Hearings set for oil speculation restrictions

By Nicholas Zeman | June 09, 2009
Posted July 15, 2009

Just a place to park money-sometimes that's what the commodities futures market is. "Investors who have no interest in taking any physical ownership of crude oil pour a lot of money into the market as a hedge against the weakening dollar," said David Swenson, professor of economics at Iowa State University in Ames, Iowa. "So we've seen some strange behavior in oil prices."

Complaints about "strange behavior" and market volatility have led the Commodities Futures and Trading Commission to hold hearings on oil speculation during July and August. The CFTC currently sets and ensures adherence to position limits with respect to certain agriculture products. This is not the case for energy markets. "For energy commodities, futures exchanges set position limits and accountability levels to protect against manipulation and congestion, but individual exchanges are not required to set and enforce position limits as a preventative measure against excessive speculation," the commission said in an official release. A position is the number of outstanding contracts a particular trader possesses.

Preventing excessive speculation in the oil futures markets impacts biofuels-both ethanol and biodiesel-because it allows them to perform more closely in their roles as petroleum replacement products, Swenson said. Large liquidation events, or "sell-offs" put downward pressure on the price of oil and restrict the cost competitiveness of biofuels.

Soybean futures, following reports of an excellent crop, have seen a lot of pressure in recent weeks, and for the most part, crude is trading at less than half the price of last year. Therein lies the paradox for the biodiesel industry. Cheap oil makes biodiesel less cost competitive as a substitute transportation fuel, but cheap veg oils lower operating expenses.

There's not necessarily any logic behind the trend of commodities often rising and falling in tandem, however, other than the influence of a large number of speculators who all buy and sell a certain way, said a trader in a conversation with Biodiesel Magazine.

A speculator is usually defined as a player who has no interest in executing a contract or taking physical ownership of a commodity, like a fuel or soybean delivery. Powerful speculators like index funds usually "stand long," meaning they bet the price of a commodity will continue to rise at a certain percentage over time. In other words, they have an interest in the continued upward pressure on prices.

The best market situation for biodesel occurs when oil futures prices are high and agricultural commodities are low, but that probably isn't going to happen in any type of business plan timeframe. "Soy oil is not going to be a feasible input for the biodiesel industry because it's been priced out by the speculator," said the trader. "We've seen some huge positions in soy oil."

So feedstock procurement and fuel marketing specialists in the biodiesel Industry are both are affected by the influence of speculative position limits on the commodities futures markets. "It's no longer a hedging market," the trader, who provides risk management and feedstock procurement services for the biodiesel industry, said. "The influence of the speculator has become too great."

The Commodity Exchange Act states that the CFTC can impose limits on trading and positions as necessary to "eliminate, diminish or prevent the undue burdens on interstate commerce that may result from excessive speculation." The key word here is excessive. "I'm not saying that speculators aren't good for the market," the trader said. "Speculators can help provide liquidity to the market, but their influence, because they don't have to obey position limits, has become too great."

The Chicago Mercantile Exchange Group which owns the Chicago Board of Trade has repeatedly argued that speculators do not negatively impact supply and demand fundamentals of the market and federal regulations could actually have an adverse affect. In addition, others have said situation might be more about politics than it is about economics. "They have precious little evidence as to the way speculators truly affect prices," Swenson said. "They really don't know."
 
 
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