Curb oil speculation? Why that's folly!
Regulators are gearing up to set limits, but that's just a good way to encourage hoarding.
By Jon Birger
Word is that the Commodities Futures Trading Commission is set to do an about-face on the role speculators play in setting oil prices. According to the Wall Street Journal, a CFTC study set to be released next month will find speculators to blame for last year's high prices. Presumably, the study will provide some intellectual justification for the Obama administration's plan to rein in oil speculators.
I'm on record in this space arguing that traders who flip futures contracts -- in other words, speculators -- cannot have a material impact on price if they're never taking physical delivery of the commodity. Until now, that's been the position of the CFTC, and it has also been the finding of countless academics who've studied this subject.
Yes, oil companies also faulted speculators for high prices last year, but who can blame them for wanting out of the political firing line? Oil company traders knew full well that the commodity funds that buy and sell futures contracts are not equipped to take or make delivery of oil. Oil refiners understood that speculators must sell their futures contracts before they expire. That's why the near-future price of oil -- the price of oil for September delivery, say -- cannot get too far away from the realities of supply and demand in the physical market. No oil company trader worth his salt is going to pay an above-market price to a commodities fund manager who is under time pressure to sell.
Indeed, this helps explain why at the peak of the oil market last June, the average commodities hedge fund, as tracked by the FTSE CTA Managed Futures Index, had a minus-2.2% trailing 12-month total return. Speculators' poor returns also demonstrate that a lot of them were, contrary to popular myth, betting that oil prices would go lower, not higher. In other words, they were speculating the wrong way.
So what happens if the anti-speculator lobby gets its way? Stop Oil Speculation Now, a coalition of airlines, gas-station owners, and heating-oil companies, wants legislation that would put strict limits on futures trading by anyone who does not intend on taking delivery of oil. U.S. Rep. John Larson of Connecticut, chairman of the House Democratic Caucus, has introduced legislation that would do just that.
My response: Be careful what you wish for. If you tell investors that they have to take delivery in order to invest in oil, that's exactly what they will do. They will store oil in every onshore oil tank or offshore supertanker they can get their hands on, thereby siphoning off oil that would otherwise be available to consumers. It will be a replay of the late 1970s, when the Hunt Brothers took delivery of 10% of the world's silver supply, causing silver prices to quadruple.
Don't believe me? Consider what happened in January, when the price of oil futures four months out was $15 a barrel higher than the spot price, which incentivized oil companies and investment banks to store oil like crazy.
So if Congress and President Obama really want to enact regulation that encourages hoarding, I say go right ahead. It will prove my point -- albeit at the expense of 300 million American consumers.