"Speculative Nonsense, Once Again"

I think it would be fair to describe Paul Krugman as frustrated:

Speculative nonsense, once again, by Paul Krugman: OK, one more try. ...[T]he mysticism over how speculation is supposed to drive prices drives me crazy, professionally.

So here's my latest attempt to talk it through.

Imagine that Joe Shmoe and Harriet Who, neither of whom has any direct involvement in the production of oil, make a bet: Joe says oil is going to $150, Harriet says it won't. What direct effect does this have on the spot price of oil - the actual price people pay to have a barrel of black gunk delivered?

The answer, surely, is none. Who cares what bets people not involved in buying or selling the stuff make? And if there are 10 million Joe Shmoes, it still doesn't make any difference.

Well, a futures contract is a bet about the future price. It has no, zero, nada direct effect on the spot price. And that's true no matter how many Joe Shmoes there are, that is, no matter how big the positions are.

Any effect on the spot market has to be indirect: someone who actually has oil to sell decides to sell a futures contract to Joe Shmoe, and holds oil off the market so he can honor that contract when it comes due; this is worth doing if the futures price is sufficiently above the current price to more than make up for the storage and interest costs.

As I've tried to point out, there just isn't any evidence from the inventory data that this is happening.

And here's one more fact: by and large, futures prices over the period of the big price runup have been slightly below spot prices. The figure below shows monthly data from the EIA; as the spot price shot up, the futures price (that's contract 4, the furthest out) actually lagged a bit behind. In other words, there hasn't been any incentive to hoard.

As I've said, I don't have a political dog in this fight. But the nonsense in this debate makes me want to shoot someone in the face.

Update: I see that Michael Masters, about whom I had some flattering things to say a few days ago, is now telling Congress that gasoline will go back to $2 a gallon if we crack down on speculators. He forgot to mention that cold fusion will solve all our energy problems any day now.

Where's the incentive to hoard?

Update: Also see Free Exchange.

Comments

[spencer]

I've looked at this chart for years and concluded that the futures market is not a forecast of what prices will be in the future. The futures market does not know anything that he sport market does not know.

The spread between the spot and the futures market is the price that clears the market between those wanting to sell the risk that prices will be higher in the future and those who are willing to take that risk for a price. Neither know what the price will be in the future.

[anne]

There is reason for the frustration, for we are masking proper examination of needs in meeting commodity production and use and this is continually worrisome beyond domestic markets. Lack of adjustment here can and often does mean relatively more impact in developing markets. I am especially concerned here with our lack of attention to grain production for food and the extent to which that effects peoples in developing countries. China is coping properly, but what of South Africa or Nigeria?

[anne]

http://www.irinnews.org/Report.aspx?ReportId=78842

June 20, 2008

Maize - the Unaffordable Staple
By IRIN

JOHANNESBURG - With global high food prices apparently here to stay, economists in South Africa warn that despite a bumper maize harvest, worldwide demand and soaring agricultural input prices mean that even maize-meal, the country's staple, could be off the menu.

Food prices in South Africa have risen by 15.7 percent since April 2007, and maize-meal – a stiff porridge, the starch of choice - had gone up by over 25 percent, Patrick Kelly, Consumer Price Index Manager at Statistics South Africa (STATSSA), told IRIN.

John Rook, Programme Manager of the Regional Hunger and Vulnerability Programme in South Africa, told IRIN that when over half the family income was spent on food, even a slight price hike on maize-meal could really hurt.

"The poorest are hardest hit; they spend the highest portion of their income on food," he said, and with meagre budgets already overstretched, "they can't keep on absorbing food price rises."

According to the latest Income and Expenditure survey by STATSSA, income deciles 1, 2 and 3 - each representing 10 percent of the total South African population, starting with the poorest - respectively spend 80, 45 and 36 percent of their income on food.

Bad for the pocket and bad for health

A year ago, one kg of maize-meal cost around US$0.60, now it sells for $0.75. Average income in the lowest 10 percent of the population is less than $19 per month, and the average consumption of maize-meal is 10kg per person per month, making the implications of a price rise painfully clear: for 4.7 million South Africans one year ago, just over 30 percent of income would have been spent on maize-meal, compared to nearly 40 percent today.

Hester Vermeulen, a researcher at the Bureau for Food and Agricultural Policy (BFAP), an independent research unit involving the University of Pretoria, the University of Stellenbosch and the Department of Agriculture, said rising maize-meal prices could worsen South Africa's already poor nutrition levels: over 30 percent of pre-school children are stunted.

"Considering the five most widely consumed food types [maize meal, white sugar, tea, whole milk and bread] in terms of very poor consumers, maize porridge contributes about 54 percent of energy intake," she noted....

[anne]

What then of corn production here, corn production for food?

[R]

How about less mouths to feed? Poverty ridden countries like Africa have been like this for decades. Has the energy-intensive 'Green Revolution' really changed anything? Billions of dollars have been thrown at Africa and there's little to show for it. It's not going to get any better anytime soon. The demands we're making on an increasingly fragile planetary eco-system are coming to a tipping point. Nature will take it upon itself to correct the balance. You might be able to distract Mother Nature with technology, but you sure can't fool her!

[Fred]

It would help to have charts of oil and food prices in terms of euros, as well as in terms of dollars, to show how much of the rising prices are simply a consequence of the falling dollar.

[robertdfeinman]

I'm glad to see Krugman explain this to those who haven't accepted this from others.

However, he is wrong about one thing (and I'm one of the ones who has been saying there is no speculation), that is that there may be hoarding, but it has to be done by the oil producing states.

If leaving oil in the ground now is going to see it jump 30% in price within a year why rush to pump it? There are two factors which we don't really know, what is the actual oil demand and how much does a "shortage" affect the price? The types of figures that are available, such as US gasoline consumption are too limited to determine worldwide trends.

Countries can also lie about how much oil they are producing, and it is hard to determine this contemporaneously. Simple measures like shipping volume aren't good enough with the large amount of fuel being shipped by pipelines.

Notice that Saudi Arabia's promise (twice) to pump more has had no affect on prices. This may be because no one believes that they will actually make good on the promise, or it may be because traders know that other states will cut back to keep prices high. OPEC is not a functioning cartel, it is a fractious one.

It would seem that there are speculators, but they are the governments of Nigeria, Venezuela and other opaque states.

[robertdfeinman]

The European Tribune blog actually has a few regulars who know what they are talking about (they deal with type of thing professionally).

Here's today's installment from one of the most knowledgeable:

Countdown to $200 oil (7) - Saudis announce oil production increases - again

It's filled with citations to promises from the Saudis from the past few years about how they were increasing the supply of crude, but how the overall production seems to stay pretty much the same. Take a look at the quotes and the charts.

It wouldn't hurt if Krugman consulted some of these guys either.

[anne]

"Billions of dollars have been thrown at Africa and there's little to show for it."

Rubbish; now try thinking.

[david]

The argument for speculation isn't about how the futures market works; it's that the run up in prices has been too fast to reflect changes in supply and demand. China was not discovered last August.

I'm agnostic, leaning speculatively driven in middling part, because it looks like a bubble, and the experts kept telling me that the last things that looked like bubbles weren't.

For instance, CRE. Still haven't hit that one yet, but it's coming.

[R]

Mmmm.... African success stories. Lessee, Kenya is on the edge, Liberia, the Ivory Coast, Ethiopa, Eritrea, Nigeria. Let's not forget Somalia. Still a wonderful and safe vacation spot.

The Chinese have it right though. They're signing up to build railroads and infrastructure in many of these hotspots in exchange for developing oil and mineral rights. The Chinese are willing to overlook that minor calamity they call 'human rights' over there.

Life is not that precious Anne. It is an increasingly cheap commodity. I'll never forget an article written by a couple of cyclists who transversed the African continent. They described the horror of seeing road kill of the human kind, fully flattened out and left out there for good. We do better with our pets here in the United States. In the big scheme of things, we're really not worth all that much are we?

The tide is turning.

[stick]

I came across these comments over at Brad DeLong's place, and I was wondering what you fine folks over here think about it:

1. "I thought that speculation worked like an old fashioned bear pool than a market corner. The idea isn't to control the commodity, but rather the market for the commodity. If you make the right trades at the right times, you can convince others that the market is stronger or weaker than they thought. They'll adjust their buying and selling behavior accordingly and reinforce your move. Once the stream gets flowing, you sell out, take your profit and watch the whole thing fall apart."

2. "That's how I see it. The speculators don't have to hold the contracts as long as there's a going market. They can sell five minutes or one or two days later when the price is higher. I don't see how the aggregate of that activity requires a lot of extra storing. But it would certainly drive up the price."

--- This is how I've been reading the issue of speculation and oil markets as well. I'd love to hear what you guys think...

[Winslow R.]

How much of an 'investment' is needed for speculators to determine the timing of a Nigerian rebel assult?

http://www.iht.com/articles/2008/06/19/africa/20nigeria.php

Perhaps speculator 'investments' can force oil to remain in the ground.

[Bruce Wilder]

John V recently introduced me to Hanson's Law, and I find I already have need of it.

There's some kind of missing qualifier on "speculation" in Krugman's piece -- Krugman has a very specific strawman version of "speculation" that he's projecting on to those, who are saying, "speculation is driving prices up". And, if he is narrowing his focus to those, who contend that there is some easy policy intervention to end speculation, and bring prices down, maybe he has a point, maybe he should shoot someone in the face.

In Krugman's view, the thesis that speculation is driving up prices must mean, quite specifically, that speculators are hoarding oil, keeping it off the market.

I think speculation is driving up the price of oil, but I think it is happening, precisely because there is so little possibility of hoarding.

Spencer has it right: the spot/futures market is about buying and selling risk, not oil. There's not enough slack in the system, and this is increasing the risk premia associated with being able to deliver oil.

The spot market is only a small part of the whole oil market; it is a safety valve for a system in which the requirements of the refining and distribution pipeline for schedules, planning and constancy can not be met by the actual pattern of oil production. The spot market is a marginal market -- the day labor market in a world of salaried, contract players.

This is peak oil. Very little light, sweet crude is available to the spot market. There are few incentives to invest in increasing slack in the system, because the system is never going to grow again. There are high risks of supply disruption.

Maybe the problem is that I tend to think "speculation" is a good thing, with a genuine economic function, and others don't. To my mind, speculation is doing exactly what it should do, assigning an appropriate price to hedge oil delivery contracts denominated in dollars.

says...

i have often wondered about speculative bubbles - int eh stck market bubble of the 20s, or tulip mania, were there people "hoarding" these things? no - the rpice went up merely because of "irrational expectations" that the price was going to go higher.... like any kind of panic.

[anne]

"Let's not forget Somalia. Still a wonderful and safe vacation spot."

Rubbish; but try thinking in time.

[Richard H. Serlin]

Paul,

Please keep in mind that it's very dangerous for public figures to work heavily when very tired and sick. Things can slip out, and it's not just some colleagues who hear them in a conversation, it gets in the press -- Bill Clinton once said every major mistake he made was done on sleep deprivation.

The comment, "the nonsense in this debate makes me want to shoot someone in the face.", clearly is likely to hurt your ability to persuade others to support good things a lot more than it will help it.

Please be extra careful when you are sick and tired, or maybe even cut back more than you have been, until you are better.

Thanks for all the great good you do.

Richard

[Richard H. Serlin]

Sorry, I posted the above on the wrong blog. -- Like I said about working while sleeping.

[Michael McKinlay]

It is called Peak Oil ...

We are now using 6 barrels of oil for every new barrel discovered.

The last major discoveries of conventionally recoverable crude were in the 1960s. All the major exporters have peaked sans Angola and Iraq. Texas, Mexico, Venezuela, the North Sea, Nigeria, Russia, Iran, Kuwait, the Emirates, China, Saudi Arabia are plateaued or peaked.

Peak Oil is here folks, and with it you get ever higher prices or demand destruction.

[odograph]

World oil production (and consumption) has been remarkably flat for the last 3 years. What in that environment will an inrush of commodity investment do? It can only inflate prices.

The only question is what happens next. If prices fall then those prices were a bubble. If they hold then they were a rather unfortunate example of price discovery.

Krugman is more than smart enough to see that, and so he must be calling it as price discovery, and the long term price.

(I actually guess 50:50. There have been fundamental changes but on the heels of that, a hot money bubble.)

[muirgeo]

I guess I'm confused. It sounds to me that Krugman is claiming speculation and bubbles don't happen. Here in California I've seen energy prices from Enron speculation and market manipulation go up 10 fold and more and then drop down. Recently I saw my house value go up 50% and then down again. I presume speculation had something to do with it. Now oil futures are as I understand being traded in Enron accounting styles that occur out of the light of day so how does anyone know how speculation is effecting prices? Michael Greenberger former director of the Commodities Futures Trading Commission suggested to the senate that I'm paying as much as an additional $1.25 a gallon of gas for paper pushers on Wall Street.

[MG]

"I guess I'm confused. It sounds to me that Krugman is claiming speculation and bubbles don't happen."

Absolutely not. Krugman called the real estate bubble when others denied it. (I think he attributed the California electricity crisis to strategic witholding of generation.) But oil futures positions have to be closed out every month so if prices exceed physical market-clearing levels, inventories should appear somewhere. There are some arguments why this might not happen. I think he is frustrated by people who just cry speculation without making a logical case for it.

[anne]

MG:

"I think he attributed the California electricity crisis to strategic witholding of generation...."

Right.

[anne]

http://www.earthpolicy.org/Updates/2008/Update72_data.htm#table4

January 11, 2008

World Grain Production, Consumption, and Balance, 1960-2007

(Million Metric Tons)

2000 1,843 1,857 -15
2001 1,875 1,902 -28
2002 1,822 1,909 -88
2003 1,862 1,934 -72
2004 2,043 1,990 53

2005 2,017 2,019 -2
2006 1,992 2,043 -51
2007 2,075 2,098 -22

[No strategic witholding here though.]

[James]

The notion that the futures prices have 'no relation' to the price of goods in the real physical market is absolute nonsense.

[anne]

http://www.earthpolicy.org/Updates/2008/Update72_data.htm#table14

January 23, 2008

U.S. Fuel Ethanol Use, Grain Production, 1980-2007

(Million Tons)

2000 16 of 340
2001 18 of 321
2002 25 of 294
2003 30 of 345

2004 34 of 386
2005 41 of 363
2006 54 of 336
2007 81 of 414

[vincerinos]

I love the Krug Man but I don't know why this issue has his back up. Seven years ago he made the right call on California's energy markets. But now when the same dog is barking in the oil pits it seems like he doesn't want to call in animal control.

[anne]

Notice then the relation between fuel and grain prices, from 2000, while grain yield growth slows.

http://www.earthpolicy.org/Updates/2008/Update72_data.htm#table13

April 9, 2008

World Grain Yield Annual Increase by Decade, 1950-2007

1950-1960 2.0%
1960-1970 2.5
1970-1980 1.9
1980-1990 2.1
1990-2000 1.2
2000-2007 1.2

[dd]

"California's power crisis is first and foremost a crisis of underinvestment -- a booming state economy undone because nobody built the power plants and gas pipelines it needed."
Reckonings; Real Reality's Revenge
By PAUL KRUGMAN
Published: December 31, 2000
http://query.nytimes.com/gst/fullpage.html?res=9C01E6DF143BF932A05751C1A9669C8B63

On 9/2/2003 Krugman wrote:
"Most independent experts now believe that during 2000-2001, price manipulation by energy companies, mainly taking the form of ''economic withholding'' -- keeping capacity offline to drive up prices -- added billions of dollars to California's electricity bills. A March FERC report concluded that there had been extensive manipulation of prices in both the natural gas and electricity markets."
Another Friday Outrage
http://query.nytimes.com/gst/fullpage.html?res=9C00E2DA1538F931A3575AC0A9659C8B63

[don]

says...
"i have often wondered about speculative bubbles - int eh stck market bubble of the 20s, or tulip mania, were there people "hoarding" these things? no - the rpice went up merely because of "irrational expectations" that the price was going to go higher.... like any kind of panic."
You are confusing the spot and futures markets. PK is talking about the effects of speculation in futures markets.

[Fred]

Any intelligent commodities trader who looks at the price history of oil since 1970 is going to be very, very cautious about betting on continued high oil prices. Peak Oil is no more an explanation for high prices now than it was back in 1980.

One reason many producers have not invested so as to increase oil production is precisely because they have consulted with intelligent commodities traders and the advice they have received is simple: enjoy the high prices while they last, but don't expect them to last forever. All commodities tend to be subject to wild price swings and oil is no exception. It takes a long time to get new production going, so that if you invest when prices are high, there is a good chance they will be low when the production comes online, and you end up losing your shirt. This happens over and over in the commodities business, but maybe the oil producers have finally wised up. There are also cartel issues, but commodities cartels have a very poor track record of preventing cheating in the long run. There is almost irresistible pressure for producers to increase government spending in response to high oil prices. Only the Norwegians, who have an extremely disciplined culture, have been able to fully resist this. Assume that the producers are acting as a cartel and withholding production to keep prices up. Also assume that at least some of these producers are spending every penny that comes in. Then if the price ever drops even slightly, for whatever reason, there will be strong pressure to increase production so as to make up for the lost revenue due to these decreased prices. In other words, both upward and downward price movements are self-reinforcing, given certain very reasonable assumptions.

It isn't just oil. All commodities are going to tumble at some point in the next few years.

[BrotherMaynard]

Fred...

"Also assume that at least some of these producers are spending every penny that comes in. Then if the price ever drops even slightly, for whatever reason, there will be strong pressure to increase production so as to make up for the lost revenue due to these decreased prices. In other words, both upward and downward price movements are self-reinforcing, given certain very reasonable assumptions."

Bingo!

Venezeula's deficit requires almost $100 oil...now, whats some black swan that can come along and tank prices to that level where OPEC panics and pumps...hmmm...i know! How about spec limits and margin increases!

We've seen this movie before.

[BJ Feng]

Unfortunately, thanks to bad management or stupidity, some countries aren't able to increase production because they've spent all their profits from oil leaving none or little for exploration. Mexico and Venezuela are examples, their governments need everything they can get to keep afloat their social programs, there isn't any for new development. Production continues to decline for both countries.

In theory, spot and futures prices should converge on delivery days. The spot prices for oil are also very high, if speculators aren't taking delivery, then why isn't there a surplus on the spot market? Inventories also aren't at highs.

What we have is a perfect storm of different situations that have converged. Old supergiant oilfields are on the decline, exploration has been discouraged or is impossible (ANWAR closed), the places where new discoveries can be brought online are dangerous (Nigeria, etc.) or are hostile to foreign investment (Russia, Venezuela), and emerging nations are growing richer and more oil thirsty.

In the long run, it is stupid for the oil producers to let prices get this high, high enough for alternative energies to be viable. But they simply cannot raise the supply fast enough in the near future, if at all. Oil is a very capital intensive industry, governments seem to have forgotten that it takes billions of dollars and a lot of time to get oil out of the ground. They are quick to seize revenues, but in doing so, discourage new sources. When the old gushers decline, they then wonder why new ones aren't coming online.

[Can't Admit Mistake]

There's a good reason Krugman can't abide the fact that speculators are to blame. These are the same speculators (banks, IBs, and the hedge funds they sponsor) that he was so keen to bailout.

Using the bailout proceeds, these speculators are taking Helicopter Ben, Krugman, and all the foolish "save the economy" types for a lucrative ride. With the US public paying the cost. This is what passes for the US financial system these days. What a travesty.

[JV]

Hahhahahaha,

Thanks for the post Mark. You mean that there are no easy answers?? No dollar gasoline without drilling for more oil and building more refineries under American control to manage the prices that others charge? Supply and demand??

Tulip frenzy in oil because all that money the Chinese have taken, from us buying junk from them, has to go somewhere other than US housing which has tanked?

(For those of you thinking about oil supplier issues try Spengler at Asia Times today. Very interesting piece on Iran corruption and oil politics.)

No easy answers for any of this. Too many people and too many emerging economies like china, India, Viet Nam, Brazil that want a good quality like like America. Takes food, energy and land. They can buy more of it now because they are transferring our wealth to themselves by selling us junk we don't make any more.

The US has to take care of ourselves and back off on globalism and free trade and learn to lead by example again. A little protectionism and closed door policy might not be such a bad idea again.

Interesting times.

says...

dd,

Beautiful. Just beautiful. Looks like someone got shot in the face with that call.

dd says...
"California's power crisis is first and foremost a crisis of underinvestment -- a booming state economy undone because nobody built the power plants and gas pipelines it needed."
Reckonings; Real Reality's Revenge
By PAUL KRUGMAN

[a]

"Well, a futures contract is a bet about the future price. It has no, zero, nada direct effect on the spot price."

Well I'm not sure what he means by "direct". If the buyer of a futures contract is a speculator and the seller is a hedger, then the seller may hedge by buying spot oil and storing it. This effects the spot price. Does that count as direct?

[reason]

OK ONCE AND FOR ALL - PRODUCERS KEEPING OIL IN THE GROUND IS NOT SPECULATION - IT IS ASSET MANAGEMENT!

Sorry for shouting.

Krugman is right here folks! If you want to say speculators are driving this you need to clarify the mechanism and find the smoking gun. Name calling won't do it. And Krugman has a history of being right, time and time again.

And commodities markets (especially bulky difficult to store commodities) are not the same as stock exchanges or novel tulips. Commodities are produced in masses and used up in masses - every day by end users.

Please go over to the oil drum and read all about production volumes, all liquids vs crude oil only, EROEI, net exports vs total production (but remember here that Brasil is an important offset here - a net importer that has shown the largest increase in production in recent years).

[hari]

Paul is not right!

He's avoiding the issue why crude speculation is difficult to unearth by CFTC - relative symmetry between spot price and market speculation does not discover the problems CFTC has to decypher if the market is being cornerd or not by non-traditonal traders.

Yesterday's Congressional Hearing the panel of experts agreed on a consensus price of $70-75/barrel/crude. Rest, they argued, was speculative non-traditonal traders who are leveraging crude spot prices.

The panel added -

* supply/demand is not transparent and/or elastic;

* speculation by non-traditonal traders (hedge funds, pension funds, investment banks, etc);

* globalization and IT impact on spot prices.

If Paul thinks speculation is NOT driving the crude prices beyond consensus price ($70-75/b), he's professionally obliged to discuss his findings and elaborate on it. Don't use junk logic, please!

[hari]

I may add 1970's inflation was triggered by OPEC cartels decision to quadruple its barrel price. I saw it first on sea lanes on bunker fuel costs. So trasportation is a good area in which to discover the real cost of energy price(s).

Nixon was not only perpelexed by double digit inflation but also by the declining dollar rate against major trading partners; so he decided to unlink the dollar/gold standard!

Nixon also introduced Price Control - on what I can't recall.
I was at OECD Sec and we're unable to understand what was really going on in DC.

Is there any comparison now and 1970s spike on oil price?
I suppose this is a serious question for academics. However, if global crude supply is being once again put right in centre (this time) of globalization - with emerging markets consuming a significant part of incremental supply - the energy crisis is not going to end like in 1970s. China's Vice-Premier was present during last Sun Saudi's meeting on oil price speculation. So was Indian Min of Fin. Therefore, I suggest, the solution will demand OPEC cooperation with the OECD and Emerging Markets - to discover how speculation is driving the crude prices. And how to stop it, if at all possible.

US/CFTC will have to put on its regulatory hat and decide what (new) instruments of policy are required to blunt the role of non-traditional traders in the crude market. Traditional traders are buyers and sellers in the Futures Market. Non-traditional traders don't seem to be *sellers* from evidence of the Panel @ yesterday's Congressional Hearing.

[hari]

I may add 1970's inflation was triggered by OPEC cartels decision to quadruple its barrel price. I saw it first on sea lanes on bunker fuel costs. So trasportation is a good area in which to discover the real cost of energy price(s).

Nixon was not only perpelexed by double digit inflation but also by the declining dollar rate against major trading partners; so he decided to unlink the dollar/gold standard!

Nixon also introduced Price Control - on what I can't recall.
I was at OECD Sec and we're unable to understand what was really going on in DC.

Is there any comparison now and 1970s spike on oil price?
I suppose this is a serious question for academics. However, if global crude supply is being once again put right in centre (this time) of globalization - with emerging markets consuming a significant part of incremental supply - the energy crisis is not going to end like in 1970s. China's Vice-Premier was present during last Sun Saudi's meeting on oil price speculation. So was Indian Min of Fin. Therefore, I suggest, the solution will demand OPEC cooperation with the OECD and Emerging Markets - to discover how speculation is driving the crude prices. And how to stop it, if at all possible.

US/CFTC will have to put on its regulatory hat and decide what (new) instruments of policy are required to blunt the role of non-traditional traders in the crude market. Traditional traders are buyers and sellers in the Futures Market. Non-traditional traders don't seem to be *sellers* from evidence of the Panel @ yesterday's Congressional Hearing.

[reason]

Hari,
who are the experts and what is their track record. Some experts in this field have a great record of having been consistently wrong (unlike Krugman who has been consistently broadly correct). And I don't understand the point about globalisation and IT??? And if you look at the 5 year chart of oil prices, they follow a very nice flattish exponential curve. Krugman sees things very clearly and simply. If he is wrong, he is wrong because of special circumstances (he isn't an expert in this particular field). I'm yet to be convinced there are special circumstances in this case.

You speculation in commodities such as oil and grains is quite different to speculation in financial papers and metals. Holding costs are high, supply is (to a varying extent) elastic and there are spot markets and inventories that make excess supply or demand conditions clear. It don't believe these "non-traditional" traders are fools they can only win on the basis of following demand and supply conditions.

And perhaps the congress is only hearing what it wants to hear.

[reason]

Hari...
You really should read the oil drum so you understand what facts are coming from both sides in this debate.

[hari]

Futures Market was introduced by CFTC to cater to hi fi sector dealing with commodities. Spot Price is linked to Texas Intermediate Crude (TIC) and futures market is driven by it up/down.

A commdity trader is a speculative trader based on knowledge of supply/demand and seasonal adjustments. And he is a buyer and seller which keeps the market moving...

Non-traditonal traders are part of the problem...and Congres is likley to *punish* their inadvertent influence in the market with a regulatory regime after the current Hearing(s).

[hari]

Paul is referring to the *experets* in his uppdate. So he was also listening to the Congressional Hearing. There were four experts, if I recall, who were part of the Panel yesterday. I don't recall the names. I don't need Oil Drum to tell me how commodity markets operate....

[vincerinos]

OK, so the Krug Man voted for it before he voted against it... I should have said "he got it right (finally) five years ago" or something like that... my bad

dd says...
"California's power crisis is first and foremost a crisis of underinvestment -- a booming state economy undone because nobody built the power plants and gas pipelines it needed."
Reckonings; Real Reality's Revenge
By PAUL KRUGMAN
Published: December 31, 2000
http://query.nytimes.com/gst/fullpage.html?res=9C01E6DF143BF932A05751C1A9669C8B63

On 9/2/2003 Krugman wrote:
"Most independent experts now believe that during 2000-2001, price manipulation by energy companies, mainly taking the form of ''economic withholding'' -- keeping capacity offline to drive up prices -- added billions of dollars to California's electricity bills. A March FERC report concluded that there had been extensive manipulation of prices in both the natural gas and electricity markets."
Another Friday Outrage
http://query.nytimes.com/gst/fullpage.html?res=9C00E2DA1538F931A3575AC0A9659C8B63

Posted by: dd | Link to comment | June 23, 2008 at 07:28 PM

[ndd]

Two things:
Sounds like, per says...' quote above, Krugman believed the California energy shortages were driven by the market at the time they were occurring, and only came round to the correct answer a couple of years later. Not a good precedent.

Generally the discussion of futures vs. spot markets is over my head. Nevertheless, I encourage everybody to go over and read Jesse's Cafe Americain on this issue. Best educational discussion contra Krugman I've read so far.

[anne]

"Krugman believed the California energy shortages were driven by the market at the time they were occurring, and only came round to the correct answer a couple of years later."

Not true.

[anne]

http://query.nytimes.com/gst/fullpage.html?res=9C01E6DF143BF932A05751C1A9669C8B63

December 31, 2000

Real Reality's Revenge
By PAUL KRUGMAN

Phil Verleger, my favorite energy guru, believes that we have only begun to pay the price for the exaltation of clicks and bytes over bricks and mortar. For example, he argues that an important reason for the broader global energy problems of the past year, which sent prices of oil and natural gas as well as electricity soaring, was the neglect of exploration and extraction in favor of sexy new-economy ventures. Actually, he puts it even more strongly: ''The United States has proceeded like a third world country. Our firms and consumers have purchased the latest technology gimmicks without bothering to build the necessary infrastructure.'' (If you've ever been in a developing-country hotel or office building during a power outage, you know what he's talking about.)

If he's right, the two great nasty economic surprises of 2000, the tech bust and the energy crisis, are two sides of the same coin: both reflect the fallout from an infatuation with the new that made us unmindful of the old.

Of course, there's more to it than that. California's power crisis isn't just about misguided investors, too excited by the new economy to maintain the old infrastructure. It's also a tale of misguided policy -- of an ill-conceived deregulation plan gone very wrong.

One indication of how badly deregulation has misfired is this: while the error of the tech sector -- overestimating the demand for its services -- was severely punished, the error of the California power companies -- underestimating the demand for their product -- has been richly rewarded. You don't have to be a raving populist to think that there is something wrong with that, and you don't have to be a conspiracy theorist to wonder whether there are some perverse incentives when an industry dominated by a few large players finds it hugely profitable not to invest....

[MG]

dd has attempted to distort history by cherry-picking two quotes, one from Dec 2000 and the other from 2003. The power crisis had barely started, in December 2000. It certainly had not been going on for several years as the run up in crude oil prices has. Here is what Krugman wrote three months later in March 2001:

Mar. 25 2001
The Price of Power

By PAUL KRUGMAN

Welcome to the Cartel California. Last week a report by the Independent System Operator, which runs California's power grid, made it more or less official: the electricity crisis in the Golden State is partly the result of market manipulation by power generators. The report alleges that generators overcharged the state's utilities, which distribute power to consumers, by more than $6 billion over a 10-month period.

The report is almost certain to be ignored by federal authorities. But I'll come back to that in a minute. First, there are a couple of things I need to make clear about the report's claims.

The I.S.O. is not alleging that power generators were part of some vast conspiracy. Actually, I shouldn't have used the word "cartel" in the opening sentence. The generators didn't have to conspire: the logic of the situation made it easy, almost irresistible, for each individual company to manipulate the market. In fact, to believe that the generators didn't engage in market manipulation, you have to believe that they are either saints or very bad businessmen, because they would have been passing up an obvious opportunity to increase their profits.

Imagine the situation: it's a hot summer, and the California electricity market is very tight. You are one of only a handful of major players selling wholesale electricity. Surely the thought has to occur to you: what would happen to prices if one of my plants just happened to go off line? And when companies act on that thought . . . well, you get the picture.

It's also important to realize that accusations that power companies were withholding electricity to drive up prices didn't emerge out of nowhere when the crisis erupted; this isn't a case of politicians suddenly looking for scapegoats. On the contrary, economists were raising red flags about the possibility of market manipulation long before California's woes hit the headlines. Indeed, some economists warned about the issue before California even deregulated: there was clear evidence that "market power" was a problem in Britain, which began experimenting with deregulation and privatization years before the movement came to America.

And the research evidence continues to pile up. Just before the I.S.O. issued its report, the economists Paul Joskow and Edward Kahn circulated a study that found strong evidence that "exercise of market power" played a large role in raising electricity prices last summer. The authors aren't leftists, or even opponents of deregulation. They were merely trying to look objectively at the evidence, which points more or less unmistakably to the conclusion that deliberate withholding of electricity to drive up prices has been an important factor in the California crisis.

Still, there is every reason to believe that Washington will turn a deaf ear to this evidence. As an article in this newspaper explained on Friday, the Federal Energy Regulatory Commission, which is supposed to act as the nation's watchdog over the energy industry, lately seems more like a lapdog. I was particularly struck with the report that FERC's staff found that California's power companies "had the potential to exercise market power," but could not conclude that they had actually used that power. As I said, those power generators must be saints, bad businessmen, or both.

What should the regulators be doing? I'm skeptical about proposals to make the generators pay big fines; it's not clear that you could figure out which company was responsible for which part of the problem, or for that matter that the companies were doing anything illegal. What FERC could do is impose a temporary cap on wholesale prices. This would limit the financial damage to California — the state government is currently spending more than a billion dollars a month to subsidize electricity purchases. And in a market where "exercise of market power" is a major factor, a wholesale price cap might actually increase supplies, because power companies would no longer have an incentive to withhold electricity to drive up its price.

But it's not going to happen. Blame knee-jerk free-market ideology, or the political influence of the power companies (many of which are based in, yes, Texas). Whatever the reason, it is hard to imagine an administration less likely to be sympathetic to California's plight than the one currently in power.

And if this indifference makes Californians angry, it should.

[anne]

http://query.nytimes.com/gst/fullpage.html?res=9401E3D7123CF936A15750C0A9679C8B63

March 25, 2001

The Price of Power
By PAUL KRUGMAN

[anne]

http://www.pkarchive.org/economy/Wolak.html

May 27, 2002

Frank (Wolak) Thoughts On The California Crisis
By Paul Krugman

We're approaching the first anniversary of the sudden, unexpected end of California's energy crisis. I went way out on a limb, at least by journalistic standards, by saying that market manipulation was a key feature of that crisis. I have since been vindicated: arguments that people called leftist nonsense a year ago are now conventional wisdom.

But of course I wasn't a brilliant investigative reporter; I just knew enough to talk to the right people, and to understand what they were saying. Paul Joskow and Severin Borenstein were very helpful. But my most helpful source of all was Frank Wolak, the Stanford professor who also heads the CAISO market surveillance committee. (CAISO is the "system operator").

In a recent paper Wolak offers a very nifty model to explain what was going on. However, as they say in the journalistic trade, he buries his lede: the model is in passing, amid a dense discussion of institutions and their reform. So I thought I would lay it out here, to give you an idea of how I think about the whole thing.

Wolak's model starts with a simplified demand curve. We assume that the demand for electricity is totally inelastic at some given quantity - say 900 megawatt-hours - until the price reaches a ceiling, say $1000 per mwh. It doesn't matter for current purposes whether that's a legal ceiling or the price at which utilities simply refuse to buy.

On the supply side, we assume that there are a smallish number of generators, each with limited capacity - let's say 5 generators with a capacity of 200 mwh each. Each generator has a marginal cost of, say, $20 per mwh actually produced.

Wolak assumes that in the market, each generator submits a bid price for its capacity; then the system operator takes the bids in increasing order of price, but pays all producers the highest bid actually taken. This is a stylized version of the PX, or day-ahead, market that actually operated. He also assumes implicitly that the bids are submitted in order - that the generators go one by one, each knowing what the previous bids were. (It's possible to do this with simultaneous bids; in that case it's a mixed-strategy equilibrium, with qualitatively similar results.)

So what's the Nash equilibrium of this game, given total capacity of 1000 and demand of 900? The first four generators submit bids at $20, their marginal cost; the last generator bids $1000, the maximum. It knows that it will sell only 100 mwh, half its capacity - but far better to sell 100 units at $1000 than 200 at $20!

The really striking thing, of course, is that there is excess capacity in the system - yet the price goes sky-high. And with a little realistic friction added, you could easily imagine blackouts and brownouts as part of the picture. Let me also stress that this is a non-cooperative equilibrium - it doesn't involve collusion, let alone conspiracy, among the generators. You don't have to imagine Ken Lay and Dick Cheney sitting in a room, trading sneers, and chortling over the havoc they are wreaking (which isn't to say that this might not have happened!). All it takes is individual firms, acting in their individual self-interest.

The resemblance of this story to the actual crisis in California, with a record number of plants closed for "repair", with shortages and blackouts continuing through the low-demand winter months, is obvious. Yet the whole exercise may seem suspiciously quick. If it's so easy to have a crisis in which market manipulation produces very high prices, why doesn't it happen all the time? And why did the crisis suddenly end?

But that's the beauty of Wolak's model: the price-rigging equilibrium only happens if the numbers are right, and so it can collapse if the numbers change. In fact, Wolak offers a clear story both about why California plunged into crisis, and why it plunged back out again.

First, it is or should be obvious that the high-price equilibrium only happens if there isn't too much excess capacity. Specifically, the excess capacity must be less than the capacity of a single producer. If demand were 800 instead of 900, the last bidder would not be able to drive up the price. Even if demand were 900, there would be no price-rigging if there were 10 producers, each with only 100 units of capacity.

Wolak's explanation of the onset of the crisis, then, is that the necessary margin of excess capacity was lost - partly because of demand growth, partly because a drought cut off the supplies of hydro that California normally counts on.

Why, then, did the crisis end? ...

[anne]

http://select.nytimes.com/search/restricted/article?res=FA0C10FC3D5B0C738DDDAB0994D8404482

December 10, 2000

California Screaming
By PAUL KRUGMAN

California's deregulated power industry, in which producers can sell electricity for whatever the traffic will bear, was supposed to deliver cheaper, cleaner power. But instead the state faces an electricity shortage so severe that the governor has turned off the lights on the official Christmas tree — a shortage that has proved highly profitable to power companies, and raised suspicions of market manipulation.

The experience raises questions about deregulation. And more broadly, it is a warning about the dangers of placing blind faith in markets.

True, part of California's problem is an unexpected surge in electricity demand, the byproduct of a booming economy. It's possible that the crisis would have happened even without deregulation.

But probably not. In the bad old days, monopolistic power companies were guaranteed a good profit even if their industry had excess capacity. So they built more capacity than they needed, enough to meet even unexpectedly high demand. But in the deregulated market, where prices fluctuate constantly, companies knew that if they overinvested, prices and profits would plunge. So they were reluctant to build new plants — which is why unexpectedly strong demand has led to shortages and soaring prices....

[ndd]

Anne, MG:
Thanks for the follow-up, but I read Krugman's Dec 2000 article as blaming market forces (supply and demand) for California's electricity crisis, before coming round to the contrary view several months later. And I am struck by how easily the same analysis from his December 2000 and March 2001 articles can be applied to today's energy market. Again, I recommend you read the article in Jesse's Cafe Americain to which I have linked.

[Andrew]

Which of the following statements is true?

1. PK is correct, and spot prices are not significantly influenced by betting on futures. The two markets are separate and unrelated.

-or-

2. Jesse's Cafe is correct (thanks for the link, ndd), and price discovery for spot markets is not only influenced by futures speculation, futures play a predominant role.

I don't know nearly enough about the way these markets work to know the answer.

[hari]

It seems the *specualtive nonsense* is all about Paul and not his kid glove approach to crude bubble....

It was the Enron Loophole, stupid, that allowed the Calif power shortages....

[anne]

Ndd:

http://jessescrossroadscafe.blogspot.com/2008/06/does-paul-krugman-understand-us.html

MG & Andrew:

I'm thinking, but look to grain.

[anne]

Hari look to grain, from 2000.

http://www.earthpolicy.org/Updates/2008/Update72_data.htm#table4

[hari]

Andrews - your (2) is right...

If you're a commodity trader, you'd take cognizance of what the speculators are doing not only *betting* on futures price but the actual *volume* they're holding-on...the latter will tell you the direction of the spot price market.
Traditional movement in volume are generally known to traders who may or not take profit and get out....depending on what's going on in futures market.

[hari]

Dean Baker wants some *bloodletting on WallStreet* and bring a stop to speculative *greed* which has examplified American capitalism last two decades or more.

Congress is likely to deal with it, from what I heard during the hearing yesterday, but it's true not all speculation is bad...and I wouldn't consider traditional commodity trader a greedy speculator - compared to the likes of a Hedge Fund with its leveraged positions to cream the margins of a deal.

Let's be very clear, it's the *deregulation* of hi fi sector under socalled Libertarian free market (excuberance) ideolgy that's responsible for today's pitfalls.

[Andrew]

hari,

Thank you for answering, but I not sure I understand entirely.
Could you give an example scenario to illustrate how this works?

[ddt]

is anyone starting to notice a pattern here?

Everyone who actually has hands on experience in the futures market is certain that speculation is at least a significant part of the run-up. (Krugman conveniently avoids mentioning that Masters wasn't alone up there)

On the other hand there's PK who has his own definition of speculation and refuses to listen to anyone, because what is happening now doesn't fit with his textbook.

When Krugman starts talking about how he wants to shoot people in the face because the debate makes no sense, maybe he should consider that the problem lies with him. It's pretty clear that this is a weak spot for Krugman. "Show me the inventory" doesn't quite cut it. If you ask me, that is a good example of a plug your ears "la-la-la-" nonsense argument.

[reason]

In my case, the trouble is that this is a case of the boy who called wolf. People have been saying oil prices are a bubble caused by financial speculators for years. The trouble is the lack of a clear description of a mechanism that doesn't involve a build up of stocks.

Check out a's comment
http://economistsview.typepad.com/economistsview/2008/06/speculative-non.html#c119923876

for instance of one trying to argue against Krugman without being aware that he is actually arguing FOR what Krugman is saying.

If you want to speculate on oil price rises you have to buy some oil and hold it, selling it later for a profit to an end user. But the higher price (normally) should increase supply and decrease demand making it harder to find a buyer. And we have seen some demand destruction (the US is using less benzine than a year ago). With derivatives, as Krugman you are in essense making a bet - but ultimately the outcome of the bet is decided by what happens in the spot markets.

So either it is demand and supply driving the price higher rather than speculation (which at most brings the price rise forward) or something odd is happening. This argument, doesn't apply to land or shares for instance since they are not a flow like a commodity but a stock.

And all those people who say Krugman changed his mind about the energy crisis in California, it looks to me like you haven't understood the content of those articles that Anne posted. In particular, the argument today that you will find for instance in the oil drum is that in fact the difference today is that oil supplies are so tight that one supplier (Saudi Arabia) can control the market. This is what IS similar to the argument that Krugman made about the energy market in California. But this was a totally different circumstance. We were not there talking about the extraction of exhaustable raw materials from the ground. The market had been changed from a monopoly market that DELIBERATELY kept excess capacity to a competitive market that saw excess capacity as an unnecessary cost (from the point of view of any individual supplier). Supply could still have been easily increased, if the market thought that was profitable. It is NOT clear that that is the case today with the (worldwide) oil market.

[lonesome moderate]

vincerinos:I love the Krug Man but I don't know why this issue has his back up. Seven years ago he made the right call on California's energy markets. But now when the same dog is barking in the oil pits it seems like he doesn't want to call in animal control.

This is all about numbers. Krugman called the manipulation of California's power markets when he found data that indicated that. He has denied the possibility of a similar conspiracy in the oil markets because he hasn't found any similar "smoking gun" numbers.

[reason]

Bruce Wilder...
I'm not sure I understand what the difference is from what you are saying and what Krugman is saying or what other sort of speculators you are talking about. A speculator is someone who thinks something is incorrectly priced and tries to make a profit on the basis of that. i.e. A speculator things he sees the supply and demand situation BETTER than people dealing on a day to day basis buying and selling the commodity. What IS complicated here is that higher prices might result in marginal producers deciding they now have enhanced market power and that their asset in the ground will appreciate faster than the return on alternative assets. But as this is true for the world as a whole, this is not speculation, it is asset management. If they believed the speculators were wrong (and the price their oil will fall in the future), then they would increase production now resulting in a fall in the spot price. As this has not happened in at least 5 years of people saying this is a speculation bubble, I don't believe them. At most it has a minor effect in the last year and soon enough any speculators will get badly burned.

[cheekhiaw]

What if the 'inventory' that Paul Krugman cannot see is actually in the pipelines and the oil tankers, and the inventories are being sold just a wee bit latter than they used to be but sufficient to drive a 'rush'?

[ddt]

"reason says... So either it is demand and supply driving the price higher rather than speculation (which at most brings the price rise forward) or something odd is happening."

You're almost there. Something odd IS happening. Everyone else has come to that conclusion and is trying to figure it out. The market is not functioning properly. Everyone else is asking "Why?" but Krugman is just plugging his ears and screaming that "the market is functioning perfectly! We don't need no stinkin' regulation!"

[reason]

I followed the link from ndd and I found this
We're more familiar with the metals markets than we are with oil, but we assume the principles are similar.

Uh Uh ... I'm sure metal stocks are much higher relative to flows and it is easy and cheap to store. I also think that for technical reasons in metal markets the rate of production is much easier to change. That is quite different. Grain markets are a much better comparison, but still not quite the same because grains are renewable and not subject to depletion.

And as for believing the traders - what is a trader - someone who knows the price of everything but the value of nothing.

[reason]

ddt - then Krugman is saying - then show me exactly WHAT is happening that is odd - stop speculating (in another sense) and produce the smoking gun.

[ECONOMISTA NON GRATA]

Speculators....? Inventories.....? What kind of nonsense is this....? As it relates to crude oil, inventories are in the ground..... As I posted in these comments recently....

".............."The council will listen to a report by deputy chairman of the Shura water and public utilities committee, Salim bin Rashid Al Marri, who will argue for cutting crude supplies to maintain the Kingdom's underground reserves.

"Marri will seek to persuade council members that the oil production must be linked to the country's actual development needs not the needs of foreign consumers," Alriyadh newspaper said in a report from the capital Riyadh........."

Please bear in mind that producers are more likely to curtail output over an extended period of time.... In the mean time all we're going to get from producers is cheap talk and flattery to keep out emotions in check...

I also mentioned previously regarding the price of crude in EU vs. US... +267% vs. 542%.... 12/31/01 - 05/30/08.... Perhaps, Greenspan, Bernake and Paulson are the speculators, speculating with policy.

Please folks... You're supposed to be smarter than the average bear here... Give me a f__cking break...

Some of our politicians are in the "Drill" mode... Yes let's drill everywhere, let's drill in ANWR, let's drill on our beaches, let's drill in your back yard, let's drill in the Grand Canyon.... Drill everywhere, but sell it to the highest bidder and that changes nothing.

We may get a small speculative shakeout that may ease crude prices to the 120 to 110 level, perhaps even down to 90. However it will not stay there long and even if it did, 100 oil isn't going to help anyone. The likelihood is that crude prices are going to move higher and higher, sometimes slowly, sometimes quickly. Speculators or no speculators....

Best regards,

Econolicious

[ddt]

reason - just because we don't have the simple solution to a problem doesn't mean that there is no problem. That is the absurdity of Krugman's position that is driving everyone who is actually working towards a solution nuts.

Do you think there is a problem with world hunger? OK, now if you don't give me a smoking gun that is the cause, I will deny that there is any problem.

See the weakness there?

[cheekhiaw]

As some commentators alluded, may be it is due to the other inventory that is building up - the US Dollar inventory??

[Alex Tolley]

Given that supply is increasing and demand is falling, why are prices rising or still so high?

I think PK is wrong on influence of speculators in the short term (but not the longer term).

This link shows that oil futures are settled physically.
nymex contract terms. Therefore if a holder of contracts can convince the market that he intends to take delivery, this increases apparent demand and price will rise. As Bruce Wilder noted, the risk premium for delivery increases when supplies are tight.

Now arguably, if the definition of speculator is very narrow, then PK is right. But I would argue that when the Hunt brothers tried to corner the silver market in the 1970's, they were speculators using both the markets and holding the metal.

PK is arguing that no such equivalent oil is being held in storage. But as I said earlier, this may not be needed if the players can convince the market that they intend to take delivery, they can suck in a lot of new moneygoing long oil futures, even as they roll over their contracts. The huge increase in open oil contracts suggests that this may be happening.

Has anyone looked at the numbers and determined how much of the supply is held by open contracts and what might happen if a player looked like taking delivery?

[Andrew]

cheekhiaw,

A weaker dollar certainly plays a role, but that is a pretty easy component to parse out. If the dollar has dropped by 2% over 3 months, then 2% of the increase in oil prices over that time period is due to a weaker dollar (these aren't the actual numbers, if someone knows them offhand, please share).

[reason]

ddt -
as regards world hunger (wrong term most people are eating normally, the extremely poor are facing starvation), we know that grain stocks have been falling, so we know that demand and supply are out of balance. Speculators could make the situation worse by holding what stocks there are off the market. But in the case of oil, some people think there is plenty of supply available, but if that is the case and high prices are destroying demand - where are the stocks. And remember my argument - if suppliers DON'T believe the market price will be maintained, then it is in their interest to supply more now. If they, however, believe prices are headed higher it is in their interest to hold their stocks in ground. So even this "speculation" story is really a supply and demand story.

[MG]

Alex: "Given that supply is increasing and demand is falling, why are prices rising or still so high?"

What is your source for this information?

"..if the players can convince the market that they intend to take delivery, they can suck in a lot of new money going long oil futures"

So someone is building stocks to deliver against the speculative position. Fine, what do they do with them when the speculators don't take delivery? Continue to hold them at a loss (storage costs + the forward curve slopes downward)?

Economista: "You're supposed to be smarter than the average bear here"

But maybe not the average bull.

[Andrew]

Something else to consider:

The timeline of the Iranian oil bourse coming online, and the rise in oil prices over the last year.

[ddt]

reason - I was just using world hunger as an example of faulty logic, I wasn't actually trying to get into the commodity issues there. Krugman's argument is fundamentally invalid in strict logical terms is what I'm trying to point out (invalid in the sense that modus ponens is valid as an argument structure).

Perhaps another example would help. Say I am a public health official who is seeing the first cases of AIDS. I can tell that the cause is a contagious, serious disease causing people to die from simple infections.

Along comes Krugman and says "Nonsense, in order for it to be contagious, there has to be a VIRUS! Show me the VIRUS! Show me the mechanism! If you can't, then this is just a matter of people with weak immune systems dying, nothing new here".

Well, given that HIV has yet to be discovered, I can't point to the smoking gun virus. It would appear by his own faulty logic that Krugman is correct and there is no virus, but in reality he would be horribly, horribly wrong. That is the danger of fallacious arguments.

No matter what Krugman is trying to say, regardless of the subject, regardless of any evidence, his argument is fundamentally flawed, and utterly invalid. It proves absolutely nothing.

[ndd]

ddt:
While my best guess as to what will happen with prices corresponds with E.N.G.'s comment, I agree with you that it is interesting that traders and economists have such different takes. On Saturday Barron's had an article suggesting oil was in a bubble and would return to $100 a barrel, and I noticed the same thing: per the reports, oil company insiders and traders all seemed to think this last move (from $100 to $140) was speculative. Contra reason, Jesse's point about those who get their hands dirty in the field vs. those with briefcases 100 miles away is well taken.

[anne]

http://krugman.blogs.nytimes.com/2008/06/24/iron-resolution/

June 24, 2008

Iron Resolution
By Paul Krugman

Chinese steelmakers have agreed to a 96 percent increase * in the price they pay for Australian iron ore.

One interesting point about this case is that, as I understand it, iron ore isn’t traded on an international exchange; trade takes place through bilateral deals between producers and consumers. In other words, there isn’t any easy way to speculate on future iron ore prices.

Yet ore prices are surging like oil prices. A bit more evidence against the speculative frenzy hypothesis.

* http://www.ft.com/cms/s/0/bca835f2-4125-11dd-9661-0000779fd2ac.html

[anne]

http://krugman.blogs.nytimes.com/2008/06/24/hell-freezes-over/

June 24, 2008

Hell Freezes Over
By Paul Krugman

I agree with a lot of what this WSJ editorial * says. The difference, I think, is that they seem to believe that speculation is always good; I don’t, but I fail to see any evidence that speculation is the villain in this particular crisis.

This John Dizard piece ** in the FT, by contrast, is very close to what I’ve been saying:

"For example, one of Senator Lieberman’s witnesses, hedge fund manager Michael Masters, compared an 848m barrel increase in index speculators’ positions over a five-year period with the 920m barrel increase in total Chinese demand. In other words, the speculators were almost as big as China.

"Nonsense. Speculators only increase the demand for oil, or any other commodity, when they buy physical product and hold it off the market."

I’d qualify that by saying that speculators can create incentives for other people to hold physical product off the market, if they drive the futures price well above the spot price. But that hasn’t happened.

And by the way, the fact that futures prices have generally been running a bit below spot prices also undermines the idea that oil producing countries have an incentive to leave the stuff in the ground. The only way that makes sense is if the producer thinks that futures prices are understating the likely future price — which pretty much lets speculators in the futures market off the hook.

* http://online.wsj.com/article/SB121426475050198395.html

** http://www.ft.com/cms/s/0/afe0e50c-4185-11dd-9661-0000779fd2ac.html

[save_the_rustbelt]

My major beef with Krugman is that he is the end-all authority on just about every topic in the whole universe.

No one knows everything about everything. Not even an economist.

[ndd]

Anne:

Yet ore prices are surging like oil prices. A bit more evidence against the speculative frenzy hypothesis.

Permit me a counterpoint. In November 2005, the typical price of the median house in the Fort Myers, Florida areas was $369,900. Because this represents an actual transcation between a willing buyer and seller, does that mean that housing in the Fort Myers area was not in a speculative bubble?

You may wish to consult the Cape Coral housing tracker in connection with your answer.

[anne]

Good grief, no one knows nothing except for the folks who have been wrong year after year. If nothing else, we have been through a profound bull market in commodities that intelligent investors, like, say, like, Warren Buffett have been openly preparing to take and taking advantage of since 1998 and 1999. What though could Buffett know about investing?

There is a bull market in commodities, an unfortunate bull market in the case of fuel and grain but a bull market that has developed through the decade and while there are speculators in commodities the bull market has been driven fundamentally.

[anne]

Lose on as many have for years, who cares, but nutty conservative investment advisers drove the losing for years and knowing that might be useful for the crowd that is tailing after them so awfully late.

Look at the grain markets, simply look, and understand how profound the bull market has been, how grounded on fundamentals, however unfortunate, while ethanol fiends do not even have the decency to ask a short term limit to the use of grain for fuel as the market continues to tighten impossibly in poorer countries.

[macburger]

There is a bull market in commodities, an unfortunate bull market in the case of fuel and grain but a bull market that has developed through the decade and while there are speculators in commodities the bull market has been driven fundamentally.

Ah another one of the Greenspan worshippers.

Is this bull market like the erstwhile bull markets in internet stock, housing, financials et al?

"Bull" market in that sense really has a different meaning - like the colloquial "Bull!".

Well the worth the read..

Bull! : A History of the Boom, 1982-1999:
Maggie Mahar

[anne]

Look at the numbers, ask what it means that consumption has been greater than production in grain market for 7 of the last 8 years, that productivity in grain production has for reasons I do not understand slowed markedly since 1990, that irrigated land has become limited, that farmable land has become limited, that food for fuel will take about 1/4 of our corn crop this year, and tell me where the speculation has been, where all the surplus grain is being mysteriously stored to mysteriously increase prices.

I invest, and I really do want to know these things.

[anne]

"'Bull' market in that sense really has a different meaning - like the colloquial 'Bull!' "

There we have the typical idiocy, meant to intimidate which is the point when idiocy is the refuge from thinking. Notice how impressed I am by intimidating idiocy.

[anne]

http://www.earthpolicy.org/Updates/2008/Update72.htm

April 16, 2008

World Facing Huge New Challenge on Food Front: Business-as-Usual Not a Viable Option
By Lester R. Brown

The chronically tight food supply the world is now facing is driven by the cumulative effect of several well established trends that are affecting both global demand and supply. On the demand side, the trends include the continuing addition of 70 million people per year to the earth's population, the desire of some 4 billion people to move up the food chain and consume more grain-intensive livestock products, and the recent sharp acceleration in the U.S. use of grain to produce ethanol for cars. Since 2005, this last source of demand has raised the annual growth in world grain consumption from roughly 20 million tons to 50 million tons.

Meanwhile, on the supply side, there is little new land to be brought under the plow unless it comes from clearing tropical rainforests in the Amazon and Congo basins and in Indonesia, or from clearing land in the Brazilian cerrado, a savannah-like region south of the Amazon rainforest. Unfortunately, this has heavy environmental costs: the release of sequestered carbon, the loss of plant and animal species, and increased rainfall runoff and soil erosion. And in scores of countries prime cropland is being lost to both industrial and residential construction and to the paving of land for roads, highways, and parking lots for fast-growing automobile fleets.

New sources of irrigation water are even more scarce than new land to plow. During the last half of the twentieth century, world irrigated area nearly tripled, expanding from 94 million hectares in 1950 to 276 million hectares in 2000. In the years since then there has been little, if any, growth. As a result, irrigated area per person is shrinking by 1 percent a year.

Meanwhile, the backlog of agricultural technology that can be used to raise cropland productivity is dwindling. Between 1950 and 1990 the world's farmers raised grainland productivity by 2.1 percent a year, but from 1990 until 2007 this growth rate slowed to 1.2 percent a year. And the rising price of oil is boosting the costs of both food production and transport while at the same time making it more profitable to convert grain into fuel for cars.

Beyond this, climate change presents new risks. Crop-withering heat waves, more-destructive storms, and the melting of the Asian mountain glaciers that sustain the dry-season flow of that region's major rivers, are combining to make harvest expansion more difficult. In the past the negative effect of unusual weather events was always temporary; within a year or two things would return to normal. But with climate in flux, there is no norm to return to.

The collective effect of these trends makes it more and more difficult for farmers to keep pace with the growth in demand. During seven of the last eight years, grain consumption exceeded production. After seven years of drawing down stocks, world grain carryover stocks in 2008 have fallen to 55 days of world consumption, the lowest on record. The result is a new era of tightening food supplies, rising food prices, and political instability. With grain stocks at an all-time low, the world is only one poor harvest away from total chaos in world grain markets....

[anne]

"Between 1950 and 1990 the world's farmers raised grainland productivity by 2.1 percent a year, but from 1990 until 2007 this growth rate slowed to 1.2 percent a year."

I am wildly optimistic about the applications of technology, but what does such a marked slowing of productivity for so long in grain production mean? I have not had an optimistic answer for all my considerable asking, so far.

[macburger]

I invest, and I really do want to know these things.

Invest?

I do not think it means what you think it means.

[anne]

http://www.nytimes.com/2008/06/22/business/22indiafood.html?hp&pagewanted=print

June 22, 2008

India's Growth Outstrips Crops
By SOMINI SENGUPTA

JALANDHAR, India — With the right technology and policies, India could help feed the world. Instead, it can barely feed itself.

India's supply of arable land is second only to that of the United States, its economy is one of the fastest growing in the world, and its industrial innovation is legendary. But when it comes to agriculture, its output lags far behind potential. For some staples, India must turn to already stretched international markets, exacerbating a global food crisis.

It was not supposed to be this way.

Forty years ago, a giant development effort known as the Green Revolution drove hunger from an India synonymous with famine and want. Now, after a decade of neglect, this country is growing faster than its ability to produce more rice and wheat.

The problem has grown so dire that Prime Minister Manmohan Singh has called for a Second Green Revolution "so that the specter of food shortages is banished from the horizon once again."

And while Mr. Singh worries about feeding the poor, India's growing affluent population demands not only more food but also a greater variety.

Today Indian agriculture is a double tragedy. "Both in rice and wheat, India has a large untapped reservoir. It can make a major contribution to the world food crisis," said M. S. Swaminathan, a plant geneticist who helped bring the Green Revolution to India....

[Fred]

Anne: search on Ukraine. I read an article recently that say that improved productivity there could easily swamp the world's grain markets. It will take perhaps 2 years to bring them up to speed.

[hari]

Now suppose Fed hikes rates tomorrow by 25p. What impact would it have on commodity/crude prices?

My guess is that if Fed shld surprise us with a 25bp uptick
there will be a lot of losers on CFTC/Futures Market.

Reuters is anticipating a run on the dollar, if Fed shld hold neutral and do nothing about rising commodity speculation. While ECB may do just the opposite next month to contain inflation.

[anne]

Also, because I am still annoyed about using Somalia as an instance of development failure in Africa, it could be helpful to remember that a stabilizing Somalia was invaded and occupied by Ethiopia in December 2006 with American encouragement and assistance as another effort at limiting supposed resistance to American policy in the Middle East. There has been continual turmoil in Somalia from December 2006, with an estimated million people driven from homes by violence.

Sadly, a portion of Somalia, Somaliland, which has long been peaceful and developing well and continually looked for assistance from the West to cement the development, was almost completely ignored and is currently experiencing both the effects of increased food prices and a fierce drought accentuating the food problem.

[anne]

http://www.earthpolicy.org/Updates/2008/Update72_data.htm#table3

Ukraine is promising, there is always promise, but exported 1.2 millions tons of corn in 2007 to our 62 million tons. Wheat was 5.2 to 32.5. Rice was not a significant export. Ukraine is not yet among the top 10 grain exporters.

[anne]

http://www.earthpolicy.org/Updates/2008/Update72_data.htm#table3

January, 2008

Top Ten Exporters of Total Grains, 2007

(Million Tons)

1 United States 106.1
2 Argentina 28.1
3 Canada 18.6
4 EU 14.3
5 Russia 13.1
6 Australia 10.6
7 Thailand 9.3
8 Kazakhstan 9.0
9 Brazil 8.7
10 Vietnam 5.0

Note: Total grain includes barley, corn, millet, mixed grain, oats, rice, rye, sorghum, and wheat.

[Fred]

The commodities bull market is real. And the reason is that commodities were beaten down so many times in the past that all the producers gave up hope sometime in the 90's and refused to believe there could ever be another bull market. So they postponed investing longer than would have been normal. Now they finally believe the boom is real. So we are seeing a massive increase in commodities investment in everything except oil, which is controlled by a cartel. We're getting mighty close to the point where all this new production comes online, as well as to the point where demand (which is inelastic in the short run) finally decreases in response to the higher prices via substitution effects. There is also going to be further decrease in demand if we get a global recession, which I think highly likely. Put all this together, add in some speculation, and you have the prospect of a truly massive commodities bust.

High oil prices are the result of cartel behavior. The cartel works in the short run, but in the long run members of the cartel (being human) tend to naturally increase their consumption spending to match their increased income. Once spending equals income, for any member of the cartel, cheating becomes very likely. Cheating knocks the price down, which prompts further cheating in order to make up for the reduced income, in order to avoid riots among those who have come to depend on the increased spending. Panic sets in and the price collapses. I give another 2 years max for this to happen with oil.

[Fred]

Ukraine is not important now but just look at the map. Ukraine is equivalent to the American great plains. They still haven't overcome the old Soviet incompetence factor. That could change very easily.

[anne]

Fred et al, please keep records of promising discussions of commodity production, especially food, as in the case of Ukraine.

http://www.earthpolicy.org/Updates/2008/Update72_data.htm#table3

January, 2008

Top Ten Exporters of Corn, 2007

(Million Tons)

1 United States 62.0
2 Argentina 15.0
3 Brazil 9.0
4 Paraguay 1.6
5 Ukraine 1.2
6 China 1.0

Notice the astonishing differences.