close out their positions as the spectre of physical delivery looms large.
I might be able to "buy" a tanker full of crude for delivery in January 2014, but come December 2013 I had better have a place to take delivery of that oil or face severe financial consequences. So, I have to close out my position.
That is, I have to sell that oil to someone who actually can, and will, use it. If I have had some hair-brained idea, to which I remained wed until the bitter end (unlikely for an astute financial trader) that is badly out of line with the market, I can take a huge bath. That happens.
I think there is a large debate as to whether or not financial speculators really have that much impact on the final product pricing.
I am sorry, but traders are like lawyers, always making excuses and trying to justify the harm they do. Enron is a greate example, they were basically a trading company.
ReplyDeleteSo what we do in many markets, the oil market included, is not free trade. Zach really puts it in perspective - he is not interested in buying oil at all, only profiting on it increasing in price. He points out that he has to close out his position before he actually has to take delivery of the oil.
The free enterprise system is based on buyers and sellers, not traders.
Traders are like lawyers, always trying to justify what they do no matter what harm it does to the country and the economy.
ReplyDeleteFree trade is between buyers and sellers, not traders.
Zach nails the problem with traders, they are not even interested in buying anything, only profiteering on price changes. As he says, he has to close out his position before he would have to take delivery on the product.
Things like trading and futures all seemed like good ideas when they started, much like many goverment programs. The problem is that people figure out ways to take advantage of them.