Why did the price of oil drop?

Discussion in 'Business & Economics' started by desi, Aug 16, 2008.

  1. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

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    No, your are confusing or mixing the role of speculators and monoply makers. Yes, monoplies do tend to make prices higher. Speculators actually have the effect of making it HARDER for a group to create a monoply. To use my "corn example" again:

    Suppose some grupe of wealthy Mexicans, via influnce on the goprverment, gets high tariff on importing corn and then begins to buy corn growing land, hoping to create a corn monoply and sell tortia flour for douple the normal price, etc.

    Well fortunately there are speculators who will see this and also both buy up corn planting land (making the creation of a corn monoply more difficult) and ALSO they will be buying corn on the futures market, making the current price rise. Pedro, who was going to plant his land in beans, see that corn is going up in price NOW and decides to plan corn. So this too helps keep the price of corn flour for next years tortilas more reasonable by increasing the supply of corn.

    Again: Speculators perform a valuable service by advancing part of probable future effects (price changes usually) into the present so that the price changes are more smooth with less shock. They send a very valuable "signal" now about what is likely and production of what may be in short supply begins to increase sooner, making the damage less than it would be if there were no signal. Often the reason there is no signal*, is that the government is controlling the price, making speculation impossible and assuring that soon there will be a big shock and shortage. Rent controls are the classic example of how government create housing shortage in the future. Speculator can not act now to help prevent that future housing shortage.

    Keep the effect of monoplies and the effect of speculators clearly separated. One is helpful the other damaging.

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    *Centrally planned economies mainly collapse because they lack this market place signal which speculators strongly provide.
     
    Last edited by a moderator: Aug 18, 2008
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  3. kmguru Staff Member

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    Knowing that the supply is tight, would a speculator buy the product now, hold it to create a shortfall and sell it at a higher price than the speculation? That is what they do in India unless Government intervenes...and if the government investigates, all they will find is the standard buy low sell high routine....the only time, this would not work is if there are too many suppliers...but lately, suppliers are consolidating....
     
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  5. S.A.M. uniquely dreadful Valued Senior Member

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    Yeah, thats what I mean. But who would artificially drop oil prices? Why?
     
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  7. Syzygys As a mother, I am telling you Valued Senior Member

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    The speculation instrument futures were originally developed as insurance. Let's say you are an airline and the price of oil is relatively low. You buy a shitload of oil futures, and if the price go up, you lose money on the gasprice increase, but you make it back with your long futures. basicly you can lock in current prices. The same applies if you are a certain commodity seller and you don't want to sell lower, you short the futures and you have a guaranteed price...

    That's how SouthWest airlines was able to be profitable, when everyone else was losing money...
     
  8. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

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    Syzygys is exactly correct. However he fails to note as I did that the buying of future delivery oil not only removes risk from the airlines but also from the producers of oil. They can thus decide to invest more in oil production operations with less risk.

    Again speculators help everyone in the long run basically by providing a signal now which makes for more production of what would be a more sever shortage in the future if this signal did not exist. (Like my rent control example making speculation impossible and creating housing shortages etc.) My prior two post explain not only Syzygys' facts, but also the mechanism by which the benefits of speculators are achieved.
     
  9. S.A.M. uniquely dreadful Valued Senior Member

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    How does this work?
     
  10. kmguru Staff Member

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    Does this assume speculators are different entities than monopolies or producers? What if they are the same?
     
  11. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

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    I guess it might be possible, but I do not see how this could be. The speculator, almost by definition is NOT a producer and by definiton the the monoply is the only producer.

    To use Syzygys's NWAirlines example: NWA is not producing oil, it knows it will have need in the future and expects the price to be higher then, so it speculates and buys it now. This sends a signal to all that in NWA's POV oil prices are going up. If this is the dominate POV, then oil companies will try to increase production, perhaps start a shale oil project, etc.

    Most speculators are not the ultimate consumers as NWA was. They for example are traders active at the Chicago Board of Trade. They study everything they can* trying to correctly anticipate the future and place their bets on how the price will change and in the future when their contract term expires they will profit or lose. (Actually most will have sold before expiration to some other speculator) In any case They take risk away from the producer who can then afford to make more of what ever he produces due to his lower risk and we all benfit with the resulting LOWER price the greater supply makes.
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    *Years ago, this even included picking up information thru the windows of the US Dept of Agriculture with telephoto lenses etc. in the weeks before the DoA's crop forcast were to be released. Now the DoA's windows are painted black.
     
    Last edited by a moderator: Aug 18, 2008
  12. kmguru Staff Member

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    That makes sense. Even the farmer analogy. What I have difficulty is that if I am Klaxxon (no relation to Exxon) and a oil producer with 8000 oil wells, refinery and have my own distribution and retail system (i.e. a vertical integrator) and I have $100 Billion in the bank, why should I care about the speculators?
     
  13. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

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    If these well informed researchers of future prices strongly lean to the idea that the price is going up, you may decide to take part of your 100 billion and drill a few more wells.

    I.e. life is tough for a speculator - his very actions tend to make him wrong! He sends the signal that causes the production changes that make his POV less likely to be what happens in the future.
     
  14. Syzygys As a mother, I am telling you Valued Senior Member

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    Let's say you are a small jewelry maker, who uses 1 lb of gold in every 6 months. You are happy with the current goldprice and wouldn't mind it to be guaranteed. So you buy gold futures that covers your 1 lb gold usage. The point here is that the futures are much cheaper (because of leverage) than the physical gold, so with relative small amoutn of money you can control your supply.

    If the goldprice goes up, you have to pay more 6 months from now for your next supply, but you make that back buy selling the now more expensive gold futures.

    If the goldprice drops or stays the same, you lose on the future (cost of insurance) but your next goldsupply will be cheaper or the same.

    Carmakers also use currency futures to smoothen out currency fluctuations, because it can adversely effect their steel, tire,etc. supply or their cars' selling price...

    Now if enough airlines get the same idea of buying lots of oil futures, that could move the oil price higher.
     
  15. S.A.M. uniquely dreadful Valued Senior Member

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    Ah I see, I'm a duffer in economics.

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  16. Syzygys As a mother, I am telling you Valued Senior Member

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    The single biggest oiluser in the world is the US Dept. of Deff. so I wouldn't be surprised if they were also buying shitload of oil futures now that the prices are dropping....

    (specially when they have the sure inside info on when the next war starts)

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  17. OilIsMastery Banned Banned

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    Communist nonsense...

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    And now that the commodity price is down, hedge funds and speculators are reentering their positions.
     

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