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Airlines, unable to manage risk, scapegoat oil markets

The e-mail blitz was on this afternoon. Several airlines sent out their bulk-mails, announcing their opposition to “speculators” in the oil market. In an orchestrated letter signed by 12 airline CEOs, the airlines blamed the oil market for their companies’ woes. It’s a maddening piece of propaganda.

The airlines’ efforts to blame the oil market’s participants for causing the price of oil to go up is a red herring. Speculators exist, sure, but unlike the housing market’s speculators, in which investors actually bought physical properties to affect market pricing, oil futures market participants aren’t actually taking delivery of oil. They’re effectively wagering on the direction of prices, but that doesn’t directly affect oil supply or real consumptive demand.

The letter is chock full of misinformation and dumb logic. For example:

A barrel of oil may trade 20-plus times before it is delivered and used; the price goes up with each trade and consumers pick up the final tab.

The price goes up every time? If so, why would anyone sell? No one has ever lost money on a trade? What market is this, and how can I participate?!!

Our country is facing a possible sharp economic downturn because of skyrocketing oil and fuel prices…

It’s a smidge more complicated than that, guys. War in Iraq and Afghanistan, mortgage meltdown and uptick in foreclosures, trade deficits, currency devaluation, bloated consumer debt, runaway derivatives markets… But anyway…

…speculators who trade oil on paper with no intention of ever taking delivery…

Umm, that’s an argument against futures markets in and of themselves, and not against speculators per se.

The Economist has a good breakdown of the “blame the speculators” logic this week. Forgive me for quoting them at length:

[Blaming the speculators] holds obvious appeal for those looking for a scapegoat. But there is little evidence to support it. For one thing, the surge in investment in oil futures is not that large relative to the global trade in oil. Barclays Capital, an investment bank, calculates that “index funds”, which have especially exercised the politicians because they always bet on rising prices, account for only 12% of the outstanding contracts on NYMEX and have a value equivalent to just 2% of the world’s yearly oil consumption.

More importantly, neither index funds nor other speculators ever buy any physical oil. Instead, they buy futures and options which they settle with a cash payment when they fall due. In essence, these are bets on which way the oil price will move. Since the real currency of such contracts is cash, rather than barrels of crude, there is no limit to the number of bets that can be made. And since no oil is ever held back from the market, these bets do not affect the price of oil any more than bets on a football match affect the result.

The market for nickel provides a good illustration of this. Speculative investment in the metal has been growing steadily over the past year, yet its price has fallen by half. By the same token, the prices of several commodities that are not traded on any exchanges, such as iron ore and rice, have been rising almost as fast as that of oil.

Bottom line: The airlines are whining. Suck it up. It’s your business. Manage it.

One surprise: Southwest signed the letter. By the logic of the letter, Southwest is one of the “speculators,” and in fact it’s a major reason Southwest has been eating everyone else’s lunch. Yet they signed the letter decrying their own business practices. Huh.

Less surprising: The signature of United. Despite having a CEO who previously worked at Texaco, these guys couldn’t figure out how to manage fuel prices. When they emerged from bankruptcy, they based their business plan on an unrealistic $50/barrel oil. It was trading around $65/bbl at the time, and it hasn’t gotten any cheaper. ($142/bbl today.)

The airlines who today whine about the oil market moving higher are complaining about their poor past decisions. They’re hatin’ the player and the game.

That said, if you want to check out the airlines’ “campaign” to stop investment, or “speculation,” they’ve got a website which I am loath to link to, but offer up for the sake of fairness and equal time. It’s