Monday, June 23, 2008

Conservation: Speculators Do It BEST

I often ask my students, “How many of you are in favor of conservation?” Every hand goes up. I then ask, “How many of you are in favor of speculators?” and almost no one raises his hand. The students see conservation as a noble activity that prevents people from squandering resources now to insure that adequate quantities will be available in the future. On the other hand, they see speculation as the greedy hoarding of valuable resources now in order to gouge those who will need those resources later. I attempt to explain that if they are serious about conservation, they should also applaud speculation. The speculation that results from private property and the desire for profits is the most powerful force for beneficial conservation.

Speculators make money only if they conserve wisely—buying resources (holding them off the market) when they are less valuable and selling them (making them available) when they are more valuable. If speculators don’t conserve enough, they pass up profitable opportunities to buy low and sell high, and if they conserve too much they lose money by buying high and selling low. The speculator who consistently makes mistakes is soon relieved of the money necessary to continue speculating.

For example, at the first indication that next year’s Brazilian coffee crop will be devastated by a frost, speculators will immediately purchase raw coffee beans to store them until next year. Consumers will still see plenty of ground coffee in the stores, but suddenly the prices will be higher. What consumers don’t see is that coffee prices will be lower next year than they otherwise would have been because they are higher today, and that their reduced consumption today will be more than compensated by their greater consumption later. The complaint will be that greedy speculators have unnecessarily driven up prices. Interestingly, the universal complaint against speculators that they cause current prices to be too high is really a complaint that they conserve too much.

The important point is that anyone who believes he has better information on the future value of resources or commodities than is reflected in market prices can both profit personally and benefit society by acting on that information—if he is right. So when conservation is left to speculators, far more relevant information from far more people with far more at stake is acted on than if conservation is left to government.

~University of Georgia Economist Dwight Lee

14 Comments:

At 6/23/2008 9:42 AM, Blogger Dave Narby said...

Mark,

Love this blog, but sometimes I wonder if you're putting Libertarian ideology ahead of fixing a very real problem...

I'm sure many of us would appreciate your response to this:

"If you had to rank them, which is the worst: Enron, California, and energy trading or maybe Amaranth and natural gas. Today, the charge is oil speculators and the ICE exchange.

What the three have in common is the Enron loophole, part of a law snuck in by Phil Gramm with a lame duck Congress and President in 2000. The law was written by Enron lobbyists and allowed some commodity trading to be free of regulators.

Back in 2001, when California reeling from brown outs, the usual suspects were rattled off: more demand, not enough supply, California's weird pricing mechanism. But once FERC, the Federal Regulation of Oversight and Energy, was granted oversight to look into the matter, the brownouts stopped.

And we later learned that Enron was screwing California to the tune of $48 billion by instructing power plants to shut down.

See the link: http://www.cbsnews.com/stories/2004/06/01/eveningnews/main620626.shtml

And it happened again with natural gas.

In 2002, natural gas was $3 per MMBtu. The price in 2005 spiked as high as $14 after Katrina and then Congress considering adding new regulations on nat. gas and the price fell by a 1/3. In 2006, the price went to $4.80, and a hedge fund named Amaranth blew up.

"Amaranth Advisors LLC controlled more than half the U.S. natural gas market and evaded regulators in the biggest-ever hedge fund collapse, a Senate investigation found."

The Commodities Futures Trading Commission told Amaranth to liquidate its position on the NYMEX because its bidding had already moved natural gas prices far beyond the reasonable limits of supply and demand. Once the CFTC told it to back off its natural gas futures contracts, Amaranth simply shifted gears, got out of the NYMEX, placed its massive bets outside of government regulation in ICE, the Intercontinental Exchange.

"The report also calls for closing the so-called Enron loophole, which allowed Amaranth to do more business on electronic trading systems such as Intercontinental Exchange Inc. after being forced to reduce its positions on the New York Mercantile Exchange, where benchmark gas futures trade."

And now we come to oil, and the same bs arguments about supply and demand come into play. As I have previously written, supply and demand are in much better balance now than in 2006, so what has changed?

In Jan. 2006, the Bush administration allowed the ICE, based in London, to trade WT oil futures without oversight of the CTFC, Commodity Futures Trading Commission.

And who runs the ICE commodity exchange? ""The Intercontinental Exchange (ICE) was the brainchild of Morgan Stanley, Goldman Sachs, British Petroleum, Deutsche Bank, Dean Witter, Royal Dutch Shell, SG Investment Bank and Totalfina."

ICE now controls 30% of all the oil futures market, and the money in said market has exploded from $13 billion in 2000 to $260 billion today. And unlike the NYMEX, the ICE is unregulated, and traders can do just what Amaranth did. The CTFC tells them to stop speculating on oil on the NYMEX, and they just go right over to ICE.

But finally some relief is on the way, the CTFC is now going to start monitoring the ICE. See the link: http://www.iht.com/articles/2008/06/18/business/oil.php

This weekend the Saudis brought the world together for an oil summit and despite the Saudis claim that speculators were to blame, Samuel Bodman, chairman of the department of energy, said oil prices were based on supply and demand.

You would think if Bodman were to make a statement like that, it would be known how much oil is being tied up by speculators. However, when Senator Richard Durbin asked what percent of oil trades were being monitored by the CTFC, Walter Lukken, chair of the CTFC, said he didn't know.

Unfriggin' real. They know but they don't know. I should also mention that on the ICE, because of the Enron loophole, oil futures can be leveraged on a 10:1 basis. I think oil prices like nat. gas and energy will come down with regulators looking.

However, there is a simple way to see if oil prices are high due to speculation. Outlaw leverage on oil futures and tax gains on oil futures at a 95% rate. If it is all supply and demand, the price shouldn't drop at all.

And that is not the only damage done to the economy by Gramm, he also had a role in the subprime fiasco. "Gramm’s deregulation legislation as a senator help set the stage for banks to slice up subprime mortgages, bundling them with other mortgages, to hide the credit risks, and selling mortgage bundles to other investment firms."

After his run in the senate, Gramm soon there after started working for UBS (probably because Enron was bankrupt).

But Gramm is back in politics now as McCain's economic guru. McCain better jettison this clown if he wants any chance at winning.

I cannot believe one man has done this much harm to the U.S. economy.

As far as AFN goes, I think we will start to see oil prices slide once regulators look at oil. The same has happened before with nat. gas and energy. And not only are these traders going long oil, they are going short the dollar."

(courtesy of my friend DocJoe at http://messages.finance.yahoo.com/Stocks_(A_to_Z)/Stocks_A/threadview?m=tm&bn=51408&tid=23466&mid=23466&tof=2&rt=1&frt=1&off=1 )

 
At 6/23/2008 9:51 AM, Anonymous Hayek Fan said...

Prof. Lee's students would deny it, but they're speculators too, if they've ever rushed to fill their tanks in expectation that gasoline will cost more tomorrow.
In the face of relatively inelastic demand, the only way to slow speculation is to permit supply to expand, as the market will do when left to operate.

 
At 6/23/2008 10:08 AM, Blogger Sophist said...

Associating conservation with speculation is the ultimate straw man a sophist can possibly think of.

According to the straw man, the solution to the energy problem is to make everyone a speculator. That would maximize the objective function wouldn't it? Or it won't, and that means some should be the speculators and some others their victims for optimum conservation?

Whatever happened to sanity? Has insanity hit the door of major university accross the country?

Is that what our children are taught? No wonder corruption is all over the place.

 
At 6/23/2008 10:11 AM, Blogger juandos said...

"In the face of relatively inelastic demand, the only way to slow speculation is to permit supply to expand, as the market will do when left to operate....

Excellent point hayek fan!

Hey dave narby, do you have anything credible to bolster this statement by you?

"What the three have in common is the Enron loophole, part of a law snuck in by Phil Gramm with a lame duck Congress and President in 2000. The law was written by Enron lobbyists and allowed some commodity trading to be free of regulators"...

I've run into a bunch of conspiracy noise when trying to find it but I've yet to see something of substance about it...

I can almost understand this supposed bit of Enron manipulation: "And we later learned that Enron was screwing California to the tune of $48 billion by instructing power plants to shut down"...

I mean it seems like from where I sit California citizens apparently have a yen for being hosed, why couldn't Enron get a bit of that action?

Very interesting stuff you have posted dave narby and thanks...

 
At 6/23/2008 10:31 AM, Anonymous Anonymous said...

The rationale of conservation and speculation going hand-in-hand assumes the speculator lives forever and is willing to wait indefinitely for profits. That is not the case.

There is an excellent case to say, keep oil in the ground until 2100 when it should be an inflation-adjusted $400+ or more per barrel. However I think only KSA is thinking on that kind of a time-frame.

 
At 6/23/2008 11:00 AM, Blogger Marko said...

Whenever someone blindly states "we can't drill our way out of this problem", just blindly state "we can't conserve our way out of this problem". Just as valid an assertion.

Also, next time you think about conserving, think of all the hard working people you put out of work! Especially when you re-use. Each time you re-use a plastic bag, you are helping put plastic bag makers in the unemployment line. Just think about it, you cruel, cruel conservers.

People before Conservation! Power to the People!

 
At 6/23/2008 12:10 PM, Anonymous Anonymous said...

Mark,
Given this and your previous posts on the subject, I am led to ask: If the speculator buys today at the spot price and sells tomorrow at the inflated price resulting from scarcity plus storage costs, wouldn't it be cheaper overall for the consumer if he (the consumer) could just pay the inflating spot prices over that period minus the storage cost. Wouldn't this be like cost averaging in the stock market, and over the year the same commodity would have been cheaper overall?

 
At 6/23/2008 10:10 PM, Blogger Dave Narby said...

You guys are missing the point. It's not speculators, but the degree and leverage with which they are allowed to do it.

10:1 margin and no delivery requirement creates and environment extreme and damaging volatility.

@ Juandos: You might start here: http://www.google.com/search?hl=en&lr=&safe=off&as_qdr=all&q=enron+loophole+ken+lay&btnG=Search

 
At 6/23/2008 11:37 PM, Blogger juandos said...

Thanks for the Google Search Link

Again dave narby another excellent suggestion amigo...

Much appreciated...

 
At 6/24/2008 6:58 AM, Blogger OBloodyHell said...

> I cannot believe one man has done this much harm to the U.S. economy.

Three words: John Maynard Keynes.

Not only did he give the USA the "pleasure" of the 1970s, but he and his successors have been screwing Japan's economy for the last 15 years.

 
At 6/24/2008 7:17 AM, Blogger OBloodyHell said...

> Associating conservation with speculation is the ultimate straw man a sophist can possibly think of.

And failing to argue against the treatise by labelling it "a straw man" is the ultimate argument of an incompetent debater.

Calling it something does not make it so.

> According to the straw man, the solution to the energy problem is to make everyone a speculator.

a) In essense, everyone IS a speculator, as noted by the commenter who said "everyone who specifically went out to buy gas because they thought the price was going to go up is a speculator".
b) To speculate requires assets. If you fail to speculate correctly, you LOSE those assets (did you not read more than the first sentence?), hence, people who are BAD at speculating (i.e., conserving -- and that's a LOT of people) will lose their shirts, and get out of the speculation market.
c) The point is to normalize pricing, to reduce the volativity of it, by averaging out spikes and troughs (Yes, you might argue it's failed at the moment... this is yet to be determined as fact, however, and only time will tell).

> Whatever happened to sanity? Has insanity hit the door of major university accross the country?

Yes, it's called "modern liberalism". It's been touching down, tornado-like, a lot of other places, too, and leaving little more than rampant destruction in its wake.

> The rationale of conservation and speculation going hand-in-hand assumes the speculator lives forever and is willing to wait indefinitely for profits. That is not the case. There is an excellent case to, say, keep oil in the ground until 2100 when it should be an inflation-adjusted $400+ or more per barrel.

Since the only way that would happen is if SOME people use it UP in the meantime. So your argument falls apart right from the start.

And frankly, I personally suspect this may, indeed, be one of the rationales behind the current US Oil Policy -- Use theirs. Keep ours until it's much more expensive. Save money in the very long run.

I have no evidence to support that idea, but as an idea, it does make US oil policy make a certain amount of sense.

OTOH, if someone develops some new "magic" energy technologies in the next couple decades (storage + generation), the price/value of oil goes waaay down, and that decision becomes potentially bad (it may be saved by use of oil as a chemical feedstock, which means that the error would be substantially ameliorated by such an event)

> 10:1 margin and no delivery requirement creates an environment extreme and damaging volatility.

So you are vehemently against Fractional Reserve Banking and strive to get laws passed which disallow it?

Wasn't there a CD entry showing that the economy has been more stable in the last 70 years, not less?

Why does your claim not apply to banking (i.e., the money supply), if it applies to oil markets (i.e., the oil supply)?

 
At 6/24/2008 9:26 AM, Blogger Sophist said...

obloodyhell, do you argue for just the shake of arguing?

Nothing you say makes sense. You confuse orchestrated speculation (something similar to market cornering) with your average Joe guessing what the price of gas might be down the road.

You can't be that dumb, or maybe you are, who knows after all, I have seen people posting all kinds of nonsense over the years without realizing their IQ does not qualify them doing so.

 
At 6/24/2008 5:08 PM, Anonymous Anonymous said...

Dave Narby,


"And we later learned that Enron was screwing California to the tune of $48 billion by instructing power plants to shut down."

Aren't you missing out on a few pertinent facts? For example, consider the story of Rancho Seco Nuclear Generating Station opened in 1975 which was designed to generate 900 megawatts of electricity enough to power 900,000 homes. This government facility was converted to solar power and now generates a colossal 4 megawatts of electricity. A large portion of California's electricity is imported from other states yet Enron doesn't seem to be pulling any strings.

http://www.manhattan-institute.org/html/_wsj_californias_energy_colonialism.htm

I think I smell the faint aroma of burning shorts.

 
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