Why Do Oil Speculators Cause So Much Grief at the Pump?

MAKING SENSE -- April 19, 2012 at 2:19 PM EDT

Why Do Oil Speculators Cause So Much Grief at the Pump?

Larry Bessler purchases gasoline at a Shell station. Photo by Scott Olson/Getty Images

Paul Solman frequently answers questions from the NewsHour audience on business and economic news on his Making Sen$e page. Here is Thursday's query:

Name: Jim

Question: Please explain why speculators are allowed to disrupt gas prices, thereby causing so much hardship on ordinary citizens.

Paul Solman: Because the market for hedging against the risk of producing or consuming gas would then cease to exist, as would the market for predicting future prices, a market that helps producers decide how much and when to produce.

Say you run an airline whose solvency depends on stable gas prices. On the futures market, you can lock in the price of gas for future delivery, thus protecting yourself from a run-up. Southwest Airlines famously did this a few years ago and protected its solvency against the huge price spike of 2007-2008. If there were no speculators to take the other side of the bet, Southwest would have been unable to hedge and entirely at the whim of the marketplace. Iran closes the Straits of Hormuz? Gas prices might spurt once again and hobble any airline that didn't hedged, but not if they'd protected themselves on the futures market.

The plain truth is that markets are made up of producers, consumers and speculators and always have been. The justification for the speculators is that without them, markets would be "thinner," less "liquid." That is, fewer players, meaning higher costs to making trades; more room for manipulation.

The argument against the speculators, of course, is that they make markets swing wildly, based on waves of fear and greed.

Both the justification and argument against are true.

This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions.

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