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An Anti-Speculative Bubble

The opinions expressed by columnists are their own and do not necessarily represent the views of

The global market for oil has, in the imagination of Washington, a mysterious quality that should occupy academic economists for a long time. The market only works when the price moves in one direction -- down.

If the price goes up, some nefarious manipulator is responsible, whether it's oil-company executives, gas-station gougers or -- now -- speculators.

It used to be that price increases were summarily blamed on oil executives. This theory always raised the question: If their greed explained high prices, what accounted for low prices? Their generosity?

If they are guilty of theft at $140-a-barrel, were they being charitable at $20-a-barrel in 2002? And why do their bouts of greed and charity seem, with a suggestive exactitude, to coincide with times of tight or abundant supply?

Thankfully, these imponderables can be put aside now that oil executives are as powerless as anyone else in the hands of ... speculators.

These speculators -- on whom Democrats in the Senate are proposing a legislative crackdown -- are said to be responsible for bidding the price of oil upward beyond any considerations of supply or demand.

Institutional investors and others buy contracts for oil on the futures market, basically making bets on the future price of oil. They can guess that it will go up or go down, and if they're wrong, they lose money.

So they have an incentive to act in accord with their appraisal of market fundamentals. Just because a lot of people bet one way on the future price won't necessarily make it so. And it doesn't necessarily affect the price right now.

In theory, it could if the future price were so high that people were hoarding oil, pinching the supply now to sell it later. There's little evidence of that. Or if producers were leaving oil in the ground to sell it later. Production has declined slightly in recent years, but from factors like the dysfunction of Mexico's state-owned oil company and the dwindling oil in the U.S. in those areas that Congress deems acceptable for drilling.

Global supply is simply very tight. The world only has roughly 1.5 million barrels in spare capacity a day, a razor-thin margin. Any significant supply disruption and people who need oil won't get it.

That risk -- and expectation that supply will remain tight in the future -- gets built into the current price.

But the two words Democrats are loath to utter about oil are "supply" and "demand." Sen. Byron Dorgan, D-N.D., rose on the floor of the Senate last week, outraged that we have a Commodity Futures Trading Commission to protect the public from fraud and abuse, and yet here the price of oil still has gone up. The Senate bill would require the commissioners to be "the referees for this marketplace."

Sen. Dorgan adduces wrongdoing from the sheer fact of the precipitous price increase. But oil is susceptible to big spikes and drops because demand and supply are "inelastic," i.e., they don't adjust easily.

Despite the explosion in the price of gas, miles-driven has declined only 1 percent in the past year. Likewise, new production takes years to come online.

Sen. Dorgan is exercised that the number of speculators has increased "from 37 percent to 71 percent," which he deems "pretty substantial evidence." Of what, exactly? The amount of speculation proves nothing.

As The Economist has noted, speculation in nickel increased recently as the price of the metal dropped by half, while the price of commodities like iron ore and rice not traded on any exchanges has increased.

The Senate bill would only introduce genuine distortions into the oil market, and make life more difficult for oil consumers who are quite reasonably using the futures market as a hedge against higher prices.

If Congress wants a scapegoat for the run-up in oil, it should revert to the ancient practice and literally expel a goat from the U.S. Capitol.

Atavistic, yes, but no less irrational.

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