The Simple Economics of Commodity Price Speculation

The price of crude oil in the U.S. never exceeded $40 per barrel until mid-2004. By 2006 it reached
$70, and in July 2008 it peaked at $145. By late 2008 it had plummeted to about $30 before increasing
to $110 in 2011. Are speculators at least partly to blame for these sharp price changes? We clarify
the effects of speculators on commodity prices. We focus on crude oil, but our approach can be applied
to other commodities. We explain the meaning of "oil price speculation," how it can occur, and how
it relates to investments in oil reserves, inventories, or derivatives (such as futures contracts). Turning
to the data, we calculate counterfactual prices that would have occurred from 1999 to 2012 in the absence
of speculation. Our framework is based on a simple and transparent model of supply and demand in
the cash and storage markets for a commodity. It lets us determine whether speculation is consistent
with data on production, consumption, inventory changes, and convenience yields given reasonable
elasticity assumptions. We show speculation had little, if any, effect on prices and volatility.