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Are current high oil prices driven by increasing world demand or by speculation?

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Wiki User
June 21, 2008 3:05PM

It's not an either/or situation. Today's crude prices are

affected by both current supply and demand as well as speculation

-- which is NOT a bad thing, despite what some politicians,

populists, and demagogues would have you believe. Speculators use

futures markets to purchase oil -- or gas or wheat or corn,

whatever -- at today's prices in the hopes of selling their

holdings later at higher prices. That serves a valuable purpose,

and not just to those engaging in the speculation. Another massive

cause of this rise in price has been, indirectly speaking the rise

in growth and consumption in India, has driven inflation rates up

to, as of now 11.5 %.

Let's say corn is selling for five dollars a bushel today and

you think it will sell for twice that price a year from now. You

could buy a thousand bushels for five bucks a bushel, store it, and

then sell it next year for ten bucks a bushel and make a nice

profit. Well, what is the effect of your doing that? It does two

things: 1) it reduces the available supply of corn today, because

you are storing it for next year, and 2) it increases the demand

for the corn today, because you are creating demand for speculative

reasons, not because you wish to feed your cattle or your family.

So, your purchase -- and the purchases of other speculators -- has

the effect of lowering supply and increasing demand, which places

upward pressure on today's prices. You might think that's a bad

thing, but it's not, because futures markets allow us to allocate

valuable resource over time better than if we didn't have futures

markets. Without them, there might be lower prices today when a

commodity is not in short supply, but there would be greater

shortages later on. By increasing prices sooner rather than later,

speculators provide a valuable service. Short-term prices go up

more rapidly than they might have had there been no speculation,

but future prices are reduced because of the greater supply of the

commodity that is created when stored quantities are released for

sale. The higher short-term prices also send signals to consumers

to consume less and producers to produce more or find alternative

products. In summary, speculation and futures markets help us

allocate valuable resource over time, by increasing prices today

(by reducing supply) and lowering them tomorrow (by increasing

supply).


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