from Lind-Waldock:
By Kristina Zurla Landgraf ISSUE 808 | August 2009
This time last year, crude oil prices were soaring to new record highs above $147 a barrel, and anxious consumers and regulators were pointing fingers at what--or who--was to blame for the price escalation. Speculators and index funds active in the futures markets took the heat. Even though crude oil futures are down about 50 percent from that peak, this summer the spotlight again has turned to speculators as a new administration looks for ways to appease the public still shell-shocked over the 2008 financial crisis and leery of possible market manipulation.
The Commodity Futures Trading Commission (CFTC) again has reopened the discussion, conducting three days of hearings in late July on the topic of speculation in the futures markets, and the impact on market pricing. New restrictions on trading may result as regulators look for ways to reduce price volatility.
While no action has yet been taken, participants in the futures markets should take heed of the developments. Some say it could trigger a plunge in the price of oil or other markets in the short run if index fund participants face limits and have to exit positions. In the long run, some say it could hamper efficient price discovery as well as drive business overseas.
It had seemed this issue had been put to rest last year when after a series of hearings and discussions in the early summer of 2008, the CFTC’s Interagency Task Force on Commodity Markets issued its “Interim Report on Crude Oil,” which concluded that fundamental supply and demand factors provided the best explanation for the rise in crude oil prices to their record highs. “There is no statistically significant evidence that position changes of any category or subcategory of traders systematically affect prices,” the CFTC said.
In a further statement in September 2008, the CFTC found that while crude oil futures prices were rising from December 2007 to June 30, 2008, in fact, the activity of commodity index traders in crude oil at that time reflected a net decline of futures equivalent contracts. Speculators and index funds were off the hook, or so it seemed.
This year, crude oil has seen its price more than double from its January low of just over $32, and worries about rising prices reignited. CFTC Chairman Gary Gensler said the agency “must seriously consider setting strict position limits” in the energy markets. He also stated that the hearings were “an opportunity to determine how speculative position limits could be used to address excessive speculation, not how we can eliminate speculation.” By law, the CFTC can set limits on the number of positions a trader can take in the futures markets, even without any evidence of excessive speculation.
CME Group CEO Craig Donohue testified to the CFTC that “efforts to control price or volatility by position limits is a failed strategy” and that there was no proof that putting position limits on these market participants will have any positive impact. However, he said the CME recognizes the concerns respecting the role of index funds and swap dealers in the futures market, and in particular, the impact that their participation in the markets might have on energy prices.
“We are prepared to respond to those concerns by adopting a hard limit regime for those products, including single-month and all-months combined limits in addition to the current limits that apply during the last three trading days of the expiration month,” he said.
Concerning the influence of index funds, Donohue said “index investing is an efficient means for thousands of small traders to gain the benefit of asset diversification or to hedge risk,” and that “contrary to the picture painted by a few witnesses at recent Congressional hearings, index funds are not monoliths where a single speculator, who controls a large block of capital, stays long against all odds and logic.” Read the full text of Donohue’s CFTC testimony.
ICE Chairman and CEO Jeffrey Sprecher cautioned in his CFTC testimony that “during times that unpopular price signals are being sent by markets, it is often tempting for policy makers to take pro-active steps to address what they perceive to be structural problems in the market. While well intentioned, these measures often fail to achieve their desired objectives or, worse yet, lead to unintended consequences such as increased price volatility and distortion of important price signals that would otherwise be discovered in properly operating markets.” Read his full testimony.
If the CFTC puts new price limits in place, some say investors in popular commodity-based exchange-traded funds (ETFs) may be rushing for the exits, triggering possible short-term declines in commodity markets such as crude oil.
The day the CFTC hearings began on July 29, crude oil futures plunged to a three-month low. Some analysts that day said the decline (driven mainly by a supply report) was exaggerated by fears of CFTC action.
However, some say the CFTC won’t want to create chaos, and any measures enacted may not have sweeping market impact on all participants. An announcement from the CFTC is expected later this month.
