Do You Like the Stable Price of Coffee? Thank a Speculator!

When oil prices went through the roof in 2008 (regular gas went over $4 a gallon near my home), outraged pundits everywhere blamed speculators--those greedy traders who drive up the price of necessities just to line their pockets. When oil prices then crashed through the floor in 2009, I was stunned to see regular gas selling for $1.48 a gallon. But I was not surprised to see that no one gave speculators credit for driving those prices down.

Speculators get castigated for making things more expensive. Alas, they never get praised for making them cheaper.

Most people think gas prices are set by oil companies (read: greedy oil companies). But actually they are set in the open market by speculators and hedgers (together known as traders) who trade oil and gas futures contracts. Why is this done? Because we have not found a fairer, more reliable way to discover the price of oil and other commodities like corn, wheat and coffee, than the free, open and competitive buying and selling of thousands of traders.

Futures contracts exist to allow buyers and sellers to lock in future prices of commodities, and thus hedge uncertainty. Starbucks, for example, is keenly interested in keeping the price of their coffee products stable. The actual price of raw coffee beans on the future market--what it would cost someone to buy raw coffee at any moment--fluctuates, sometimes dramatically.  Below is a chart showing how the price of coffee rose steeply from 2010 to 2011, almost doubling, and then by 2013 collapsed back below its pre-2009 price.

Now, I like to drink Starbucks coffee, and I did not notice the price of a tall house blend doubling in 2010 and then dropping like a rock in 2011. In fact, I've been amazed how their coffee has maintained basically the same price for at least eight years running. Why didn't Starbucks products reflect the price changes in raw coffee seen on the chart? Because thanks to the futures markets Starbucks was able to lock in coffee prices that favor them as much as possible. This allowed them to anticipate how much coffee will cost them in the near future, to smooth out fluctuations, and offer a predictably priced cup of coffee.

But in order for Starbucks to hedge the future price of coffee to their benefit, there has to be someone on the other side of the trade who hopes to benefit as well. But that trader hopes prices will do exactly the opposite of what Starbucks hopes for. The trader who enters into the trade with Starbucks is called a speculator--someone who hopes to profit by betting on the short term movement of prices. The futures markets could not operate with only hedgers. It needs speculators to take the other side of trades. Without speculators, prices of retail products, like coffee, would fluctuate much more dramatically than they do now.

Like I said, we haven't been able to find a fairer way to set prices than the open markets. What would be the alternative? A coffee pricing committee? And just how would they decide what the fair price of a Venti latte is? For all the accusations of greed in the financial markets, you can bet a global coffee pricing committee would be the target of all kinds of unseemly influence by everyone with a vested interest in either raw coffee being expensive (like growers) or being cheap (like Starbucks).

Yes, speculators sometimes drive prices in irrational ways. But over time, they help give us the closest we can hope to get to correct prices. So the next time you pay that same $1.65 plus tax for a tall Blonde Roast at Starbucks, thank a hedger for locking in the price, and a speculator for taking the other side of the trade.