Kevin Drum wonders why I'm opposed to a bill that does "sensible" things like regulating position limits. The historical purpose of position limits is, as noted in his comments, to prevent attempts to corner the market in a commodity, as happened with silver in the 1970s, and all sorts of things prior to them--the corner attempt used to be a common tactic in the stock market before the Depression-era reforms.
I think this is probably wise, though it should be noted that most corner attempts end with the speculator losing his shirt, so you're mostly preventing venal idiots from handing a lot of money to other people. But that's not what the current rules are trying to do. They are aimed at hedge funds betting on the future price of oil.
Those bets provide the market with valuable information: a lot of people think that the price of oil is going to go up. The effect of that information is to raise the future price, which makes current consumers unhappy. But in fact, if the speculators are right, they're doing us a service by giving us a basically gradual price rise that helps us conserve. If they are on the money, and Congress chases them out of the market, we'll suffer more later, wishing all the while that we hadn't used the stuff so profligately. If they're wrong, later we'll have cheap gas and more fuel efficient cars, hardly a tragedy.
There's another reason it's stupid: oil is a globally traded commodity. Congress can chase hedging activity out of the US, but it cannot actually wring any speculative premia out of the market, because the speculation will simply move offshore. Congress can control pretty effectively things that are made and used in the US, but oil follows the law of one price pretty astoundingly closely. All it can really do is chase away hedge fund and exchange jobs--one reason that London and other exchanges have been picking up financial business from us. In some cases, I think the rules make it well worth chasing that business away--our accounting standards are unusually rigorous, and a damn good thing. But this bill certainly doesn't bring anything to the table that makes it worth its costs.
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Position limits on oil trading: why not?
24 Jul 2008 01:25 pm
Comments (30)
If Bob Barr were president he'd veto this nonsense.
This issue is more proof that Kevin Drum is a frubbin moron. I wonder why I even bother going to his blog anymore.
But in fact, if the speculators are right, they're doing us a service by giving us a basically gradual price rise that helps us conserve
This line made me smile. And if I wasn't so cynical, I'd probably laugh. Ha.
Speculators do more than provide "valuable information"; they take the other side of trades so that other market participants (e.g., farmers, business owners, etc.) can hedge themselves against the risk of commodity price fluctuations. You can't have the hedging of risks without the speculation on the other side.
Mike Norman on AM radio in Dallas has said for years that 'speculators were driving up the price' and yadayada. he offers as an example of what could be done what Roosevelt did during WWII to control the price of raw materials like Nickel as an example of what should be done. It might be interesting historically to know what was done.
Ole FDR was fond of price controls.
Which may have been halfway effective in a relatively self-contained and protectionist country like the US circa 1930. Personally I doubt it. But in any case, it isn't going to work in a globalized commodity market.
In addition, were it effective I think:
Given that the high oil prices we now have have crunched our economy, I'd say prices have peaked. "Speculators" can't bid up oil more without it actually costing them.
All this legislation is likely to do is lock in the high prices, as it will prevent people from rightly shorting oil.
I think a hypothetical will help people understand what a futures market is for.
Let us say that I am Southwest Airlines and I want to hedge against the risk that my jet fuel will become more expensive in the future. Now, I don't enter futures markets to forward buy my jet fuel- I already have suppliers that will supply me in the future, but that in those agreements the price for each delivery is the spot price on the day of delivery, and I don't want to run the risk that that spot price in November 2011 has doubled. What do I do? I buy a futures contract on the commodity that most closely tracks the amount of jet fuel I will want to buy in Nov 2011. If the spot price of oil is double in Nov 2011, my contract, purchased today to take delivery at a much lower strike price, will net me a big profit- a profit that has hedged away most or all of my increased costs for jet fuel.
Now, if speculators on the long side are driving up futures price, this send signals to producers to sell these contracts to lock in prices they will be quite happy with, and allows them to adjust their production upwards as they see fit, and it sends signals to users of oil that they might want to start conservation/replacement efforts today.
Of course, the people who are being called speculators are not all, or even mostly, gamblers-they are fund managers trying to hedge the effect higher oil prices will have on their investments, like stocks and bonds.
The present bill seems more likely to protect speculators from losing money to the users/producers who will usually know more about the future price of oil.
Mike Norman on AM radio in Dallas has said for years that 'speculators were driving up the price' and yadayada. he offers as an example of what could be done what Roosevelt did during WWII to control the price of raw materials like Nickel as an example of what should be done. It might be interesting historically to know what was done.
The City must love Congress.
Effect of gas prices on food. Not good.
CHAMPAIGN, Ill. — Soaring energy prices will yield sharp increases for corn and soybean production next year, cutting into farmers’ profits and stretching already high food costs, according to a new University of Illinois study.
Costs to get crops in the ground will jump by about a third in 2009, fueled by fertilizer prices expected to surge 82 percent for corn and 117 percent for soybeans, said Gary Schnitkey, an agricultural economist who conducts the annual survey of input costs.
Fertilizer – the biggest non-land expense for corn and soybean farmers – is tethered to the same cost spiral that has driven steep gasoline and heating price increases over the last few years, said Schnitkey, a professor of agriculture and consumer economics.
“Roughly 80 percent of the cost of producing nitrogen fertilizer is natural gas, so as natural gas costs have gone up so have the costs of those inputs,†he said. “Phosphorus and potassium are mined, and as energy costs increase, mining costs increase.â€
Good post, short and clear. Thanks
Deliveries of all oil products – a measure of demand – fell 3.0 percent compared with the same first-half-year period in 2007, with gasoline deliveries slipping 1.7 percent.
To Megan and her libertarian commentators:
Thanks for the love guys. I never knew that I was so popular. Here I was thinking that I was just a greedy sonofabitch (albeit a rich one). But who knew my greed was actually providing such a valuable service to the nation and the farmers/ producers/ users. Can't some of you get elected to Congress? Just kidding. Anyway, did I tell you about the killer condo I bought in Kensington? That's right - I'm moving to London from where I hope to keep fighting the good fight for the farmers, producers, and users.
Regards,
the Speculator (who is not a venal idiot)
And the decline in gasoline demand was the first significant one recorded in 17 years.
What was happening 17 years ago?
Election year politicking. Thats why its there, to make it look like Congress is doing something.
But who knew my greed was actually providing such a valuable service to the nation and the farmers/ producers/ users.
Indeed, who could have known that individual persons' greedy actions could provide benefit for society, regardless of their intent? Who could have imagined such a possibility?
Speculators do more than provide "valuable information"; they take the other side of trades so that other market participants (e.g., farmers, business owners, etc.) can hedge themselves against the risk of commodity price fluctuations. You can't have the hedging of risks without the speculation on the other side.
My impression from reading the bill is that it has some words saying it doesn't apply to 'legitimate hedgers and their counterparties.'
Which is why I think this bill is basically useless for its stated purpose -lowering energy prices - but mostly harmless; it will only move some marginal trading activity overseas.
I'll have some more trickle down and side of fries please...
I find it both quaint and scary that US Congress people think that they have the power to change the price of oil in a significant way.
Yes speculators may be playing a role. But the economic rise of China, India, parts of Eastern Europe, etc. is dramatically increasing demand.
All the easy-to-get oil is gone or already connected to an oil well. Future supply is going to be more limited, and costly to extract.
It's quaint and scary that congress thinks a bill to restrict certain financial activity will change all that.
Perhaps our wise politicians want to restrain speculators so that the upcoming carbon taxes won't hurt so much? Durrr.
this article is stupid.
So to Yancey, while I think that this bill is stupid, it won't do anything to mess with hedging. Currently, broker dealers in the commodity markets are required to report which orders are from hedgers and which are from speculators. Currently, there are ALREADY limits on leverage used by those classified as speculators by the CFTC. I assume that this bill only applies to those who are classified as speculators by the broker dealers.
Now, everything Megan said still applies, of course. Speculation does help provide valuable information to the market.
This reminds me that in the Soviet Union to buy anything for one price with the intent to sell it for a higher price was automatically called speculation and was outlawed. Is this where we are heading?
Were on a road to serfdom
Come on inside
Takin that ride to serfdom
Well take that ride
Alex Tabarrok has pointed out that Congress, due to strenuous lobbying, banned futures trading in onions back in the fifties. Since then, onions have apparently been subject to extremely volatile price swings. This seems to suggest that speculators in commodity futures do indeed cushion the market.
Yancey: What hypothetical? (though I'm guessing you already know this...)
According to NPR last night, Southwest is the only US airline to report profits consistently for (?large number of) quarters, largely due to their skill/luck in hedging AvGas. If I remeber the report right, about 75% of their current profit is directly due to that. Interestingly, the article ended saying that SWAir is backing off on hedging, and has not made new contracts for something like 15 months now.
Megan: While I've frequently disagreed with your comments, there's no argument here. Congress's approach will increase volatility, magnify risk and cause significant harm to our financial markets. Oh, and it won't do a damn thing to fix what the broke.
I manage risk for a global financial corporation, and specialize in particularly ugly fat-tailed operations risk. Derivatives markets are complex animals (aka "too hard for a congress person"), but they provide liquidity that reduces volatility. If you want an introductory read into this, read Richard Bookstaber's "A Demon of our Own Design" (and pay particular attention around page 218-219). Bookstaber does an excellent job explaining the concept of liquidity being provided.
If you want the quick version without the read, here it is: Derivatives markets are all about buying, selling and sharing risk, and liquidity risk is a huge part of that. Liquidity providers command a premium for their service, but make markets more efficient. The more of them you have, the more accurate prices are and the less volatile your market is. If you understand finance and markets, you understand that Congress's proposal will make things much worse, and probably cause serious, long-term harm to the economy. Some have estimated that it may damage the U.S. enough permanently relegate us as secondary to China and other emerging powers. Interestingly, if you read Obama's "citizen of the world" speech transcripts, this mirrors his party's long-term goals.
Blaming "speculation" is insanity: YOU speculated when you bought a single share of a company, expecting it to pay a dividend and/or be worth more when you sell it. YOU speculated when you bought a house expecting capital appreciation. Indirectly, the markets also provide a signal, which a competent Congressperson would recognize. High oil futures prices? It's a signal that Congress refuses to do a damn thing about anything, lacks any competence or direction, and is intent on screwing the little guy because the current leadership thinks the little guy will blame Bush. At the same time, the futures market can forecast Chinese, Indian and other demand, and look at OPEC's refusal to produce more given their satisfaction with higher net income at higher prices.
The reality is, for all who have a clue about markets and risk, Congress created this mess. If they were employed in corporate America, Pelosi & Reid would be terminated for cause. Charles Schumer would be sentenced to spend 5+ years of Federal time for his crimes associated with IndyMac's failure.
Americans have a decision to make: Hold these criminals in Congress accountable, put them in prison and make them share a cell for life with Bernie Ebbers, or see your portfolios disappear, your retirement vanish, your social security become bankrupt, and your tax rates consume your earnings. As too many Americans not only ignore these crimes, but support greater excess with incompetent candidates like Obama and McCain, there should be no sympathy for them. For every American who chose an unaffordable prescription drug benefit, they deserve to learn that it comes at the cost of their children's liberty and financial freedom.
ben (5:03 on the 24th) pretty well nailed it: the purpose of this is not to reduce the price of oil. Any more than most of the hassle with getting onto an airplane today is intended to actually make flying safer.
No, in both cases, the only intention is to make the public see (incorrectly, but who cares) that the politicians are "doing something" to address what the public sees as a problem. If it accomplishes that, and so helps the politicians get re-elected, it is a total success. Whether it actually does anything to change the problem is irrelevant.
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I'm not a trading pro, but my understanding is the futures market ("speculators" - oooh scary... I also have money in my 401k "speculating" the price that someone pays for my shares when I sell them will be higher than when I bought them), but back to the point, futures provide immediate liquidity now.
They aren't just willy nilly betting, they are paying for those options now. That adds cash to the market, and allows farmers or oil explorers to see what the future price could be and incentives them to explore, produce, etc.
Or we could just make $2/gallon gas a mandate or start forced rationing and watch how fast exploration and refining grinds to a halt.
Posted by sam | July 24, 2008 1:49 PM