All the Airlines Hate the Evil Oil Speculators

A colleague today asked me whether I was going to blog about the ‘open letter’ from a dozen airline CEOs calling for regulation of oil speculation, blaming Congressional inaction for their fuel price woes. I scoffed, and said no. Of course, others have scoffed online and I didn’t want to feel left out.

Holly Hegemen of PlaneBuzz sticks a picture of Dr. Evil on her website and suggests that the airline industry is posturing the role of “victim”. I surmise it’s pressure for Congress to do something and if Congress can’t solve the fuel problems, then this is just act one… As victims there will be future calls for handouts, and it doesn’t matter a whit whether speculation is driving the price of oil or not.

On balance there’s probably not much impact on price, and certainly long-term price. There are still some technical economic debates about the role of speculation, its intertemporal effects, and the extent to which it can change the incentives for pulling out of out the ground now versus later. Tyler Cowen sums up some of these discussions.

But even if all of the arcane economics could be convincingly worked, there’s little if anything to suggest that government regulation could do much about it.

Paul Krugman likes regulation but even he doesn’t think it would reduce the price of oil. And he acknowledges that buying a futures contract is not the same as actually burning oil, that there’s still the same demand for using oil.

Of course the first problem is even beginning to formulate a clear definition of speculation, something Southwest Airlines certainly understands well — in fact it’s odd to see Southwest’s CEO sign onto this letter. Much of their profitability the past several years has been a result of fuel hedges. Buying futures contracts. Speculating in oil!

This is all a canard, orchestrated by the US airline industry’s lobbying group (the Air Transportation Association put together the joint letter). So you know it’s about positioning to get something from Congress.

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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  1. What I find most interesting is that this Open Letter is being sent to consumers/frequent flyers. Yes, we’re supposed to sign/send a letter of support. But in today’s airline environment, why would we want to? Just another example of an entire industry that has one of the worst business models I’ve ever seen.

  2. I don’t think you have a very good understanding of the speculative situation in oil. I have devoted much of the last decade of my professional life studying the trading in that commodity and there is no doubt in my mind that it has become a speculative financial instrument and not a “commodity” trading on the laws of supply and demand.

    And this pretty much stinks — for airlines and everybody else who actually uses the stuff. I know of no economics textbook which suggests it’s a good idea for the price of an essential product to be determined by folks trading “paper barrels” of the stuff instead of real barrels. And anyone who thinks the paper market — which is now several times larger than the real market — isn’t determining price, is deluding him or herself.

    Even if you don’t think the airlines know what they’re talking about, consider the position of Exxon. I think Exxon is probably the best run company in America. They know the oil business better than anybody. They think this is a huge financial bubble. And it’s hurting their business — and their stock price — because it’s impossible to effectively run your business when the product you sell is in bubbleland.

  3. If that were true it would be possible to construct a series of short positions in oil and make a huge financial killing when the bubble bursts.

    It’s certainly POSSIBLE that it’s true, but it’s far from a foregone conclusion, certainly far enough that it makes no sense for the government to step in to try to pop a bubble which may or may not exist, and in ways it’s unlikely to be able to control.

    It’s at least as possible that the low prices of the past several years were a bubble of the opposite sort, an undervaluation of the asset.

    Now, is reversion to the mean the most likely scenario or is the current price the best approximation of long-term value? If you or I actually knew the answer to that we’d be much wealthier than we are.

    But the point is that the government certainly can’t regulate us out of high energy prices.

  4. Government can’t regulate us out of FUNDAMENTAL high energy prices, but they can regulate us out of high SPECULATIVE energy prices. Government does this all the time. For instance, there are certain margin requirements for buying stocks, generally 50%. The margin requirements for buying oil are a tiny fraction of that that. Why? I have no idea. It enables the kind of nutty control over the futures market that Goldman Sachs and Morgan Stanley currently have.

    For those who say we can’t be sure this will work, I say what do we have to lose? I don’t think it credible to suggest prices will go up more than 100% a year without the financial speculators on balanced supply and demand!

    This bubble extracts an enormous cost on all Americans, funnels gazillions of dollars to unsavory dictators, threatens our economy with deep recession, and is killing the airline industry we all know and love. I don’t think we can move fast enough against the speculators.

    FWIW, I also believe we should do more to produce oil at home, develop alternatives, and encourage conservation. But these are solutions for the long term. First we have to address the speculation issue (for instance, speculators don’t care that Americans are using 4% less gasoline than we did last year).

  5. 50% margin limits are imposed on equity trading for individuals because the SEC doesn’t want normal individuals borrowing excessively against shares and risking not just their savings but all their assets if they get things wrong. These margin limits don’t apply to broker-dealers, which is to say the investment banks/hedge-funds/etc., not because these groups necessarily are smarter, but because they are “responsible adults” who can afford to make mistakes. This is also the reason you’re not allowed by the SEC to invest in hedge funds unless you have $1MM in assets…they don’t want average joes investing in highly leveraged products. Interestingly, despite the fact that hedge funds and banks have been trading stocks at 8 to 1 or higher leverage throughout this highly volatile period, none of the blowups that have occured have been produced by trading in equities…it’s all been debt and commodities. The rules are certainly not designed to reduce volatility in the equity markets – which are in fact generally more volatile than commodities markets.

    Since commodity trading, unlike equity trading, is professionalised, there’s no reason to protect the traders from themselves, and hence no reason for high margin requirements.

    In any case, if oil were overpriced, you would expect to see big inventories building up as producers sold futures at high prices and then held the oil for later settlement of those contracts. As it stands, inventories are at very low levels – the UK has seen fuel shortages this year. When inventories start to rise, I’ll blame speculators, and not until then.

  6. I agree with iahphx on this one. The current oil price is a result of mere speculation, not fundamentals. The major problem is that people forget what the instruments of the financial market are and what are not. Everyone is trying to make money the same way they would on financial markets… yet they don’t realize that the same principles do not apply to commodities, housing, etc.
    Investment banks and wealth management institutions hire 24 year old kids that have no real life experience but they went to a good school (that their daddy paid for) and obviously they have no clue what to do at their jobs… and just like a good herd that follows their shepherd they blindly take any advice they can get… in the 90s someone told them that dot-com companies were the shit – and they invested billions, stocks skyrocketed… until 2001 when the whole bubble bursted. Then someone else told them that subprime mortgages packaged under fancy names were the real investment of the future… why not, as long as one believes that housing prices can rise indefinitely! LOL. Obviously, the housing bubble is gone too (and we haven’t seen the worst of it yet, trust me).
    It’s not hard to figure out what’s happening now. The money is being channeled into commodities and speculators once again believe that these will rise indefinitely (or at least that they will be able to get out before the bubble bursts again). The result is food shortages around the world, airline and automotive industry collapse, inflation, economic downturn, rising unemployment, and maybe worse.
    The only good that can possibly come out of this mess is that there is finally some serious interest in alternative fuels. After all, gas explodes.

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