Friday, August 22, 2008

Are Oil Prices Rigged?

The question of whether oil prices are rigged may turn on another question: when buyers and sellers negotiate over the price of oil, where do they look for price signals?

The case for yes, they're rigged, as advanced by Ari Officer and Garrett Hayes, seems to hinge on this claim:

[T]he vast majority of oil consumed in the world is purchased through private deals, given the massive undertaking of physically delivering millions of barrels. However, a series of private deals cannot establish a market price. Because pricing in the futures market is transparent, in that trade activity is publicly available, it establishes the widely accepted benchmark for the price of oil. In other words, the futures market serves as the price discovery mechanism for the oil the world consumes.
The case for no, it's not rigged, as advanced by Paul Krugman, goes this way:
Imagine that Joe Shmoe and Harriet Who, neither of whom has any direct involvement in the production of oil, make a bet: Joe says oil is going to $150, Harriet says it won’t. What direct effect does this have on the spot price of oil — the actual price people pay to have a barrel of black gunk delivered?

The answer, surely, is none. Who cares what bets people not involved in buying or selling the stuff make? And if there are 10 million Joe Shmoes, it still doesn’t make any difference.

Well, a futures contract is a bet about the future price. It has no, zero, nada direct effect on the spot price. And that’s true no matter how many Joe Shmoes there are, that is, no matter how big the positions are.
Presumably the spot price is negotiated on the basis of something, but if the actual deals are as closed as Officer and Hayes suggest, Krugman's distinction between spot deals and bets becomes hard to maintain.

This seems like an empirical question. Does someone have the answer?

1 comment:

Chris said...

The case for oil being rigged, as presented by Officer and Hayes does not hinge on the claim you presented. The Officer-Hayes Hypothesis hinges on the claim that the futures market is much smaller than the physical oil market - the market which the vast majority of oil the world consumes is purchased on. The smaller futures market dictates the price of oil in the larger market, however the smaller market is so small it can be easily manipulated - thus manipulating the larger market. A good two sentence summary of their hypothesis can be found on the wikipedia page: http://en.wikipedia.org/wiki/Officer-Hayes_Hypothesis