When discussing the role of speculators in the oil market, there’s a tendency of people to want draw comparisons with stock speculation and investing. But this comparison is highly inappropriate because oil and oil futures are nothing at all like equity securities.
Let’s back up a moment. Benjamin Graham is often described as “the father of value investing.” Warren Buffett often cites him as his primary teacher. According to Graham, “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
Put in this simple way, no one is a speculator. Everyone trades with an idea that they will achieve an adequate return and the hope that their principal will be safe. What Graham was really getting at was that investing necessitated an analysis of the business, its management, its potential for profits. Buffett’s reference to buying stocks he would feel comfortable owning even if the stock markets were closed for years is a better way of describing value investing.
Oil, under this way of seeing things, can almost never be an investment. It spins off no profits, has no manager, and lacks a business model altogether. There’s no natural income stream from owning oil, like there is from a bond or a dividend paying stock.
All oil purchases are speculations on future value of whatever the oil is used to make. Whether it is transportation or heating, the value of the end product eventually decides the value of oil. Between the production of oil to its final use, various players in the markets try to make educated guesses about the future prices. From the futures markets to the spot market for delivery, buyers and sellers are making bets. But, importantly, every single purchase of oil and oil futures is a speculation about the price of the product oil is used to produce.
To put it slightly differently, oil has no intrinsic worth. It simply has a value that depends on the future prices of what it is used to make.
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