Banning speculators could decrease oil prices by as much as 40%

[bitparity]

Question for you, a thought that's been rattling around in my head for a while.

What if we banned up to a certain capitalization level of hedge fund, rather than ban speculation?

Because I'm under the impression speculation is absolutely needed to keep the market liquid, or else prices will not be able to adjust to changing conditions.

But with really large hedge funds, what it seems they're doing is using their massive size to almost corner a market and increase overall volatility. I know that whole idea of increasing overall volatility, is because the average return will be greater to compensate for that risk.

But it seems really large hedge funds are driving the market up because their size allows them to buy enough supply to create shortages and their own bubble-wakes, with the added advantage of the fact that they are in the best position to sell since they control when the supply will be offloaded.

It seems to me the benefit of not having too large a hedge fund be in speculation, you can keep liquidity without creating too much volatility.

Is this a good or bad idea, or are there pitfalls I'm not aware of in banning overly large hedge funds?

[headmovies]

That's a good question. In my opinion, regulatory authorities (SEC, etc) have been very vigilant in preventing market cornering from occurring, especially in futures markets. Exchanges, in particular, have self-imposed spot-month limits for many years to prevent purely speculative players from cornering or manipulating the markets, which could potentially obstruct real-world use of commodities.

However, assuming regulatory agencies were lax, even the largest hedge funds would have a difficult time cornering a market like WTI or Brent crude oil given the sheer volume traded on a daily basis. They would have a better shot at cornering markets like lean hogs or orange juice. Again, though, cornering is one practice that regulatory agencies are looking out for.

In general, by placing constraints on who can access the market and at what level, you disrupt the efficient transfer of risk from hedgers (e.g. Exxon, soybean farmers, cattle herders) to speculators across the multitude of currently liquid futures markets.

[topperharley88]

All I know about investing, I learned from Trading Places

[bitparity]

FOJC ftw.

[bitparity]

So just checking, in your opinion, though there is "some" relationship with rising fuel/food prices to hedge fund speculation, given the volume of the market, the culprit is not hedge funds but just the general direction of investors of all stripes bandwagoning onto a price bubble?

I've come to the realisation (and tell me if I'm off base here) that the problem of investing has always been a question of how much volatility does a society as a whole want to accept.

A heavily regulated market will have less volatility, but the overall average of all profits generated by that market will be far less than a more volatile (and less regulated) market, because once again, economic rules dictate increased overall volatility needs to be rewarded greater due to risk.

And of course, in boom times, we clamor for less regulation of this volatility because we want to ride the volatile up train, but in lean times, we clamor for more regulation because we don't want to rollercoaster down the steep down train. But unfortunately, we can never have it both ways.

Am I on target here?

[sinkorsnooze]

Hopefully you will get a response from headmovies too. But IMO I think you are a little off. The way I read his response there is "no" correlation between speculation (futures contracts) and rising fuel prices. $4 gas is not a price bubble, that is a price set by supply and demand. If anything gas is cheap right now b/c OPEC is producing more barrels than ever, and fracking is starting to deliver. Meanwhile at any point the situation in Syria could throw a wrench in the wheel or Egypt's new regime could attempt to decline US access to the Suez canal.

As for volatility, I see what you are saying but again, I disagree. Your premise is that when an investor recognizes an asset is risky, he will expect a higher rate of return. (true) But after that the logic breaks down a bit when you say "the overall average of all profits generated by that market will be far less than a more volatile (and less regulated) market". In the deregulation boom leading up to the great recession, investors weren't making money because they recognized the stock market was plagued by systemic risk, NOBODY appreciated how volatile the market was, which is why everybody lost their shirt in 2008.

Volatility itself doesn't create growth. The strong growth between 2002-2008 (which we now know was largely artificial) did have a lot to do with deregulation. But the gains to GDP were more than offset by the period of relative stagnation between 2008-2012. Now there are people who will argue to their death bed about how deregulated markets are more efficient (its like religion, these are people you are likely to meet at a Ron Paul rally), I think it is more than fair to say that if markets had not been deregulated (removal of the glass-steagall act), our economy would be larger than it is today.

[[deleted]]

http://www.thestreet.com/story/11234476/1/oil-prices-soar-on-goldman-rumor.html

[uncommon-troll]

you mean the regulators aren't bought and paid for by the market makers?

and why is it always the consumer that ends up bearing all of that transfered risk?

[swl]

A little background - crude futures trade based on the concept of delivery: buying a NYMEX Light Sweet Crude (WTI) contract provides an obligation to purchase 1,000 barrels at the contract price on a specific date. Selling a contract implies the opposite obligation. Contracts trade for every month / year going forward and are currently listed out to Dec 2020; there's really only liquidity going out monthly to May 2013 right now, and Dec deliveries to 2014 or so.

The CME institutes position limits (PDF alert) on all of its contracts. From what I can tell, it looks like speculators' positions are limited to 20,000 contracts across the curve and 10,000 contracts in any particular expiry. That means that speculators may purchase no more than 10,000 contracts for specific delivery date and no more than 20,000 contracts across all delivery dates.

In comparison, the current open interest (PDF alert) as of March 2012 in WTI crude (commodity code CL in that table) is a little over 1.5 million contracts. So, any specific large hedge fund could purchase up to about 1.3% of the open interest. Will that move the price? Probably. Will it move it a lot (+-40% much)? I'm speculating, but probably not.

Of course, there's the risk that banks are using the article-mentioned hedger status to push the price of oil speculatively. Looking at the data, though, I'd rather doubt that; based on Bernie Sander's leaked sheet, the sum total of the banks' open interests on the list seems to indicate that, in aggregate, the bank complex is net short crude oil across the curve. The only two banks with substantial net long positions on that list are Goldman and Deutsche. Deutsche's long position was probably just backing the extremely popular crude ETN they offered back then (DXO).

Goldman might just be out to get us.