Ah, CNBC

http://www.cnbc.com/id/15840232?video=753754816&play=1

I have a simple rule of thumb for resolving economic questions: whatever the loud guy shouting on CNBC says is wrong. Ergo, there is oil speculation.

This argument has been thrown out before: because the spot price is based on real oil, "paper speculators" (index funds that buy and sell futures to avoid actually ever having the oil) then the real price of oil (the spot price) can't be influenced by speculators.

To paraphrase the Simpsons, Rick Santelli makes a very loud point.

His argument is essentially that if there's a lot more people speculating on oil going up then down, then when those speculators defer receiving the oil, they'll pay a premium since no one wants the oil (supply and demand).

Of course, that is exactly what's happening: the market is in contango - that is to say, there is a cost to paying someone else to hold your oil for you (so you can lock in the speculative gains). The index speculators are paying month to month. (Of course, they are rolling from 2 months to 1 months, at least in the case of Barclays oil ETF.)

So how can the spot price be affected? Simple: oil producers are in a perfect position to make a killing off of the contango.

Imagine I drill for oil in my back yard and can produce a barrel of oil a month. I enter a futures contract (locking in a higher price due to contango) to deliver in two months and put the oil in my garage. At the end of the month I look at the market and see that I can make a profit by selling another two-month contract while buying a one-month contract.

That one-month I bought perfectly balances the one I sold (two months ago, so now it's a one-month) and the barrel of oil in my garage backs the new two-month. I make (for free and risk free) the roll yield the commodity indexes are losing.

Of course, I've shut my well down. Is this a big problem? It depends on what I'd rather have: oil in the ground or dollars (which I'm making anyway).

Of course I don't even need an oil well to play this game - I could just buy one barrel of oil, sell it forward, and start rolling the contract. Essentially contango pays people to store oil.

So when you invest in rolling oil futures, you really are hoarding oil - contango is the "rent" you pay someone else to do the dirty work of stashing your barrels somewhere. (But you most certainly have a real claim on a real resource - that's what a futures contract is. No one is going to do anything else with "your" oil until the contract is settled.)

So what about the spot price? If this is all about contango and negative roll yield, why are we paying $4+ at the pump? What ties the spot price to the futures price? (Santelli's argument is that since the speculators only play with futures, they can only move futures prices.)

The answer is arbitrage. In a situation where the prices of futures contracts have gone much higher than spot prices, oil producers can make a ton of money with zero risk. They sell less oil on the spot market and more using futures contracts. As long as the price difference is larger than the storage cost, the producers make a profit, and the spot price goes up (due to a lack of supply).