Speculation, Again

Rick Newman of Useless News and World Report busts some myths. And gets to the heart of the “speculators” issue:

Many companies, for instance, want to lock in the price they’re going to pay down the road for petroleum products and other supplies they need to run their businesses. So they make agreements with suppliers on a price they’ll pay next year, or the year after, when they actually take possession of the oil. Buying and selling such “futures contracts” makes these companies speculators by definition, since they’re placing a bet on the future price of oil.

Companies doing this kind of hedging include gasoline refiners, airlines, shipping companies, and others that spend a lot on fuel or petroleum. Often they use investment banks or other intermediaries to arrange the deals. They might be gambling, but this kind of speculation actually helps companies run their businesses more smoothly, and if they guess right on future prices, it may give them a competitive advantage against other companies that don’t plan as prudently.

It’s not “gambling” that gave Southwest a competitive advantage, or nearly put Delta out of business yet again. When your largest non-fixed expense is a known quantity (how much fuel you’ll need next year, given any expansin/contraction plans), hedging in the futures market isn’t just an adventure, it’s a job.

And note that the competitive advantage isn’t just against “other companies.” A speculator who guesses wrong doesn’t stay in the market too long. Nor, not to be blunt about it, does s/he ever take delivery of the asset: they sell the contract for a gain or loss.

This is why an increase in volume in the futures market (as noted in Mr. Master’s testimony; h/t divorced one like Bush in comments here) isn’t necessarily a sign in itself of speculation. It may be a sign of corporate risk management (finally) doing its job. After all, it’s not as if the oil price trend isn’t clear.