Speculating on Speculation

By July 22, 2008Energy

Not being conversant in the futures market, we judge the anti-speculation bill, S. 3268, from appearances. It’s only been discussed in the last month or so, suggesting political motivation, and vastly expands government intervention in energy trading. Reasons enough to fear unintended consequences…like LESS energy supply.

Thankfully, the very conversant Wall Street Journal editorialists explain the legislation’s problems today, “An Energy Sarbox,” concluding that passage would drive trading overseas and actually reduce oversight and market transparency.

Because commodity futures trading is a complex financial instrument, “speculation” makes an expedient scapegoat for edgy lawmakers and even aggrieved industries — such as the airlines. But it performs a vital price-discovery function. Major energy producers and consumers, such as refiners, buy and sell these contracts to lock in oil at a future price, as a shock absorber against volatility. Essentially, they’re bets that reveal market expectations about the supply and demand of oil, as well as the rate of inflation.

Even the title of the Senate’s bill — the “Stop Excessive Energy Speculation Act” — is idiotic. True, the volume of trading has increased by about sixfold since 2000, but it can’t be “excessive.” The inviolable law of futures markets is that someone has to take the other side of any option. That is, the value of contracts agreed to by sellers anticipating that prices will fall must equal the value of contracts agreed to by buyers anticipating prices will rise. The overall size of the market is irrelevant.

Nevertheless, Congress’s legislation, introduced by Majority Leader Harry Reid, aims to cut down the volume of futures transactions. Instead of merely increasing funding and manpower at the U.S. Commodity Futures Trading Commission, it vastly broadens the CFTC’s regulatory purview. It also orders the CFTC to distinguish between “legitimate” and “nonlegitimate” traders. Legitimate firms are those trying to manage their price risks; the nonlegitimate are “speculators” purely in it for the money.

That sounds like a lot of power over the economy, political power subject to political pressure. You can bet brokers will abandon the U.S. markets for less hostile economic environs overseas.

The Senate has now convened, and Sen. Mitch McConnell just said, “Let’s be clear. Speculation is just a very little piece of a massive problem.”

Senate Majority Leader Harry Reid is now accusing Republicans of blocking needed legislation. He has his filibuster poster board on hand.


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