Krugman argues that speculation in oil futures can't have caused the current high price of oil because the future price is lower than the spot price.
Steven Waldman explains why this argument isn't rock solid. His argument is that oil demand isn't deterministic and, in the very short run, oil in different places can have very different prices. This means that the expected cost of having a tank full of oil isn't the storage cost plus interest, but the storage cost plus interest minus the "convenience yield".
What is this "convenience yield"? [snip+]
Oil is a "spiky" commodity. Every once in a while, someone really needs it, now, and will pay a premium for immediacy. The market for oil in Cushing, Oklahoma might be reasonably efficient, but what happens when someone in Peoria needs oil today? Opportunity! ... you build an oil tank in Peoria. Suppose that every month, there's a 10% chance a desperate client will offer a 5% premium for immediate delivery of all your oil, and that interest and storage cost you 0.2% per month. Then on average, you'd earn 0.5% (10% x 5%) each month from desperate clients, and pay 0.2% in expenses.
Actually I'm glad that Waldman isn't arguing with Krugman about the actual case of actual current oil prices, because I wouldn't want to disagree with another Waldman*.
He writes "I agree with Krugman that futures markets can't explain the recent skyrocketing oil prices." and "This is a disquisition, and ode, a homage and a tribute to the marvelous, mysterious, misunderstood and maligned convenience yield:"
The reason is that the convenience yield argument can reconcile one of Krugman's facts, the futures price is below the spot price, with the speculation hypothesis, but it can't explain the other -- inventories aren't growing.
In contrast, it is easy to explain the other -- the inventories in question are oil under the ground (although that should show up as a decline in production which I don't see but I only know monthly up to April). The point is that storing oil under the ground doesn't have a storage cost (you even save the interest on the cost of pumping it if you pump it later) but it does have an interest cost and it doesn't have a convenience yield.
Both facts together seem to make a solid case that the current price of oil is not due to futures speculators.