Becker is right to emphasize the role of demand and supply elasticities (how price responds to changes in demand and supply) in the startling fluctuations in the price of oil and oil derivatives such as gasoline, to deemphasize the role of speculation in those fluctuations, and to point out the social utility of speculation.
If the responsiveness of supply to an increase in demand is sluggish, price will rise steeply in the short run, to ration the limited supply among the clamoring demanders—and it will rise especially cheaply if the demanders would rather pay a high price than do without. If demand falls, price will plummet if supply is sluggish, because supply will not fall proportionately to demand—there will be oversupply. An exogenous increase in supply will cause price to drop sharply because inelastic demand implies that price must fall very far to attract purchasers for the additional demand, and thus clear the market. Increased demand or reduced supply will also have sharp effect, though in the opposite direction. So the dramatic fluctuations in oil prices that Becker documents do not require the assumption of nefarious activities by speculators.
And, as Becker also points out, those activities are not, in general, nefarious. Without speculation, the only information about values would be supplied by the actions of suppliers and consumers and others in the chain of distribution from producer to ultimate consumer. With speculation, information is often supplied by persons and firms that buy or sell on the basis of their opinion of how prices will change.
Yet speculators can destabilize markets. Speculators are interested in price changes, and know that price changes are driven in part by other speculators. In an asset-price bubble, speculators (and others) buy in the expectation of rising prices, and may believe that the asset is actually overpriced yet they keep buying because they think that other market participants believe (erroneously) that it is still underprice.
The decision of the United States and other countries that have governmental oil reserves to release a total of 60 million barrels of oil (half of it from the Strategic Petroleum Reserve, which is what the U.S. government’s reserve supply of oil is called) could be a shrewd speculation on oil being overvalued. If it is overvalued, prices will fall, so by selling now the countries will receive more income than if they waited. The sale itself, by increasing supply, will reduce the price of oil; these countries are net importers of oil and so would benefit from lower oil prices.
But this is implausible; there is no reason to think oil overvalued. The current high prices reflects the loss of about a million barrels a day of Libyan oil because of the civil war in that country. The reduction is small as a percentage of world output, but the low elasticity of supply enables a small reduction in supply to have a big impact on price. By the same token, the modest release from the reserve—two million barrels a day for 30 days—may have a dramatic though short-term effect on oil prices, an effect that would be extended if we and other countries continued to release reserves. Our Strategic Petroleum Reserve contains more than 700 million barrels, so we could release a million barrels a day for a year and still have almost half the current reserves.
But what is the point of reducing our reserves? They have after all value as a hedge against catastrophic hits to oil supply, such as were caused by Hurricane Katrina and the BP Gulf of Mexico mishap. One possibility is that it is another short-term stimulus measure, such as “cash for clunkers” and the various mortgage-relief programs. The effects of these measures is slight, because businesses and consumers realize that they are short term and so merely alter the timing of purchases rather than increasing aggregate spending. But with the 2012 elections approaching, the Administration has an incentive to create even short-term bursts of prosperity. Consumers are extremely conscious of gas prices because of the frequency with which gasoline is purchased and the frequency with which the retail prices changes, which increases consciousness of gas prices relative to other consumer products. Hence a sudden, sharp drop in gas prices as a result of an increased supply of oil can create a feeling, but only a transient one, of improved economic prospects.