Speculating on Speculation

Now that we are facing an energy crisis, the social progressives (“democrats”) are doing what they do best: reinforcing their message that we are all “victims” and are “entitled” to all the energy we want at a price we can afford. The most recent target is the “speculators,” formerly known in more respectable times as “energy traders.” The social progressives answer – surprise, surprise: regulate them. Unfortunately, regulation will do nothing to address the underlying issue, except to eliminate what is a useful market function that provides us with an early warning of impending market movement (both good and bad) and counterbalances the market alternative, cartels.

First, let me say I am not an expert in this area by any means. However, in my consulting practice, I did assist a large energy marketing firm re-engineer its business processes, and through this experience, did come away with a good appreciation for what drove their business.

Energy marketing has nothing to do with selling energy. In fact, the objective of the business is to never, never … ever … to end up having to fulfill a physical contract. That is true: other companies deliver the product. The energy marketers job is price discovery: to predict the future price of a commodity, in this case energy, and buy and sell contracts that profit on the uncertainty in the market price. The politicians would have us believe this is “reckless wagering,” except behind each “bet” is market knowledge (actual data), information gathering (information technology), forecasting (sophisticated statistical analysis), and risk management (arbitrage and hedging). On every “wager,” there are at least two sides to the transaction – a party that will ultimately win and one that will ultimately lose, both of which are intelligently looking at the market. So, when large uncertainty in the price exists, large uncertainty in the underlying ability of the market to meet supply and demand exists. If there were no uncertainty, no price volatility would exist nor would any profit potential for an energy marketer.

The real question is “what is driving the risk?” Prospectively, I believe the energy marketers believe the answers are: (1) world demand is starting to outstrip supply (see my blog “To Drill or Not to Drill, That is the Question”), (2) America consumes a disproportionate share of the oil resource, which drives world price, and (3) America will elect a president and congress that: (a) will withdraw from Iraq, leaving 60% of the worlds oil supply in the hands of our adversaries, (b) are not willing to tap potential sources of energy within our borders; and (c) will not commit to proven energy technologies but will replace them with less dense, passive technologies and conservation that will never meet our energy needs. In short, oil is in short supply and we do not want to do anything to increase that supply except talk. We need the oil and some else owns it. My bet is the price is going to go up.

So, the moral to the story is this. When the “speculator” watchdog starts barking, let’s shoot it. Or as John Preston, of Boston University, said “The nicest thing about not planning, is that failure comes as a complete surprise and is not preceded by a period of anxiety.”