The Democrats’ Rank Ignorance, Exposed

To say that the Democrats are out of ammo would be an understatement. Their policies have failed, President Obama has no agenda for a second term, and Congressional Democrats refuse even to propose a budget. Lacking any constructive ideas, the Democrats have resorted to ignorant demagoguery. Most recently, President Obama has vowed to hire a bunch of law enforcement officers to crack down on “speculation” in the oil market.

Whatever that means. Next time one of your Democrat friends starts talking about speculation driving up the price of oil, ask him a few questions, like: How do you tell a speculator from a non-speculator? How, exactly, do “speculators” raise the price of oil? If the speculators are wrong about the fundamentals of supply and demand, won’t they lose their shirts? If speculators are responsible for high oil prices, why aren’t they also driving up the price of natural gas, which is at a historic low?

Former Congressman Joe Kennedy II wrote an op-ed in the New York Times in which he advocated a legal ban on speculation in oil. This concept is stupid on so many levels that they are hard to count. To make just one obvious point, if people can’t buy oil futures on an American exchange, they will buy oil futures on European, Asian, South American and African exchanges. Liberals sometimes seem to forget that there is a wide world out there over which we have no control.

Econbrowser took the trouble to deconstruct the goofy Kennedy/Obama proposal at length. The post is worth reproducing in its entirety:

Joseph P. Kennedy II, former Congressional Representative from Massachusetts, and founder, chairman, and president of Citizens Energy Corporation, has a proposal to make energy affordable for all. All we have to do, Kennedy claims, is “bar pure oil speculators entirely from commodity exchanges in the United States.”

Writing in the New York Times last week, Joseph Kennedy (D-MA) explained why he believes that speculators are responsible for the high price that we currently have to pay for oil:

Today, speculators dominate the trading of oil futures. According to Congressional testimony by the commodities specialist Michael W. Masters in 2009, the oil futures markets routinely trade more than one billion barrels of oil per day. Given that the entire world produces only around 85 million actual “wet” barrels a day, this means that more than 90 percent of trading involves speculators’ exchanging “paper” barrels with one another.

It’s true that most buyers of futures contracts don’t actually want to take physical delivery of oil. If I buy the contract at some date, I usually plan on selling the contract back to somebody else at a later date, so that I leave the market with a cash profit or loss but no physical oil. But remember that for every buyer of a futures contract, there is a seller. The person who sold the initial contract to me also likely wants to buy out of the contract at some later date. I buy and he sells at the initial contract date, he buys and I sell at a later date. One of us leaves the market with a cash profit, the other with a cash loss, and neither of us ever obtains any physical oil.

Let’s take a look, for example, at NYMEX trading in the May crude oil futures contract. A single contract, if held to maturity, would require the seller to deliver 1,000 barrels of oil in Cushing, OK some time in the month of May. Last Friday, 227,000 contracts were traded corresponding to 227 million barrels of oil, which is indeed a large multiple of daily production. But it is worth noting that at the end of Friday, total open interest–the number of contracts people actually held as of the end of the day–was only 128,000 contracts, much smaller than the total number of trades during the day, and not much changed from the total open interest as of the end of Thursday. Many of the traders who bought a contract on Friday turned around and sold that same contract later in the day. If the purchase in the morning is argued to have driven the price up, one would think that the sale in the afternoon would bring the price back down. It is unclear by what mechanism Representative Kennedy maintains that the combined effect of a purchase and subsequent sale produces any net effect on the price. But the only way he gets big numbers like this is to count the purchase and subsequent sale of the same contract by the same person as two different trades.

It’s also worth noting that on that same day, there were 146,000 May natural gas contracts traded, which if held to maturity would call for delivery of natural gas at Henry Hub in Louisiana. A single contract represents about 10 million cubic feet, so Kennedy’s calculations would invite us to compare the 1,146 billion cubic feet of “paper” natural gas traded on Friday with the total of 78 billion cubic feet of natural gas that the U.S. physically produced on an average each day in 2011. Once again, the vast majority of Friday’s natural gas futures trades were matched by an offsetting trade during the same day so as to have little effect on end-of-day open interest.

By what mysterious process can all this within-day buying and selling of “paper” energy be the factor that is responsible for both a price of oil in excess of $100/barrel and a price of natural gas at record lows below $2 per thousand cubic feet? I suspect the reason that Kennedy does not explain the details to us is because he does not have a clue himself.

Indeed. Joe’s great-grandfather and namesake understood how markets work, but such knowledge has long been lost to the Kennedy family.

Kennedy’s analysis continues:

Because of speculation, today’s oil prices of about $100 a barrel have become disconnected from the costs of extraction, which average $11 a barrel worldwide.

Here Kennedy shows his utter ignorance of economics. It is revealing that the New York Times chose to publish an op-ed that contained such a howler. Econbrowser comments:

Here I have a modest suggestion. If Representative Kennedy knows a way to go out and produce another barrel of oil somewhere in the world for $11 a barrel, he would do a world of good if he would actually go out and do it himself, as opposed to simply asserting confidently in the pages of the New York Times that it can be done. People with far more modest fortunes than Kennedy inherited are out there using their resources to try to bring more of the physical product out of the ground.

And many, many more would be attempting the feat if it were remotely possible to produce a new barrel of oil for anywhere close to $11.

If you want to prove me wrong, Mr. Kennedy, then don’t talk about how easy it is to produce more oil– just go do it.

No danger of that. Producing oil would actually be productive, which is far beyond the meagre talents of Joe II and his ilk.

I have a final concern about Kennedy’s policy proposal. How exactly do we define the “speculators” whose participation in the markets is to be banned? Suppose for example, we stipulate that the only people who are allowed to trade oil futures are those who are actually physically producing or consuming the product. If we do that, what happens if a particular producer wants to hedge his risk by selling a 5-year futures contract, and a particular refiner wants to hedge his risk by buying a 3-month futures contract? Who is supposed to take the other side of those contracts, if all “speculators” are banned?

Liberals never worry about such practical questions, because they have no idea why financial markets develop in the ways that they do, or what needs they serve. If you are a demagogue, you don’t really need to understand anything. That, in a nutshell, explains Joe Kennedy, Barack Obama, and a great many other Democrats.

Let me close by pointing those interested in this issue to a recent survey of academic studies of the role of speculation by Bassam Fattouh, Lutz Kilian, and Lavan Mahadeva. The authors conclude:

We identify six strands in the literature corresponding to different empirical methodologies and discuss to what extent each approach sheds light on the role of speculation. We find that the existing evidence is not supportive of an important role of speculation in driving the spot price of oil after 2003. Instead, there is strong evidence that the co-movement between spot and futures prices reflects common economic fundamentals rather than the financialization of oil futures markets.

The level of economic “analysis” engaged in by Joe Kennedy II, Barack Obama and many other liberals is so pathetic that it is almost embarrassing to take the trouble to disassemble it.

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