What Would Happen if the CFTC Limited Energy Speculation?

I believe that investment funds have had a disproportionate effect on commodities markets over the past five years. Restrictions on the holdings of commodity futures and swaps by investment funds could have an enormous effect on commodity prices and the stocks of commodity companies as well as resource-based economies if the US government restricts trading in commodity futures.

From Bloomberg:

U.S. regulators say they may clamp down on oil and gas price speculators by limiting the holdings of energy futures traders, including index and exchange-traded funds.

The Commodity Futures Trading Commission will hold hearings to explore the need for government-imposed restrictions on speculative trading in oil, gas and other energy markets, Chairman Gary Gensler said today in a statement. The agency didn’t say when the hearings would start or who would be asked to testify. ...

“Our first hearing will focus on whether federal speculative limits should be set by the CFTC to all commodities of finite supply, in particular energy commodities, such as crude oil, heating oil, natural gas, gasoline and other energy products,” Gensler said in the statement. “This will include a careful review of the appropriateness of exemptions from these limits for various types of market participants.” ...

Gensler said in a letter to lawmakers earlier this year that speculators contributed to an asset bubble in commodities in 2008. His statement broke from former CFTC Acting Chairman Walter Lukken, who testified to Congress on Sept. 11 that there wasn’t “strong evidence” index traders were driving up prices.

If this goes into effect, one must consider the secondary and tertiary effects that would certainly come into play. What would happen to the Canadian dollar? How would that effect the US consumer? Do you still want to speculate in Calgary real estate? Would funds pull all their commodity investments out and what would happen to base metals prices? Such a decision could be wide-ranging.

I am short oil.

Comments

[David Ristau:]

Yes capping speculation is long overdue. Yes it is necessary. Here is the thing. We have had regulations and rules for years and years. You know what happens? People are inventive and creative. They will do anything to make money to find the way around a law. If you think this cap from the CFTC will really make a dent in speculation in run ups and all that...you are dead wrong. The market is one big speculation, one big way to make money based on hopes, specs, etc. What that means is simply that you can't regulate what the market is...so in all honesty its really not that key.

David Ristau
President, The Oxen Group

theoxengroup.com

Jul 07 01:29 PM

[swygert@law...:]

The CFTC's possible placing restrictions on energy futures and swaps held by index and exchange traded funds, though perceived by many to be necessary, could be the first step in the eventual breakdown of legitimate future price hedging for all major commodities. In the agricultural sector, for example, this could produce great inefficiencies in the market to the detriment of both producers and consumers. Consider the stark choices that would result, for example, if commodity producers were somehow limited to selling at prices out of the ground. Just a thought.

Jul 07 02:29 PM

[swygert@law...:]

In comment above, forgot to mention I am long UNG.

Jul 07 02:30 PM

[dick streich:]

I think limits should be imposed

Jul 07 02:36 PM

[Tom Armistead:]

To some extent speculators and hedgers need each other: there is a need for speculative money in commodities futures in order to make capacity available for those who need to hedge. Problems arise when speculative activity becomes too large and crates price instability, rather than stabizing the commodity involved.

If position limits had been in effect and enforced during 2008 when oil was in a speculative bubble, much economic hardship would have been averted. Gas would not have gone to 4 a gallon, automobile sales would not have tanked, many homeowners would have been able to meet their mortgage payments, etc.

Like many other regulatory issues in the past 8 years, the pendulum swung too far in the direction of laissez faire, to a point where much preventable harm was done to the economy and financial system.

Gensler is familiar with the markets and may be able to make constructive changes without overdoing it.

Jul 07 07:21 PM

[sethmcs:]

I have a better idea. If you buy so many contracts you have to take physical delivery. If you sell so many contracts you have to deliver. Rolling over contracts makes the game possible. Game over.

Jul 07 09:09 PM

[ari5000:]

CFTC is not trying to put a limit on actual producers who need to hedge.

It would be very very easy to limit futures buying for speculators. If they NEEDED to be in oil / oil services -- there's dozens of way to get long -- equities / options on equities... there's no need for Goldman to be long 200 million barrels of oil. It's ridiculous.

Obama has so far - IMO - failed at making anything better. His decisions so far are all to the benefit of GS and the banks. So expect more failure in the guise of hope and change.

Jul 07 09:54 PM

[bigmoney:]

maybe what we need instead of OIL or USO, is something more like GLD. A company could purchase a bunch of storage tanks like what you might see at an airport, and you could buy 6000 gallons of diesel.

Another alternative is a private version of the Strategic Petrol Reserve. You could buy rights to barrels of crude oil, and they offload it from some Saudi ship, and dump it into whatever sort of structure that is similar to the governments Reserve.

There's also the idea of filling the back yard swimming pool with light low sulfur crude oil. When I fly over any cities suburbs, I see pool after pool, just sitting there, when they could all be filled with 6000 gallons of precious liquid fossil fuel.

Jul 08 12:49 AM

[long roh:]

The government is proposing limits on speculation in energy commodities for one simple reason: to bar some of the exits out of the dollar. Observe that the recent run-up in commodities closely followed the printing of money. Such run-ups crimp economic recovery (since we are a net importer of energy commodities), and undermine the very point of printing money: to stimulate the economy.

In other words, as the Fed/Treasury attempts to inflate the monetary balloon, the air is leaking out into energy commodities. Position limits on energy commodities are an attempt to plug the leak.

The government would prefer it if inflation hedgers went into gold, because it is useless from a practical standpoint and its purchase does not have the same effect on economic activity. It is simply another form of savings.

Jul 08 10:16 AM

[sethmcs:]

long roh,

Excellant comment. Makes perfect sense.

Jul 09 12:39 AM

[sbenard:]

This article is nothing but a personal opinion and policy recommendation from an unknown person. It uses a short clip of a Bloomberg article, but not real analysis other than the author's personal opinion. The author doesn't even reveal a real identity!

This will, if implemented, have catastrophic impacts on the effective functioning of the futures markets. It will lead to capital flight as money flees the Dollar, thus causing commodity prices to RISE. It will shrink the liquidity pool, thus giving GREATER leverage to well-heeled investors and companies. Would you rather swim with a blue whale in the Pacific Ocean -- or the local swimming pool? The antidote to too much influence by a few large market participants is NOT to SHRINK the liquidity pool. The antidote is to INCREASE it so that no single market participant can throw their blue whale weight around! Remember the Hunt Bros' attempt to corner the world silver market? Their influence -- and prices -- collapsed when the liquidity pool expanded until the Hunts could no longer manipulate it!

Speculators play a critically important role in the commodity markets, and they have since they were created nearly 150 years ago.

All the scholarly research, including studies completed by both the Fed and the CFTC, have consistently shown that speculative funds have NOT been driving commodity prices. Coincidence is NOT causality! It is not coincidental that the only organizations that have the data on speculative trading -- the CFTC and the futures exchanges -- have consistently and repeatedly found that speculative interests were NOT driving prices in the commodity markets.

Some of the finest research on this subject has been done by Scott, Irwin, Phd. He is the Laurence J. Norton Chair of Agricultural Marketing at the University of Illinois.

Here are a few links to some of his writing and research on the subject:

www.econbrowser.com/ar...
www.econbrowser.com/ar...
www.econbrowser.com/ar...

Among other things, the CFTC study revealed some of the following:

1) CFTC study last fall, following the commodity boom last year, found that speculators were NOT the cause of higher prices.
2) The study found that speculators were EVENLY split between long and short positions.
3) The study found that NON-exchange-traded commodities rose HIGHER and FASTER in price than exchange-traded ones! Speculators tend to STABILIZE prices, not drive them. Speculators are the first ones to see an overbought market and short that market. They FOLLOW trends; they don't create trends!
4) Speculative trades represented a smaller percentage of trades in 2008, during the commodity boom, than they did in 2006 when there was no commodity boom. Presence of speculators tends to DAMPEN and reduce price swings, NOT exacerbate them!
5) Speculative trades in any given commodity represented only 15-18% of the total. Since they were mostly split between longs and shorts, speculative longs were only about 8-9% of the total in any given commodity. There is no way a small minority of the trades could have controlled or driven the market.

Stop reacting to media-driven emotionality over arbitrage in the commodity markets, folks! If we allow this to happen, it WILL lead to HIGHER commodity prices, and collapsing Dollar, and both food shortages and long lines at the gas pump -- GUARANTEED!

Jul 10 02:09 PM