The Wall Street Journal Editorial
June 24th, 2008
“Every dogma has its day, and so it is with the posturing that blames the run-up in oil prices on ‘speculators.’ The new political consensus is that further ‘common-sense regulation’ of the energy futures market is necessary. Let’s grant that the sentiment is common, but the sense – like the evidence – is nonexistent.
“On Sunday, Barack Obama rolled out a proposal that will supposedly thwart market manipulation by ‘a few energy lobbyists and speculators.’ John McCain chimed in that Mr. Obama was merely following his lead; last week, the Republican denounced ‘some people on Wall Street’ for ‘gaming the system.’ If there’s a Congressman who isn’t calling for his own crackdown, he’s gone into witness protection. And sure enough, even this week’s impromptu oil summit in Jeddah blamed ‘speculators’ for high prices.
“The futures market may be a convenient scapegoat, but it’s simply a price discovery mechanism. Major energy consumers – refiners, airlines – buy and sell these contracts to lock in goods at a future price, as a hedge against volatility. Essentially, they’re guesses about coming oil supply and demand, as well as the rate of inflation. The political theory is that such futures trading is creating a bubble in the spot market (i.e., oil purchased for immediate delivery) beyond oil fundamentals. Thus, $4 gas.
“But there’s no inherent reason to ‘bet’ that commodities will go up rather than down. Bet wrong – place all your chips on red, say – and you lose. If a company purchases the future right to buy oil at $140 a barrel and it instead sells for $130, the option is worthless. Besides, somebody has to take the other side of any futures contract: Some are trying to predict where the price will go in the future, while the other side is attempting to sell its future price risk. But no one knows how things will end up.
“Mr. McCain calls such exchanges ‘reckless wagering.’ But speculators – normally known as ‘traders’ – are really managing the exposure risks of American businesses to higher oil prices. Traders not affiliated with major producers or consumers provide liquidity to the market. Without the second group, futures markets would be determined exclusively by commercial participants. Another word for this is a cartel.
“One omnipresent talking point is that the so-called ‘Enron loophole’ must be closed. A provision inserted in legislation in 2000 exempted certain oil contract exchanges where transactions were made via computer and telephone, rather than on a trading floor, from regulations that govern other exchange-traded commodities. But Congress ended that practice as part of its most recent farm bill, and there’s no evidence that ‘over the counter’ trading has caused the increase in oil prices. The political enthusiasm seems to arise solely from the word ‘Enron.’
“Mr. Obama and his fellow Democrats are also exercised because the U.S. Commodity Futures Trading Commission (CFTC) doesn’t directly oversee U.S. subsidiaries of foreign exchanges. For instance, the global futures market of London-based Intercontinental Exchange is regulated by the U.K. Financial Services Authority. But the FSA has extensive information-sharing agreements with the CFTC. It also has similar standards for the daily position and trade monitoring that ensures market integrity and transparency. In this global business, some of the more stringent antispeculation proposals would merely divert futures trading to Dubai or less regulated exchanges.
“Another supposed problem is the rise of commodity index funds, a newer market that is estimated at anywhere from $140 billion to $250 billion. Michael Masters, a Virgin Islands-based fund manager who has the ear of Democrats, blames pension funds and university endowments. He calls them ‘index speculators.’ Essentially, these investors buy futures and roll them from month to month as they come due, allowing a constant investment without holding oil or natural gas stocks.
“Yet these financial instruments are only new in the sense that they apply traditional stock-market indexing to commodities. It’s hard to see how this is irresponsible, and if anything it’s the reverse: Indexing is favored by investors who think it’s imprudent to gamble on short-term price swings.
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“On the other hand, inflation does lead to a misallocation of resources, so it’s not surprising that the Federal Reserve’s weak dollar policy has driven investors to commodities to protect themselves. Loose monetary policy has caused price jumps across nearly all commodities, including surges in grains and precious and base metals. The Fed’s rate-cut bender is the most important reason oil is up so sharply since last August.
“The other major factor is supply and demand, as prosaic as that might seem amid today’s political agitation. Energy consumption is surging in China and India, and global supply is not growing fast enough to keep up. Congress could do something useful if it opened up America’s vast natural resources, which are blocked by environmentalist romanticism. But then, it’s so much easier to shoot the price messengers.
