The murky task of curbing speculation

On the first day of hearings on whether commodities speculation should be more heavily regulated, new-ish chairman Gary Gensler said the Commodities and Futures Trading Commission should “seriously consider setting strict position limits in the energy markets”.

Jeff Sprecher, chief executive of Intercontinental Exchange and Terry Duffy, chief executive of Chicago Mercantile Exchange, were on the witness stand today.

Both exchange officials said they would be willing to adhere to (or in CME’s case, actually administer) more pervasive position limits. Position limits currently only apply on the final three days before a contract expires.

The problem is however is that extending position limits on non-commercial traders still leaves open a raft of opportunities for speculation to distort the markets.

On the one hand, traders who are traditionally non-commercial (ie not involved in physical oil) can simply move into the physical trading to gain exemption from such limits. There are plenty of incentives to do so anyway relating to price discovery and taking advantage of contango (Izabella Kaminska writes more about the emerging ‘physical loophole‘ on FT Alphaville). At the same time, traders that are traditionally commercial can and do make use of their knowledge to profit from speculative trades.

But putting a big fat limit on both non-commercial and commercial traders would never work either: commercial traders need the liquidity provided by speculation.

Another problem, as highlighted by CME’s Sprecher is that the wrong kind of speculative limits could simply push participants further into the over-the-counter market – and he said there had already been “numerous incidents” of this recently.

Related links:

Evil commodities regulators in the dock (FT Alphaville, 28/07/09)
CME weighing strict positions on limits, Gensler says (Bloomberg, 28/07/09)
Speculator crackdown: Who will say what? (FT Energy Source, 10/07/09)

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