Here’s some good news. Bloomberg is reporting that the Commodity Futures Trading Commission (CFTC) will holding hearings on whether or not to limit speculative trading in commodities markets, with a focus on energy. As everyone should know by now, $147. oil last year was not about peak oil and supply and demand, it was about speculation by hedge funds, banks and investment banks. Limiting the amount of speculation in commodities that are fundamental to the smooth functioning of the economy is a brilliant idea! Duhhh!!!
Bernie Sanders and Bart Stupak have called for action to avoid a repeat of last years oil bubble according to this Bloomberg article, Oil, Gas Market Speculation May Face Restrictions by U.S. CFTC. I don’t think the price of oil is going to see the sunny side of $100. for a long time even without increased regulation, but limiting speculation is a good idea anyway.
Speculation in any market is not, in and of itself, a bad thing. Speculators are an essential part of most markets, providing the liquidity necessary to facilitate commerce. The commodities markets were originally designed to help farmers lay off some of their risk and sell their crops at a reasonable price. The Chicago Board of Trade was founded in 1848. The first contract (on corn) was written in 1851 and standardized futures contracts were introduced in 1865. Theoretically someone with enough money, who could afford to assume some of that risk, a speculator, would agree to pay the farmer a set price for delivery of the crop at a future date. This arrangement greatly reduced the likelihood that the farmer would have to dump his crops in the river when he got them to market because the market was flooded with crops and nobody wanted to buy them. It was cheaper to dump them than to lug them all the way back home. The farmer had a somewhat unique problem in that, at the time, nature dictated when most crops were harvested and transported to market. The farmer couldn’t decide that because the price was down or supply was up, that he just wouldn’t bother to harvest. So everybody’s corn, wheat, etc. hit the market at the same time, hence the creation of the CBOT. However excessive speculation is a different story.
From Matt Taibbi’s article, The Great American Bubble Machine, in the July 9-23 issue of Rolling Stone:
So what caused the huge spike in oil prices? Take a wild guess. Obviously Goldman had help – there were other players in the physical-commodities market- but the root cause had almost everything to do with the behavior of a few powerful actors determined to turn the once-solid market into a speculative casino. Goldman did it by persuading pension funds and other large institutional investors to invest in oil futures- agreeing to buy oil at a certain price on a fixed date. The push transformed oil from a physical commodity, rigidly subject to supply and demand, into something to bet on, like a stock. Between 2003 and 2008, the amount of speculative money in commodities grew from $13 billion to $317 billion, and increase of 2300%. By 2008, a barrel of oil was traded 27 times, on average, before it was actually delivered and consumed.
As is so often the case, there had been a Depression-era law in place designed specifically to prevent this sort of thing. The commodities market was designed in large part to help farmers: A grower concerned about future price drops could enter into a contract to sell his corn at a certain price for delivery later on, which made him worry less about building up stores of his crop. When no one was buying corn, the farmer could sell to a middleman known as a "traditional speculator," who would store the grain and sell it later, when demand returned. That way, someone was always there to buy from the farmer, even when the market temporarily had no need for his crops.
In 1936, however, Congress recognized that there should never be more speculators in the market than real producers and consumers. If that happened, prices would be affected by something other than supply and demand, and price manipulations would ensue. A new law empowered the Commodity Futures Trading Commission – the very same body that would later try and fail to regulate credit swaps – to place limits on speculative trades in commodities. As a result of the CFTC’s oversight, peace and harmony reigned in the commodities markets for more than 50 years.
All that changed in 1991 when, unbeknownst to almost everyone in the world, a Goldman –owned commodities trading subsidiary called J Aron wrote to the CFTC and made an unusual argument. Farmers with big stores of corn, Goldman argued, weren’t the only ones who needed to hedge their risk against future price drops – Wall St dealers who made big bets on oil prices also needed to hedge their risk, because, well, they stood to lose a lot too.
This was complete and utter crap – the 1936 law, remember, was specifically designed to maintain distinctions between people who were buying and selling real tangible stuff and people who were trading in paper alone. But the CFTC, amazingly, bought Goldman’s argument. It issued the bank a free pass, called the "Bona Fide Hedging" exemption, allowing Goldman’s subsidiary to call itself a physical hedger and escape virtually all limits placed on speculators. In the years that followed, the commission would quietly issue 14 similar exemptions to other companies.
Voila! Now you’ve got a shit load of fast money sloshing around in the commodities markets. I commented here over a year ago that the fast money moved from tech in 2000, to real estate and then to oil. There was 2 trillion dollars in hedge funds (now about 1.4 trillion) a year and a half ago. That kind of money, if allowed to stampede through relatively thinly traded commodities markets can wreak havoc, not only on the market itself, but on the end users of the commodity, as almost all of us are painfully aware. We regulate the price of electricity, or at least we did until Rubin, Summers, Gramm and friends "modernized" the regulatory landscape, because it is considered essential to our daily life. Also because wild swings in it’s price would cause significant disruption to households, business and the economy in general as everyone in California can attest to courtesy of Mrs Gramm and the other officers and directors of Enron.
I remember thinking to myself when CNBC first started covering oil trading at the NYMEX, that oil is "in play" and that there are choppy seas ahead in the oil market and at the gas pump. The only benefits of wild swings in price accrue to those speculators that are on the right side of the trade. The producers benefit in the short term, the boom phase, but inevitably the boom is followed by a bust and the benefits reaped in the boom may be outweighed by the losses in bust. There is a reason why some third world countries don’t allow foreigners to own property outright. It’s because they don’t want the kind of dislocation that might occur to it’s citizens if a swarm of foreign speculators descend on it and start bidding the price of real estate up into a frenzy, and then cash out, leaving a mess behind for the locals to clean up. Sound familiar?
Regulating speculation in energy is important because we all use energy and it’s cost is reflected in everything else we buy. But IMO there is no market that needs to have speculation more tightly controlled than the grains. There is something despicably wrong with wealthy speculators driving up the price of grains and other commodities that can and will affect whether or not people around the world can afford to have enough to eat at the end of the day. If Goldman, Morgan and Merrill want play in the gold market, fine. No completely innocent bystander on the other side of the globe is going to have to go hungry because the herd is running up the price.
Please let Bernie and Bart know if you support their initiative.