The airlines suck even more today. Not because only one can manage a profit but because they are suggesting asserting speculation is the driving factor behind increasing oil costs.
Mike forwarded an email he received from Richard Anderson, CEO of Delta, introducing a 12 airline initiative to end oil speculation:
For airlines, ultra-expensive fuel means thousands of lost jobs and
severe reductions in air service to both large and small communities.
To the broader economy, oil prices mean slower activity and widespread
economic pain. This pain can be alleviated, and that is why we are
taking the extraordinary step of writing this joint letter to our
customers.Since high oil prices are partly a response to normal market forces,
the nation needs to focus on increased energy supplies and
conservation. However, there is another side to this story because
normal market forces are being dangerously amplified by poorly
regulated market speculation.Twenty years ago, 21 percent of oil contracts were purchased by
speculators who trade oil on paper with no intention of ever taking
delivery. Today, oil speculators purchase 66 percent of all oil
futures contracts, and that reflects just the transactions that are
known. Speculators buy up large amounts of oil and then sell it to
each other again and again. A barrel of oil may trade 20-plus times
before it is delivered and used; the price goes up with each trade and
consumers pick up the final tab. Some market experts estimate that
current prices reflect as much as $30 to $60 per barrel in unnecessary
speculative costs.Over seventy years ago, Congress established regulations to control
excessive, largely unchecked market speculation and manipulation.
However, over the past two decades, these regulatory limits have been
weakened or removed. We believe that restoring and enforcing these
limits, along with several other modest measures, will provide more
disclosure, transparency and sound market oversight. Together, these
reforms will help cool the over-heated oil market and permit the
economy to prosper.
What a load of crap. Providing millions of customers with evidence that’s correlation passed off as causation is misleading. I disagree with this on a number of levels but primarily with the purported premise that increased oil speculation creates high oil prices.
First, understand how speculation on oil prices occurs:
Speculation involves Futures Contracts where bids are placed to buy the physical commodity (oil in this case) at a later date at a fixed price. A Futures Contract is primarily a hedging instrument where an individual in need of a commodity can lock in a price at the contract’s rate. So one would buy a contract if he believes the price will rise in the future. A Futures Contract is by design a speculative instrument for all participants, for both the pure speculators whom strictly trade the contracts and never want to take physical delivery of the commodity and the companies that need the material to operate. This is why in retrospect, Southwest’s bet that buying oil Futures in the $50s would be a bargain looks very smart.
So how is it that speculation doesn’t spell automatic price inflation and manipulation? According to Dick et al. it certainly does, but he asserts this behind the fallacious charge that “more participants will bid to higher prices.”
The problem with this argument is that Futures aren’t sold in an English Auction where prices constantly ascend, but are traded on an exchange. This means prices are constantly bid up and down as participants battle to find the true value.
Remember that every trade in an exchange involves risk on both sides of the deal. The motivation of the buyer and seller is to maximize profits and control risk. So when a trade is made, the buyer believes that the potential for further upside outweighs downside risk to his capital. Conversely, the seller believes the price has climbed to a level where the mounting risk to his profits no longer outweighs the reward of potential future profits. Each think they are better off than the other after the transaction is complete. “No, you’re the sucker!”
With more market participants, the ability for the market to converge on the actual value of oil at it’s fair value is, in theory, maximized. More buyers and sellers means more liquidity, which reduces the opportunity for a handful of players to manipulate the price in a direction that is favorable to their interests. So more speculation actually makes the market more efficient. Everyone is motivated by profit. A contract for a barrel of oil trading hands 20+ time before the oil is actually delivered simply means that everyone that owned the paper at sometime thought they were better off than the preceding ass-hat that sold it to them.
Below is the preceding 100-day and 3-day price action. On the charts, each bar represents 30 minutes and one day of trading, respectively. The obvious trend in the longer-term is up! That’s nothing new as I’ll get to below. Zooming into levels where we can see a more granular view of the trading reveals that there is indeed an up-and-down battle between buyers and sellers. Clearly stating that “the price goes up with each trade” simply isn’t true.
[from BarCharts.com]
Dick, et. all ignore market elasticity. Oil supply has remained relatively constant in recent years while demand has increased due in large part to burgeoning emerging economies like China, India and Russia. No one anticipated the relentless double-digit economic growth from China for the last ten years. Bringing it’s 1.3 billion citizens on-line takes a lot of energy. And what about we oil hogs here in the US? With a mere 4% of the population, we use 25% or 21M of 85M barrels consumed globally every day. Only now, with gas at 4$ a gallon — and with a slowing economy, weak dollar, and shrinking credit — is demand slowly starting to be destroyed domestically. Simply put: there is strong demand and with a limited supply there will be higher prices. Speculators or not.
I’m not arguing that on smaller timeframes (minutes to days) that speculation doesn’t move price. That happens in commodities, just as it does in equities. But to say that the prevailing trend of oil isn’t upwards on the intermediate (weekly and monthly) timeframes isn’t due to natural supply-and-demand forces is patently false in my opinion, and discounts basic economic fact.
The airline industry sucks. Save the oil-hedging Southwest, the airlines have done nothing but compete and operate themselves out of profits by becoming themselves a commodity. Airlines aren’t meant to run solvently in their current form with high energy costs. This misdirection and lack of risk management is being punished buy fed-up shareholders. Their alarmism over speculation wreaks of the self-serving spread of misinformation in an attempt to blame economics and the markets for a business environment for which these 12 airlines are ill-prepared.
After the next round of almost inevitable government bailouts of these insolvent corporations, I only see seat-reducing mergers coupled with higher fares as the saving grace for many airlines. Remember that flying is not a right, it’s a privilege. Maybe it’s time we, the public, the airlines, and the government remember that.
