Speculating on Oil Regulation - Not the Most Effective Tool

In an effort to cool rising gas prices last week, Congressional regulators took steps to curtail overseas oil speculators. The move will force some overseas exchanges, which trade US oil, to share data on a daily basis and report any violations to authorities. The AP video report on the move is here.

 

The problem is, regulators are speculating about the role of speculators. It’s nearly impossible to quantify how much of a role speculation has played in rising oil prices. In fact, Senator Byron Dorgan went so far as to say regulators have a very poor understanding of futures markets and therefore “wouldn’t have a clue if there is excessive speculation in the markets.”

As we’ve discussed here before, the value of the US dollar plays a large and tangible role in the price of oil. And while speculation may play a part, the low dollar value trumps it as a key factor. So if the US government truly wants to pull a lever that could lower oil prices, it should come from the Federal Reserve. Keeping interest rates low during a time of inflation only exacerbates the problem. Therefore raising rates is much more likely to slow the rise in oil than trying to regulate speculation, a much more nebulous variable.

The bottom line is, these regulations amount to a Band-Aid on an energy policy wound that needs a tourniquet. It certainly won’t solve the problem and it won’t come close to making up for decades of questionable energy policy that helped to create the current mess.

 

Comments

[Donald Johnson:]

How can anybody say what new regulations for institutional speculators would do to commodities prices or futures markets' liquidity? Is there a history that answers that question? I have Margins & Market Integrity, state of the art research on the impact of margins in stocks and futures markets, a 1991 anthology published by Probus (defunct) and Mid America Institute (also defunct, I think). May get some guidance. There must be more recent scholarly research on the topic. Anyone?

2008 Jun 24 08:16 AM

[Umm, yeah:]

Hmm, if the Dollar is the "KEY" factor, then why is oil peaking against other currencies as well as gold?

2008 Jun 24 08:16 AM

[[e-mail]:]

I agree. The regulators have no clue. They should be questioning speculators about the basis of their perceived risk and listening carefully to the answers.

2008 Jun 24 08:22 AM

[[e-mail]:]

How intelligent would it be for a trader to agree to sell you today an oil contract maturing 6 months from now requiring him to deliver oil to you at a price of $80? Would anyone in his right mind do that? It's about the perceived risk, stupid! Wouldn't the price of the contract have to include, besides the $80, another 50 or 60, plus a profit? How can a regulator decide that it should be 50 or 60 or zero? If the government wants to take the other end of the trade at a perceived loss to peg thje price at $80, there would be plenty of takers for that, I imagine. But the world price would not really be $80, would it!

2008 Jun 24 08:42 AM

[junkyarddog:]

The regulators may "have no clue", but what is the problem raising the margin requirements from only 5% to, say 30, 40 or even 50%?

You can't outlaw speculation, but you can make it more civilized. Unless, of course, you consider "fair" someone with 5% leverage being able to roll 100%. I can't do that with my stocks, so why should commodities be an exception?

Also, in 2004 we had 13 billion dollars traded in commodities and by March 2008 this volume had increased only 20 fold, to 260 billions. I wonder if this small increase could possibly affect prices... Yes, since then the dollar must have tanked 30 fold, and demand for oil increased 50 fold, right? So, I guess oil at $140 is still a bargain.

2008 Jun 24 09:27 AM

[farmer448:]

So lets eliminate the Enron Rule, Up margin by 10% a month and see what happens to Energy Prices.

Corning markets happen. Enron in California Energy markets and the Hunt Brothers in Silver. Cut out the Monopoly and prices dive and stay down.

2008 Jun 24 10:23 AM

[elliot_mllr:]

The US government can only regulate US trading, US traders, or US products (eg, WTI contracts) traded. It cannot, for example regulate trading abroad by non-US traders in Brent contracts. I suspect that the new UAE commodities market will benefit mightily from any US regulation on oil contracts traded here, without any material reduction in the price of oil. Remember a few weeks ago, when the government suspended contributions to the SPR? That was going to lower the price of crude too.
And as to speculators, unless a pension or endowment fund wants to take physical delivery of a lot of barrels of oil, if they are long crude they will have to sell their position before the contract expiration. This should be a self-regulating mechanism.

2008 Jun 24 10:26 AM

[EconOutlook:]

This just underscores how incoherent our country's energy policy has become. Instead of focusing on the real issues, we get profits taxes, the grim specter of manipulation, and other political footballs.

Taxes, spending, the environment... these all play a role in effective energy policy, but what we are seeing right now is ordinary pandering to the electorate.

2008 Jun 24 12:29 PM

[edit5410:]

I worried too that the commodity oil trading would just move more business to ICE and others. But realized the first default in a less regulated and overseen exchange would drive the gamblers back to where their poke is safe and the payoff is safe. I like the graduated margin requirements, 10%/month, but believe 25% would likely produce the result of $70 oil. The CFTC raised margin on oil May 6 from $8,700+- to $9,700+-, without a change. The Hunt silver crash took full 100% margin and a sell only market. Brokers, banks, and oil cos. are filling politicians coffers at a horrific rate so the CFTC may not move. Putting up 7.1% of the value of an oil contract and having no reason to be in the business, ie added value, is a little much leverage even for greed factor. There are always puts and calls to satisfy greed factor.

2008 Jun 24 02:18 PM

[fran:]

FUTURES MARKETS vs CONGRESS and the REGULATORS--


will the futures market be the next industry to relocate overseas? and with it the $$$ USA currency as the basis of of exchange. when will the light come on? the USA is but one OF THE WORLD PLAYERS not the DEALER.

2008 Jun 24 02:23 PM

[CLH:]

Bob---You are right. Oil has not gone up. The dollar has gone down. Yes oil has gone up in other currencies also because ALL currencies have gone down. There is nothing behind any currency except goverment lies. Raise interest rates and oil will go down as the dollar goes up.

static.seekingalpha.co...

2008 Jun 24 04:05 PM