In Praise of Oil Speculation

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That's why I agree with you that we need smart regulation of energy markets. But unlike you, I'm optimistic about the changes in the works. You've been highly critical of Atlanta's IntercontinentalExchange (ICE), whose London unit trades an oil futures contract that's linked to the settlement price of the West Texas Intermediate contract of the New York Mercantile Exchange. You've quoted congressmen who described ICE as "dark" and "unregulated."

First, I don't rely on members of Congress to tell me who's underregulated. Second, U.S. regulators have (belatedly) put some heat on ICE. On June 17, ICE announced it would comply with Commodity Futures Trading Commission rules for reporting on large traders and capping the size of trades. I spoke with ICE's biggest competitor, Nymex (NMX), about this on July 2. Tom LaSala, Nymex's chief regulatory officer, said he was satisfied with what ICE agreed to.

The Diesel Factor and Murky Oil Data

Here's my nominee for least-appreciated factor in the runup in oil prices: diesel. You've also noticed in your columns that diesel prices have risen even more than gasoline prices. I draw a different conclusion from that. I take it as strong evidence that diesel is pulling the entire market upward. I even wrote an article (BusinessWeek.com, 5/29/08) about it. The idea in a nutshell is that diesel is scarce because of tighter sulfur standards, strong demand from China, and a steady move to diesel vehicles in Europe. Refineries can make so much money on diesel at these prices that they're competing for oil to refine into it, driving up the crude. The gasoline they get from the crude is just incidental. (By the way, that also explains why there's plenty of gasoline around.)

Now, unlike some doctrinaire believers in market efficiency, I'm perfectly happy to stipulate that speculation is responsible for big day-to-day movements in oil and gasoline prices. But who cares? That's how markets work. People bet whether oil prices should be higher or lower based on their best assessment of all the latest data, which is almost always incomplete and contradictory. (Here's a story I wrote about the murkiness of oil data (BusinessWeek.com, 5/13/08). For every piece of data you produce showing that supply seems to be exceeding demand, I could come up with a matching one for why people worry that demand will exceed supply. (I get scared just thinking about millions of Chinese and Indians buying econo-cars like the Chery QQ or Tata Nano for a few thousand bucks.)

Probably the only way to eliminate speculation from the oil market entirely would be to have the White House dictate prices. That didn't work well at all when Richard Nixon tried it.

Ed, over to you.

Coy is BusinessWeek's Economics editor.