Those pesky oil speculators. If only we could rein them in by making it more expensive to bet on oil prices. If only regulators had the firepower to track down market manipulators and impose tougher penalties on those they caught. The price of oil would surely drop, right? If only it were that easy. One thing about the oil market: It is not prone to simple solutions.
On Tuesday, President Obama announced he wants Congress to increase the amount of collateral that traders have to post to buy a futures contract. (It’s typically around 10 percent of the value of the total contract.) Obama also wants to give the CFTC an extra $52 million to pay closer attention to the oil market and dole out stiffer penalties to those who manipulate it: $10 million instead of the current $1 million. That assumes of course that the CFTC can find those manipulators.
Predictably, Republicans pounced on the idea. John Boehner called it a “political gimmick” and asked why the president doesn’t “put his administration to work to get to the bottom of it?” The irony is that in 2008, Boehner, along with 169 other House Republicans, voted in favor of a bill with similar intent. On June 26, 2008, when the price of crude was $137 a barrel, the House passed the Energy Markets Emergency Act, which told the CFTC to “utilize all its authority … to curb immediately the role of excessive speculation.” Senate Republicans later blocked a vote on the bill.
A lot of Beltway scorekeepers think Obama’s announcement is smart, simply because it produced headlines such as, “Obama moves to curb oil speculators.” That may be, but it’s not clear the plan would actually lower the price of oil, because the demand to invest in it would remain. And as a blunt tool applied to a complex problem, it would almost certainly have unintended consequences.
For all their shortcomings, speculators help markets process information sooner rather than later. For example, speculators have piled into a record number of futures contracts over the past few months, mostly off the threat of an Iranian oil embargo. That has priced in the equivalent of a more than nine-month supply of Iranian oil. Better to price that in gradually over time than all at once. “Do we really want to go back to 1973, when one morning we wake up and the price of oil has quadrupled overnight?” says John Kilduff, a partner at Again Capital, a New York hedge fund that focuses on energy. “You may not like the price, but I haven’t seen any other system work better.”
Higher margin requirements would not only make it more expensive for commercial users, such as airlines and refiners, to hedge their positions; it could also have the effect of pricing out smaller speculators, giving even more of an advantage to the largest hedge funds that are most accused of manipulating prices. Making it harder to speculate would do nothing to reduce the huge demand for oil as an investment. In fact, it may cause some of the biggest investors to leave the futures market and start buying actual oil, rather than its financial proxy. ”I don’t think it’s out of the question to think that if margin requirements go high enough, that some sovereign wealth funds would go out and start buying oil tankers to hoard oil,” says Phil Flynn, vice president for research at PFGBest, a futures brokerage.
That’s certainly an extreme scenario. But in a world of sluggish equities, low-yielding bonds, and falling currency values, it seems hard to overestimate the demand for oil as an investment—and the lengths to which big investors will go to capture exposure to it.
This is not to say the CFTC doesn’t need more resources—something commissioner Gary Gensler seems to remind us of on a weekly basis. At 700 employees, CFTC’s staff is only about 10 percent bigger than it was in the 1990s, even though the market it polices has grown 30 percent. “If the rate of innovation in the futures market is moving at 100 miles an hour, regulators are stuck in first gear,” says Tim Evans, energy analyst at Citigroup.
Although he’s against higher margin requirements, Again Capital’s Kilduff agrees the CFTC needs to beef up its staff. “I do think they need more cops,” he says. “If there’s any agency that’s been left in the dust and underfunded, it’s the CFTC.”
Michael Greenberger was the director of the division of trading and markets at the CFTC in the late 1990s. He thinks regulators there are far too few to sniff out malfeasance. “You can’t overestimate the manipulation going on in these markets,” he says. While much of that $52 million would likely go toward technology investments, some of it would buy more personnel. “Even if they gained an extra 10 staffers, it’s my own experience that a team of 10 people can do an awful lot.”