the traditional keynes and hicks approach to hedgers vs speculators

keynes and hicks felt that hedgers are short on average and speculators long. speculators are optimists in that they will think that prices will rise, so they buy long. hedgers, on the other hand, may be the producers of goods and will sell goods forward to remove the risk by locking it the price.

if that is the case, the expected future spot price has to be greater than the forward price. this "greater than" disparity compensates speculators for the risk. for example, speculators buy oil at $70 where it could possibly fetch $75 in the future. they think they will make a profit of $5 - and this compensates them for the risk. they will not sell it for $70 as there is no compensation for the risk. hedgers may also think the price of oil will be $75 in the future but they will still lock in a selling price of $70 so as to remove the element of risk. hence, both parties will be happy.

this situation is called 'normal backwardation' and keynes and hicks felt that this happens quite frequently. in this situation, the forward price is not a reflection of the expected future spot price, it is actually a little less.

it can also be the other way around where the hedgers are long and the speculators are short on average. for example, qantas needs alot of oil to operate the air planes in the future hence they buy the oil forward (hedge). if there are alot of players in the market like this, hedgers generally adopt the long position. it can be that the speculators expect a falling price and sell their products short. in this situation, the expected future spot price is less than the forward price. the hedger is willing to pay more than the expected future spot price but are happy to do so to get rid of the risk. they are willing to pay $75 for oil even though they could think that they can get it for $70. conversely, speculators sell forward at $75 and they will think it is a good price because they have a belief that the future spot price will drop to $70 - compensated for the risk.

and this is called 'contango', the former being more 'common' as felt by keynes and hicks.