The link to this open email came to me by way of my brother-in-law (bless his heart). Though this particular version resides on the Hawaiian Airlines web site, it proportedly comes from the desks of twelve major airlines. In it, the CEOs of these airlines make an empassioned plea to us, their passengers, to write to our Congressional representatives to draft legislation to limit effects of speculative oil traders to artificially increase oil prices.
The arguement laid out in the letter goes like this. In contrast to earnest parties selling and buying contracts for future delivery of oil, speculators buy and sell such contracts with no intention of taking delivery of the oil at any point in the future. With property, stock, and fixed-income markets in tatters right now, the commidity-futures markets are widely protrayed as the only market left going up for traders. And because such traders have no intention of taking delivery, the thinking goes, they have both the motive and the means to see that commodity prices, particularly for oil, only goes up.
This is a horse that will not run. An understanding of how the futures markets work and simple thought experiment bear out this contrarian conclusion.
The letter from the CEOs asserts that "a barrel of oil may trade 20-plus times before it is delivered and used." This is bupkis. Even on paper, no one on the futures exchanges is actually trading the actual, underlying commodity: they are trading obligation to buy a set amount of the underlying commodity at a future date at a specified price. This distiction is crucial, because the futures markets are trying to discern what the spot-market price of the underlying commodity will be at a point in the future. This additional element of time is also important because one cannot buy and sell a given contract forever: eventually someone holding it will have to take delivery of the physical commodity.
Consider speculators dealing with a contract for 1,000 barrels of oil (the standard contract size) for delivery in March 2009. Suppose that this informal cabal did bid up the price of contract in complete contravention of the actual supply and demand of light, sweet crude oil. The traders can continue to buy and sell this contract until February 20, 2009 (the last trading day for this contract). Whoever holds that contract (and someone must--there is always a conterparty to every futures trade) at the close of the market that day will be given notice February 22 that they are contractually obliged take delivery of 1,000 barrels of oil from the party that initially wrote the contract sometime between March 1 and March 31, 2009.
If it is a hapless speculator who happens to hold the contract at the close of trading on Feb. 20, he or she will have to turn around and sell his or her 1,000 barrels on the spot market or pay to store and insure their 42,000 gallons of oil until such time as they choose to sell it; alternatively, he or she will have to find someone--anyone--to take the contract off of their hands before they are forced to take delivery. On the last day of trading, this contract is worth no more nor no less than the spot price of oil (because who would want to buy a contract to take delivery of oil at $205/barrel when you could buy it on the spot market for $164/barrel, for example). In any case, the futures price must converge on the spot price, not vice-versa.
The idea that speculators are flooding the markets with too many contracts is also specious. Again, this is because each commodity futures contract must come due for delivery at some point in the future. Speculators are quite free to write (sell) contracts for the future delivery of oil that they do not own. Indeed, there may only be 100,000,000 barrels of oil that can be delivered in March 2009 but outstanding contracts for the delivery of 208,000,000 barrels. Come March 2009, however, writers of those contracts will have to deliver their oil, even if they have to first buy it on the spot market. While several foolish speculators having to do this might temporarily force up spot price of oil, it will also winnow the field very quickly. Even for nefarious speculators, the market can stay irrational far longer than they can stay solvent.
Because commodity futures contracts must always be delivered on and cannot take actual commodities (like barrels of oil) off of the market, I cannot see a causal mechanism that would allow future guesses about the price of oil to wreck the price-discovery power of the spot market. And even if I am wildly wrong and speculation (as opposed to supply and demand) currently dominates the oil market, the shareholders of these 12 airlines should start asking why their companies have not bought more contracts on what their senior management purport to be a sure thing.
