Experts discuss need for commodity speculation

Squeezing out speculative capital will affect commodity market liquidity, regulator must engage with market to prevent unintended consequences

Commodity market players at an event in Washington, DC yesterday repeatedly voiced concerns about unintended consequences arising from mandated position limits for contracts in commodities such as energy and metals.

The event was held by commodity market participants to examine the implications both for the over-the counter and the exchange-traded markets of the Dodd-Frank Wall Street Reform and Consumer Protection Act as it stands, four months before the ruelmaking deadline set by Congress last July.

A rule about position limits was proposed by the Commission in January and was designed to prevent market concentration and excessive speculation, which some believe have pushed up the price of commodities such as oil.

However, Tom Lasala, chief regulatory officer at CME Group and one of the speakers at yesterday's event, said the CFTC was overstepping its boundaries with the proposal. "As we see it, Dodd-Frank gave the CFTC the discretion to impose position limits if it makes a finding [that speculative activity has caused prices to rise], although the Commission has a different view," he said. "The CFTC has released no evidence to make it clear this has occurred."

The CFTC did publish a report on speculation in September 2008. It studied activity among commodity swap dealers and index traders between December 31, 2007 and June 30, 2008, at a time when the price of oil was rapidly climbing towards $147 per barrel. But the report said there was no link between rising crude oil prices and volumes flowing into commodity index trading at the time.

"Supply and demand fundamentals cause price movements, not speculation," Lasala said at yesterday's event. "Without speculative activity there will be greater volatility and it will be more difficult for hedgers to enter and exit the market."

During a separate panel discussion yesterday, Mike Gorham, director of the Illinois Institute of Technology's Stuart Centre for Financial Markets, argued that rather than inflating prices, the futures market merely signals when commodity prices are rising due to supply and demand fundamentals. "The futures market, being the locus of price discovery, signals changing prices," he said.

Participants in the panel discussion also emphasised the need for effective engagement between the market and its regulators on topics such as position limits. Another panellist, Thomas Erickson, vice-president of government and industry affairs at Bunge North America, argued one of the major risks inherent in regulated markets is "actions by governments or others in imposing rules that are not suited to the market".

"There is a need to ensure engagement is effective so [risk management] tools can continue to be used and there is enough speculative activity to generate the required levels of liquidity," he added.

James Allison, risk manager for gas and power North America at ConocoPhillips, agreed speculative activity drives hedging activity. "Think of the market as a mass transit system and a hedger as someone who wants to travel to a certain location," he said, comparing derivatives transactions to different types of vehicles. "What's better: several large but irregular buses or a large number of taxis going wherever travellers need to go?"

A lack of speculative activity would affect price discovery as certain markets become more thinly traded, Allison argued, adding to costs for hedgers.

While the panellists were clear about their belief a certain amount of speculation is healthy for the market, no-one could estimate how much speculative activity is too much. The consensus seemed to be that more information and data sharing between participants and regulators could help maintain a balance.

"There is no easy answer," Erickson said. "This is why we need effective engagement between the regulator and the market."

Gorham added: "No market is perfect. Markets can overshoot due to dramatic events. We need to be aware of this and be ready to examine the data."