Several times during the past couple of weeks I have heard pundits, politicians and various journalists explain that the reason gasoline prices are so high is because of greedy speculators. Bill O’Reilly has ranted about the speculators in oil several times lately and feels that it is his moral duty to look out for the “folks” and personally do what it takes to get the price of gasoline down to what he thinks is a reasonable level.

Let’s first define what a speculator is. A person who speculates on the price of oil will purchase oil now for a future delivery or promise to deliver oil in the future. In both cases the speculator has no intention of taking delivery of the oil or of delivering it in the future. He is hoping to go to the opposite side of the contract before the delivery date comes around.

The thought process is that the price of oil will move in the direction most favorable to the speculator before the end of the contract. So if I decide to purchase oil now for future delivery, I think that the price will go up in the future and I lock in my price now. If the price does increase before the delivery date I can unwind the contract and make a profit. If, however, the price goes down in the future then I lose money on the contract.

If I promise to deliver oil in the future at today’s price then I am hoping that the price of oil will go down before I have to deliver it and I can fulfill the contract at a cheaper price than I sold it for. If it does, then I make money. If the price of oil goes up in the future, I lose money.

In all of these circumstances there is always another person on the opposite side of the contract who believes he is right and I am wrong. Meaning that for every evil speculator betting the price of oil is going to go up, there is another evil speculator betting in the opposite direction.

It always has to be a zero sum game.

The other type of speculators are called hedgers. These are people who have the commodity in their possession, will have it soon or who will need the commodity in the future and want to lock in a price today. For example, an airline company may need to purchase a million gallons of jet fuel for their flights next month. Thinking that the price of jet fuel is going to go up, and not knowing how much, they speculate or “hedge” their purchase today and gain a predictable price for next month.

If the price of jet fuel goes up they make money by the fact that they locked in at a lower price. If the price of jet fuel goes down they can purchase at the higher price, roll the contract forward for a price or back out of the contract altogether.

Farmers work the same way. They will speculate on the price of their crops that will be harvested in the fall and lock in a price in the spring. They essentially sell their crop before they harvest and know what their profit is going to be.

Most major industries that use commodities in their business speculate on both sides of the transaction to make prices and profits more predictable.

Without the speculators that are not manufacturers or farmers, there would be very little liquidity to all of the contracts that are bought and sold. Eliminating this process will dry up the liquidity and send the commodities markets overseas where they are appreciated.

As one of those speculators and hedgers, I take umbrage that I am evil and greedy. I want to make money for my clients by taking advantage of the tools and techniques available in the marketplace. By the way, they also pay taxes on the gains in all of these transactions.

Gary L. Rathbun is the president and CEO of Private Wealth Consultants, LTD. He can be heard every day at 4:06 p.m. on “After the Bell with Brian Wilson and the Afternoon Drive” and every Wednesday and Thursday at 6 p.m. throughout Northern Ohio on “Eye on Your Money.” He can be reached at (419) 842-0334 or email him at garyrathbun@privatewealthconsultants.com.

Tags: A View from the Gulch, Gary Rathbun, gasoline costs, oil, speculators

This entry was posted on Friday, March 2nd, 2012 at 4:59 pm and is filed under A View from the Gulch, Toledo Business Link.
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