CFTC: Oil spike WAS driven by speculation, after all

[ArmorPierce]

I don't recall in high school. I have taken several economic courses in university however.

For a product that is seen as more of a necessity, a higher price will not coincide with reduce demand. Oil is a inelastic good. This means that a price rise will not coincide with a lowering of demand. This would explain why price shot way up and demand didn't fall as dramatically. Even if peak oil had been the cause, the tremendous spike should be a sign that there was speculation (or price gouging) was taking place. As I said, the belief that the price was going to be more expensive in the future causes people to buy today in attempt to get it when it is cheaper, which in turn driving up the price in the present. I consider that speculation, don't know what about others. I do think that oil is actually currently a bit underpriced.

For Simon_Jester's scenario, it assumes that there isn't already more people demanding oil and the current price is the result of that bidding. There is not

Yes, you're right price doesn't necessarily scale linearly with demand and my statement was a oversimplification/incorrect.

[Simon_Jester]

For a product that is seen as more of a necessity, a higher price will not coincide with reduce demand. Oil is a inelastic good. This means that a price rise will not coincide with a lowering of demand. This would explain why price shot way up and demand didn't fall as dramatically.

Yes, but that should also work the other way around: a small increase in demand, without a corresponding increase in supply, would drive prices very high. Because the commodity is inelastic, it takes a large price increase to drive demand back down to levels consistent with the available supply.

Even if peak oil had been the cause, the tremendous spike should be a sign that there was speculation (or price gouging) was taking place.

The problem doesn't have to be peak oil, as far as I can tell. It can be a temporary bottleneck in production, or just a natural increase in demand that happens to grow faster than production can be expanded. I'd expect the same thing to happen to the prices of other commodities when reserve production is low compared to fluctuations in demand.

For Simon_Jester's scenario, it assumes that there isn't already more people demanding oil and the current price is the result of that bidding. There is not.

Ah... I don't think I made that assumption. What I'm getting at is that the oil industry has a certain amount of daily production and a certain amount of reserve production capacity- if people start demanding more oil than they pump today, they can turn on another pump tomorrow. But that only works if the pump is already in place. It takes much more time and effort to build more wells, pumps, tankers, and such than it does to switch on the existing reserve hardware. If demand rises by 2% over the summer, the price goes up, but since the industry can also increase production by 2%, it doesn't need to rise very much.
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If demand rises beyond the limit of the reserve production available right this minute, the oil companies can't pump faster. Every barrel of oil they can possibly pump this week will be bought by someone, and someone somewhere isn't going to get theirs.

At that point, it becomes profitable for them to raise prices until some of their customers are no longer willing or able to buy oil. Unlike a situation where supply can be increased at will, there's no sense in lowering your prices in hopes of selling more, because you couldn't possibly sell more than you already are.

And when that happens, I'd expect the price to go from one stable equilibrium (small temporary spikes in demand are met with increased supply and raised prices) to another (small temporary spikes in demand are met only with raised prices).

Why shouldn't the new equilibrium price be much higher than the old? Sure, bidding wars were a factor in the old market, but they weren't the only factor. Now they are.
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We see this happen in local disasters: unless someone goes out of their way to stop it, the price of things like gasoline and bottled water go through the roof. The stores can confidently expect to sell every bit of their inventory unless their prices are completely insane, so they might as well raise their prices until the number of customers who can still afford the price equals the number of customers they can actually supply.

[ArmorPierce]

Yes, but that should also work the other way around: a small increase in demand, without a corresponding increase in supply, would drive prices very high. Because the commodity is inelastic, it takes a large price increase to drive demand back down to levels consistent with the available supply.

That's true

The problem doesn't have to be peak oil, as far as I can tell. It can be a temporary bottleneck in production, or just a natural increase in demand that happens to grow faster than production can be expanded. I'd expect the same thing to happen to the prices of other commodities when reserve production is low compared to fluctuations in demand.

Wasn't arguing that was the only thing that can cause it, agreed.

Ah... I don't think I made that assumption. What I'm getting at is that the oil industry has a certain amount of daily production and a certain amount of reserve production capacity- if people start demanding more oil than they pump today, they can turn on another pump tomorrow. But that only works if the pump is already in place. It takes much more time and effort to build more wells, pumps, tankers, and such than it does to switch on the existing reserve hardware. If demand rises by 2% over the summer, the price goes up, but since the industry can also increase production by 2%, it doesn't need to rise very much.

I see what you're getting at now. Where do you think that the price spike would stop? I think that the price spike may be close to the same with people panicking and overbidding the price but quickly level off so the high price was not sustainable.
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Snipped explanation

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We see this happen in local disasters: unless someone goes out of their way to stop it, the price of things like gasoline and bottled water go through the roof. The stores can confidently expect to sell every bit of their inventory unless their prices are completely insane, so they might as well raise their prices until the number of customers who can still afford the price equals the number of customers they can actually supply.

Yes, stores will price gouge on items that people need for as long as they are able to.

[Simon_Jester]

I see what you're getting at now. Where do you think that the price spike would stop? I think that the price spike may be close to the same with people panicking and overbidding the price but quickly level off so the high price was not sustainable.

I think the price spike would stop if the drop in demand overreacted. In that case, there will be enough oil for everyone again, and it starts making sense to underbid competing oil companies by selling cheaper oil, because you can plausibly hope to increase your market share if you're the first to cut prices a shade.

Or the spike would stop if new production facilities were created, or if some combination of both happened. What I'm saying is that a partial, possible explanation for the price spike was that (for the first time in recent memory) the demand for oil actually managed to twitch up above the maximum rate at which the industry can get oil out of the ground.

Obviously, this is most likely to happen as civilization nears the point of peak oil... and there are multiple converging surveys that suggest we are approaching peak oil. So I wouldn't be surprised to see this kind of thing happening again, unless the oil companies exercise great self-discipline and refuse to raise prices this way again. And they might do just that, because it's in their long term interests for prices to get that high. Even a few months of extremely high oil prices is a huge kick to consumers' consciousness of fuel economy.
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Yes, stores will price gouge on items that people need for as long as they are able to.

It's not just that people need them: people always need things like gasoline, food, and water. What changes in a disaster scenario is that people demand much more of it than they normally would, because they're trying to build stockpiles. So you see a sudden increase in demand that overwhelms the available supply: I physically can't ship in more bottled water fast enough to get it to all the people who want to hoard it.

Only in that situation, where I am guaranteed to sell everything in my inventory, does heavy price gouging make sense. Otherwise, one of my competitors can still outsell me by cutting prices (or just gouging a little less hard). But if everyone has the same situation of being able to count on selling as much as they can make or bring in, then no one can get an edge by cutting prices below the limit of what the customers will bear. All a price cut will do is increase the number of customers they have to turn away after they've sold out their entire stock.