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July 10, 2008
Oil Speculation
Russell Roberts
This email arrived in my inbox this morning from United Airlines:
Dear Mr. Russell Roberts,
Last week, crude oil hit an all-time high of $146, and the skyrocketing cost of fuel is impacting our customers, our employees, the communities we serve, and the economy as a whole. United, and the majority of other major U.S. airlines, are asking our most loyal customers to join us in pushing for legislation to add more transparency and disclosure in the oil markets. Please see the attached open letter from the leaders of the U.S. airline industry.
An Open letter to All Airline Customers:
Our country is facing a possible sharp economic downturn because of skyrocketing oil and fuel prices, but by pulling together, we can all do something to help now.
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.
The nation needs to pull together to reform the oil markets and solve this growing problem.
We need your help. Get more information and contact Congress by visiting www.StopOilSpeculationNow.com.
This was followed by facsimile signatures of the CEOs of AirTran Airways, Alaska Airlines, American Airlines, Continental Airlines, Delta Air Lines, Hawaiian Airlines, JetBlue Airways, Midwest Airlines, Northwest Airlines, Southwest Airlines, United Airlines, and US Airways.
Three thoughts. First, blaming speculators for high prices has always seemed to me like blaming the thermometer for how hot it is. Second, airlines speculate all the time on oil prices. I assume they hedge against future price increases. Notice that in this plea, they distinguish between paper speculators and "real" speculators as if that matters. Third, is it not strange that of all the policies that the airlines could advocate to bring down gas prices (more drilling, a change in environmental regulations, etc,) they choose this one?
The cynic in me says that the airlines must think it's good PR to look like they're fighting for lower prices and attacking speculators is about as riskless an approach you could choose.
Posted by Russell Roberts in Prices | Permalink
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Comments
Boy! The bootleggers are not so subtle anymore... I responded to their message with this (even though it probably went back to a machine):
"I can't believe the ignorance of these 12 CEOs. Speculators are a scapegoat. The real problem is the OPEC cartel."
Posted by: Unit | Jul 10, 2008 5:03:15 PM
That's almost as crass as the Pickens Plan:
http://pickensplan.com/
But your posting begs the question.. Why can't we blame global warming on the thermometer?
Posted by: BoscoH | Jul 10, 2008 5:03:35 PM
The airline executives are only doing what they've learned to do from the politicians: Find a scapegoat and blame somebody else. Never, ever take the blame yourself!
Posted by: tw | Jul 10, 2008 5:19:26 PM
Southwest Airlines is one of the biggest oil speculators around. Much of their "operating" profit in the last five years is due to successful hedging strategies.
Also, Russell- thanks for the recommendation on Curtains three weeks ago. We were on a family vacation in NYC and went and saw it solely based on hearing about it from you and it was our favorite of the 3 Broadway shows we saw. Too bad it has closed now.
Posted by: Tom Kelly | Jul 10, 2008 5:26:27 PM
I read this last night, and, later on, one thing stuck in my mind: "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."
These CEO's make it sound so easy; guaranteed profit!
But were it so easy, why aren't they doing it? Or if they are, why aren't they doing more of it?
Posted by: Nobrainer | Jul 10, 2008 5:48:54 PM
"A barrel of oil may trade 20-plus times before it is delivered and used;"
What college-educated nincompoop could actually say this? I love it when people who don't understand what futures are try to describe what happens in a future's market. Something almost tells me this has got to be a fake. If not, whoever wrote it should be thoroughly sacked.
Posted by: colson | Jul 10, 2008 5:49:49 PM
"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."
Yep, just like it did with housing speculators. Until it stopped doing so.
Posted by: Brad Warbiany | Jul 10, 2008 6:16:10 PM
As a 20 year employee in the airline industry, I am just totally embarassed by my industry's leaders. I don't know these guys really believe this garbage or if they're just so desperate they'll try anything.
It's hard to understand why airline executives would believe it's OK for them to hedge their companies' exposure to fuel prices, but not OK for my mutual fund to do so on my behalf.
Posted by: John Dewey | Jul 10, 2008 6:18:11 PM
Richard Langlois has a good posting on this utter nonsense, with an alternative letter you can send to legislators instead, at Organizations & Markets .
Posted by: Mauro Mello Jr. | Jul 10, 2008 7:24:44 PM
I got this too and sent an annoyed message back (which I had to then send via a customer service form) pointing them to the recent WSJ article on the ban on onion futures trading and telling them how disappointed I was. I was hoping one of the many econblogs I read would comment on it!
Posted by: nicole | Jul 10, 2008 7:51:00 PM
I have flown a number of those airlines. How dare they ask me for help in their scheme after the way they have treated me?
Posted by: Max | Jul 10, 2008 8:06:34 PM
"First, blaming speculators for high prices has always seemed to me like blaming the thermometer for how hot it is."
Brilliant, you nailed it! ;-)
Posted by: Speedmaster | Jul 10, 2008 8:33:19 PM
Actually, I think Southwest, as noted above, is the only airline that hedges their fuel costs by buying futures (of some sort, I doubt it's crude futures, though it could be...)
http://www.time.com/time/magazine/article/0,9171,1074147,00.html
Funny line from the Time article...
"According to Vaughn Cordle of Airline Forecasts, oil would have to shoot past an average of $65.30 per bbl. this year to affect Southwest's bottom line--not a likely scenario."
HAHAHAHA
Posted by: Xmas | Jul 10, 2008 8:41:36 PM
"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."
I've been laboring under the assumption that whenever two people trade something, they must believe there is value added in the trade.
Who are the 19 morons in this process that are leaving money on the table in their original asking price?
Posted by: Steve | Jul 10, 2008 10:24:42 PM
With my special decoder ring, I can translate the letter: Dear Congress, please send us a multi-billion dollar bailout to keep our weakest members on life support for a few more months. You can say that the nation's airline networks are critical to the health of our economy - so it has to be done...and blame it on the speculators!
Posted by: Jon | Jul 10, 2008 10:43:30 PM
There ought to be a law!
Posted by: jpm | Jul 10, 2008 11:27:09 PM
I think Jon's got it about right. They're after more than this.
Posted by: Kum Dollison | Jul 10, 2008 11:50:00 PM
I have a hard time believing that our leaders are going to allow major airlines to go bankrupt given the resulting direct and subsidiary job losses and the loss of service to the public and communities. As it is, middle-class people like myself are already getting priced out of airline travel.
Posted by: David P. Graf | Jul 11, 2008 8:48:10 AM
Are you all sure this letter is for real?
Posted by: Per Kurowski | Jul 11, 2008 8:49:14 AM
I probably should take back my simplifying "The real problem is the OPEC cartel."
In the long run even the OPEC cartel cannot really manipulate the global price of oil. But maybe their influence can be felt in the short-medium range. (I don't know). One should probably not even mention them because politicians would mis-interpret your argument as an anti-foreign tirade.
Posted by: Unit | Jul 11, 2008 8:49:16 AM
Aren’t most of us speculators? I mean many of us hold futures in airline miles that are supposed to buy us a flight in the future…if the airline makes it.
Posted by: Per Kurowski | Jul 11, 2008 8:56:56 AM
The email is for real. Forbes even has a story out on it at: http://www.forbes.com/feeds/ap/2008/07/09/ap5198656.html
Posted by: David P. Graf | Jul 11, 2008 9:02:04 AM
If you have already posted it sorry, but I can't resist
http://money.cnn.com/2008/06/27/news/economy/The_onion_conundrum_Birger.fortune/
Posted by: Per Kurowski | Jul 11, 2008 9:09:28 AM
I got 4 of these email yesterday as well. The one that stood out was United's signed by Glenn Tilton. Tilton was the former Chairman and CEO of Texaco (acquired by Chevron in 2001). If he believes this nonsense, then I see why United is in trouble.
Posted by: dtt | Jul 11, 2008 9:19:04 AM
Dick Langlois who blogs over at the Organizations and Market did the exact opposite of what was requested.
http://organizationsandmarkets.com/2008/07/10/airlines-go-medieval/
Posted by: Matt C. | Jul 11, 2008 10:26:02 AM
I wonder how the CEO's feel about speculation in airline stocks.
I'll bet there are a whole bunch of people out there buying airline stocks that never have any intention of flying somewhere.
Posted by: Keith | Jul 11, 2008 10:48:46 AM
David Graf: "I have a hard time believing that our leaders are going to allow major airlines to go bankrupt given the resulting direct and subsidiary job losses and the loss of service to the public and communities."
These were the 5 largest U.S. airlines in 1980:
United
Pan Am
American
Eastern
TWA
American is the only one that has never been bankrupt. Both United and American have laid off tens of thousands of employees since 9/11. The combined current workforce for the other three is currently .... ZERO!
I have known former Eastern and TWA employees, as well as former employees of Braniff. "Our leaders" didn't prevent the loss of their jobs. Why do you believe "our leaders" will do anything different now? Why do you think they should?
Posted by: John Dewey | Jul 11, 2008 10:57:52 AM
The reason the oil price is where it is at any given moment is because at that price, and that price only, the amount of money being bet by speculators that the price will rise from the current price is exactly equal to the amount of money being bet by other speculators that the price will go down from there. One set of speculators will win each bet, and the other set will lose. With half the bets winning and half losing, how can an otherwise respectable CEO say that speculators are driving up (or down) the price?
Posted by: Hobson | Jul 11, 2008 11:04:27 AM
Yup, I got this too. At least the airlines are getting more subtle. Last time I got a letter like this it was specifically asking me to endorse a new tax that would pay for airport upgrades.
I just love getting letters from airlines asking me to petition the government to make air travel even more expensive.
Posted by: Stretch | Jul 11, 2008 11:39:13 AM
These were the 5 largest U.S. airlines in 1980:
United
Pan Am
American
Eastern
TWA
American is the only one that has never been bankrupt. Both United and American have laid off tens of thousands of employees since 9/11. The combined current workforce for the other three is currently .... ZERO!
How much of that damage was due to a government that was bent on deregulation?
Interesting that the quality has also gone down during this same time**.
** Heavily dependent on what class one flies for the majority of flights.
Posted by: sethstorm | Jul 11, 2008 2:17:05 PM
This is q. funny. Airlines and the broader airline alliances pay internal fuel analysts to strategically source fuel, buying when price is perceived to be low and also putting alot of effort into distributing to the hubs of each airline to ensure that transport costs of moving the fuel are also low. This just shows airlines' own fuel policy is dramatically failed and essentially airlines have speculated as much as anyone else...
Posted by: matty | Jul 11, 2008 3:09:59 PM
sethstorm --
To re-phrase your question: "How much of the damage was caused by airlines which couldn't adjust to a competitive environment"?
It's true that quality has gone down since deregulation -- that's because regulation held the prices up. As a result, airlines had to compete more on quality to get passengers -- When I was a child, I got free decks of cards, pilots wings, airplane models, etc... on plane flights. I'd rather have a less expensive flight than playing cards.
The only real "regulation" the airlines need is to revoke all the laws exempting them from things such as state tort law, false advertising law, etc....
Posted by: Chris | Jul 11, 2008 3:44:50 PM
sethstorm: "How much of that damage was due to a government that was bent on deregulation?"
Hard to say, isn't it? Airline travel was deregulated in 1978, during the Carter administration. Eastern and Pan Am survived 13 more years. TWA survived 22 years.
sethstorm: "Interesting that the quality has also gone down during this same time**."
"Quality" of service - the features under the control of carriers - declined because that's what consumers wanted.
After deregulation, air fares gradually dropped, increasingly forced down by no-frills carriers such as Southwest. Air travel became economical for a much larger percentage of Americans. Airlines experimented with all sorts of options for luring customers. They eventually discovered that amenities such as meals and towels were just unimportant. For smaller city passengers, direct flights were not as important as low fares, so connections through hubs became the rule.
Deregulation by itself didn't end the rule of the legacy carriers.
The biggest change over the past 3 decades, IMO, has been the availability of information. The internet - developed long after deregulation - finally ended the premium fares the legacy carriers such as United and American depended on. The lock that travel agencies and legacy carriers had on passenger travel disappeared in just a few years.
Posted by: John Dewey | Jul 11, 2008 3:54:24 PM
I work for a major airline. We received notes to contact our Congressperson on the speculation issue. Below is the letter I mailed back to my supervisor....
I have to make a couple of comments on the future speculation topic.
The fact that oil prices are high is mainly due to central bank policy, not speculations in the oil commodity. The increase in the price of oil is the result of inflation (as well as supply/demand issues). It's interesting that when inflation sets in that the blame can run the gamete from the corporations, 'evil speculators', immigrants, or to foreign governments.
Speculators cannot indefinitely inflate or depress the price of a commodity. If you are speculating in an attempt to prop up the price above the equilibrium, then I need only short my position and wait for my windfall of cash when the price corrects. If speculation worked over the long run then it would only require a sufficiently large pile of money to corner each market. It's not that simple. (Take Delta in 2006 when the bankruptcy court gave the airline permission to hedge fuel. Delta's contracts came due in mid 2006, at the same time the market price of petroleum had a slight down turn and Delta lost well over $100 million).
Using speculators as the scapegoat isn't anything new. People even higher than CEO's are on record blaming speculators for the ills of markets. One of major complaints President Nixon made in 1971, before he took the U.S. off the gold standard, was that 'speculators' were at the root of the problem and it had to stop. The problem wasn't due to speculation in the gold commodity at that time either, the underlying true reason was the federal government printing too many dollars to support gold at the fixed exchange rate.
Here in the US the price of oil has more than quadrupled since Bush entered office in January 2001. If you price oil not in USD but in gold, the price is barely changed in that same 7-year span.
The cause of widespread increase in prices in the US (including oil) is from a marked and sustained increase in the US money supply. Again, rapidly increasing oil prices (as measured in US dollars) is the effect and not the cause of this inflation. The problem of an ever increasing money supply is the true villain – it’s been a federal action, not a speculating action.
Does this mean that the price of oil would be static without the government printing presses running overtime? Of course not. Markets are in constantly motion. We have a fixed supply of oil on the planet, and an increasing demand from a growing population and industrialization around the world ( China and India ). Some countries that use to be oil providers have even turned into oil importers today, such as Indonesia or Malaysia . With a fixed supply and an increasing demand we would expect the price of any commodity to increase, be it from wheat to oil.
Rudy Schober
Posted by: Rudy Schober | Jul 11, 2008 4:32:08 PM
A speculator is someone who buys a share of oil without the intention to take delivery of the oil?
Does that mean I am an airline speculator when I buy 1% of the shares but never intend to take delivery of 1% of their assets? I could use a 777.
Posted by: JT | Jul 11, 2008 5:20:10 PM
I have listened to the Senate Hearings on oil speculation and suggest that you go to Senator Levin's website and read his 5/8/06 statement regarding energy trading. Especially regarding ICE, Intercontinental Exchange. These same issues were discussed before the Home Land Security and Government Affairs Committee last week. They are talking about excessive speculation in Commodity Markets. It made me a believer. I know it's not the only reason for the high price of oil. There is adequate supply but demand has defied the law of supply and demand. For a tongue in cheek article read AmericanGoy's blog titled So why are gas prices rising. It's worth a look.
Posted by: PeggyLee | Jul 12, 2008 2:12:49 AM
Rudy:
I hope you told your employer "gamut", which indicates a range or spectrum, and not a "gamete" which is one-half of the gendered sex cell pair that fuses during fertilization.
Posted by: Steve | Jul 13, 2008 1:58:19 AM
Nope, only had 22 minutes to write something back before flying out on a trip. The supervisor probably never reached the word gamete before hitting delete; my letter certainly wasn't politically correct. Did you have any other thoughts on the post besides the spelling?
Posted by: Rudy | Jul 13, 2008 4:48:43 AM
Is there any way to pinpoint the cause of the problem so we can come up with a solution instead of just talking about it.
Posted by: Steve | Jul 13, 2008 7:03:10 AM
Now I'm going to have to switch my moniker since someone else showed up with my name.
In response to the other "Steve" above, I'm not sure that there is a "problem" for which "we" need to find a "solution".
Prices of all kinds of items have fluctuated up and down over the course of human history. I don't know a "solution" for that.
I have written a paper on 3rd world development aid, and how this is what it would look like (not like a bunch of hippies collecting millions of dollars and dropping it on the people) but I doub't anyone would be interested in reading the whole thing here.
I'm currently driving an hour round trip to attend one class. It's frustrating, but I'm pretty excited that I own a car, a house, and can afford to go to school.
The "solution" to many problems as I see it is that people need to start adding up the positives column instead of taking it for granted, and only accounting for the negatives in life. Oddly enough, I had a major philosophical life change by taking an accounting class. Thanksgiving is every day for me now.
Posted by: SteveO | Jul 13, 2008 2:34:19 PM
Steve: "Is there any way to pinpoint the cause of the problem so we can come up with a solution instead of just talking about it."
I assume by "problem" you mean the tendency of airline executives to demonstrate their ignorance of basic economics. My solution would be to just get out of their way and let the worst ones fail. Unfortunately, most members of Congress are equally ignorant.
Posted by: John Dewey | Jul 13, 2008 9:25:50 PM
For those of you who do not think that speculation plays a significant part in oil prices, you should do some research; start with the Commodities Act of 2000. Maybe you can pretend that you have the assets to be an oil speculator to see the possible returns. Wall Street needs to look else to make their millions. And if you think the health of our airlines is not important, you may also want do some research on what the sale of a 747 or 777 does for our GDP. Or maybe you want to fly around in 30+ year old aircraft which have exceeded thier design life while at the same time demanding low fares. We need to eat and in order to eat we need to drive and yes fly.
Posted by: Ken | Jul 14, 2008 1:19:11 AM
Ken, why should we check out the Commodities Act of 2000? That law simply was an agreement on a jurisdiction-sharing plan between the Commodity Futures Trading Commission and the SEC. Both departments had battled for decades over who should have regulatory authority over the single-stock-futures.
So, oil prices are high because of speculation in oil futures? Are Boeings planes so expensive because of steel/alloy/aluminum futures too? Did you know you can also purchase derivatives on weather data/future forecasts too, does that mean that I could save the world from no more crop failures and everyone in the world will have full bellies? Man, the power of commodities!!
Posted by: Rudy | Jul 14, 2008 5:54:34 AM
Ken: "Or maybe you want to fly around in 30+ year old aircraft which have exceeded thier design life while at the same time demanding low fares."
The average age of the U.S. passenger airline fleet is about 13 years, Ken. Northwest and American distort that industry average, with their aging DC-9's and MD-80's. But those aircraft have an outstanding safety record, and there is no reason for airline passengers to fear flying in them. U.S. passenger airlines collectively spend billions of dollars maintaining their fleets in top condition. Airline CEO's and CFO's fly constantly on those jets, and they are not going to jeopardize their own lives by skimping on maintenance.
For what it's worth, Southwest Airlines is still buying aircraft and still planning to replace its older 737 Classic jets with newer 737 NextGen aircraft. If flying older aircraft bothers you, Ken, then I suggest you fly Southwest and avoid American and Northwest.
Posted by: John Dewey | Jul 14, 2008 7:23:12 AM
I am a 20-something who doesn't know a thing about hedging & speculating. Could someone give me a Speculation & Hedge 101 crash course so I can know what to think for myself rather than take everything at face value. I came across this website and completely bought the airlines story at the top, but everyone else's arguments turned out to make more sense.
Posted by: Cooper Brown | Jul 15, 2008 7:06:56 PM
Welcome Cooper:
To try to keep it very simple, (and I apologize if I pitch this below your swing, I don't know what you know):
"Hedging" in its simplest form just means a balanced response to risk. Like "hedging your bets". People often diversify their risk in investments by not putting all their money into one stock or fund.
Speculators are people who buy and sell options and/or commodities. Oil and corn are commodities, which you or I can buy and sell. But, I can also sell you the right to buy corn at a fixed price tomorrow. If you think corn is going to go up, you can buy my option. You can exercise that option, and actually buy the corn, but you don't have to.
Options are only ultimately useful if in fact the actual change in price matches the prediction. If you buy an option planning on a price drop, you better hope the price drops. Same-same for a price increase.
People "hedge" against the future price of oil, by buying oil today. (Or oil futures, or options). If oil is $100 a barrel, and I'm pretty sure it's going to $150, it would be smart for me to buy as much as I can at $100, and store it. Or, buy options that I think will allow me to buy at any price less than what I predict it will go up to.
The reason most of the people who read this site think it's no big deal is that every time a commodity or option is sold, both buyer and seller think something different is going to happen. Just like betting on Alabama-Auburn football. You can't place an Alabama bet, unless someone else thinks Auburn is sure to win.
Essentially, a trader who sells a commodity or option, and one who is buying, are both secretly whispering "sucker" under their breath. The seller is glad he got it off his hands. The buyer thinks he got a sweet deal. With lots of people buying and selling options for increased and decreased prices, it all pretty much cancels out.
There's no way all those forces can be working in the same direction, because if everyone believed the same thing, there wouldn't be anyone willing to buy (or sell, whichever the case).
Hope that helps. There are plenty of online articles with simple explanations of stocks, commodities, options, futures. Hopefully this will give you an idea of the *debate* about the issue.
Posted by: SteveO | Jul 16, 2008 1:35:52 AM
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