Learning the ins and outs of oil speculation

I recently asked readers of Watching Our Water Ways to refer me to books or magazine articles that would help me understand oil speculation. While I don’t want this blog to turn into “watching our oil ways,” I became interested in oil speculation while writing a story about offshore drilling and have been interested ever since.

The subject of oil speculation was brought out of the closet by Congress, and U.S. Rep. Jay Inslee told me that he became convinced during recent hearings that speculation is a major force driving up the price of oil. It appears a growing number of people agree with this assessment.

A lot of my questions about markets were answered last week in a press packet released in conjunction with a new campaign by the Air Transport Association, which wants to get oil speculation under control.

Check out:

The news release by the ATA,

A new Web site, Stop Oil Speculation, Now,

The press packet (PDF 684 kb), which includes loads of questions and answers, lists of officials and companies involved in the campaign, quotes from outside experts and congressional testimony,

And the video of the press conference announcing the campaign.

The organization, of course, is speaking from a position of self interest, but some airline officials are saying officials in the Bush administration don’t seem to understand how markets work and how speculation is driving up the price of oil.

The industry group is calling for what Inslee, Sen. Maria Cantwell of Washington and other lawmakers have said are needed restrictions on the commodities and futures markets. Unless you know a lot more about commodities than I did before getting into this issue, you may find that information in the press packet is a lot of help. Here are the basic actions being requested:

  • Re-establish strict position limits on energy commodities: Position limits have existed since 1936 and work well at curtailing excessive speculation. Any trader not hedging with the intention of taking physical delivery of a commodity must be subject to strict position limits.
  • Close the London Loophole: Foreign Boards of Trade with U.S. Terminals trading futures contracts that cash-settle against U.S. contracts should face the same regulations as U.S. exchanges. It is not fair for U.S. futures exchanges to face more regulation than their foreign counterparts trading in U.S. commodities.
  • Regulate “swaps trades”: – All trades in the over-the-counter (OTC) swaps market must be subject to strict position limits. It is unfair to exempt swaps dealers from the same regulations that other market participants face. Experts have estimated the size of the OTC markets to be nine or ten times larger than the futures markets.
  • Fully close the “Enron loophole”: “Exempt Commercial Markets” that trade U.S. contracts nearly identical to fully regulated contracts should not be exempt from the same regulations that apply to Designated Commercial Markets such as the NYMEX.
  • Bring transparency to all energy trading: Positions of traders in all markets should be reported to the Commodity Futures Trading Commission (CFTC) and should be categorized based on where the trades occur and who is doing the trading. This will provide vital information to detect and prevent market manipulation.

By the way, Cantwell has signed onto legislation proposed Sen. Joe Lieberman, an independent from Connecticut, and Sen. Susan Collins, R-Maine. It is legislation that the ATA folks say will go a long ways toward solving the problems created by speculation.

You can read the text of the bill at Congress.org, which provides a link to the Library of Congress.

Also, Fortune magazine has published a recent article on oil speculation, but the overall conclusion comes in the introductory line below the headline: “There’s a lot we don’t know about how the oil futures markets now work. Congress should find out.”

One thought on “Learning the ins and outs of oil speculation

  1. During the past week, oil prices have fallen nearly $20 per barrel, the largest drop in history. The key to remember is that “speculation” goes both directions. We only complain about it, however, when it goes up.

    Additionally, I am not sure what “speculation” is. What is the difference between someone who buys a stock expecting the price to go up and a “speculator” who does the same? If speculators only drive the prices up, why would anyone ever sell? Why not just hold on to the commodity forever and watch the value of your asset go up? The answer is that people make the best assessment of the value of a commodity they can and they risk their own money to back up that assessment and as demand falls due to conservation or other reasons, prices will fall, making oil less valuable. I may disagree with the assessment of others about the value of oil, but they are risking their own money.

    Finally, the government’s ability to “correct” these rises in price is questionable at best. The government intervened with similar rules to prevent speculation in the onion market. Depite the rules, onion prices are more volatile than most other commodities.

    I’m not thrilled about paying high gas prices, but it is my choice and I have the option to conserve as so many already have. Artificially increasing or decreasing the price of oil for political convenience only brings more pain and the types of unintended consequences we’ve seen with the biofuel mess.

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