The Simple Economics of Commodity Price Speculation †

2016, 8(2): 85­110 http://dx.doi.org/10.1257/mac.20140033 By Christopher R. Knittel and Robert S. Pindyck* The price of crude oil never exceeded $40 per barrel until mid-2004. By July 2008 it peaked at $145 and by late 2008 it fell to $30 before increasing to $110 in 2011. Are speculators partly to blame for these price changes? Using a simple model of supply and demand in the cash and storage markets, we determine whether speculation is consistent with data on production, inventory changes, and convenience yields. We focus on crude oil, but our approach can be applied to other commodities. We show speculation had little, if any, effect on oil prices. (JEL G13, G18, G23, G31, Q35, Q38) Commodities have become an investment class: declines in their prices may simply reflect the whims of speculators. --The Economist, June 23, 2012 Tens of billions of dollars went into the nation's energy commodity markets in the past few years, earmarked to buy oil futures contracts. Institutional and hedge funds are investing increasingly in oil, which has prompted President Obama and others to call for curbs on oil speculation. --New York Times, September 4, 2012 Federal legislation should bar pure oil speculators entirely from commodity exchanges in the United States. --Joseph Kennedy II, New York Times, April 10, 2012 he price of crude oil in the United States had never exceeded $40 per barrel until mid-2004. By 2006 it reached $70 and in July 2008 it peaked at $145. As shown in Figure 1, by the end of 2008 it had plummeted to about $30 before increasing to $110 in 2011. By late 2014, it dropped below $60. Were these sharp price changes due to fundamental shifts in supply and demand, or are "speculators" at least partly to blame? This question is important: the wide-spread claim that speculators caused * Knittel: William Barton Rogers Professor of Energy Economics, Sloan School of Management, Department of Applied Economics, Massachusetts Institute of...