Futures markets like those which drive oil and gas prices are a function of two groups of market participants – hedgers and speculators. Those, incidentally are the CFTC’s terms so don’t confuse them with the politically charged versions the p resident is using.
Hedgers are farmers, importers, exporters and manufacturers who depend on consistent pricing to make, sell or otherwise produce something using oil. They participate in the markets in order to keep prices stable to protect against pricing risk. But they can only buy or sell so much. They are actually interested in delivery of the oil or gas they need.
For example, McDonald’s (NYSE:MCD) wants to hedge against rising potato costs that could affect the profitability of its world famous french fries. The farmer who sells them potatoes normally wants to hedge against falling potato prices so as to maximize crop prices and his profit margin.
The position is much the same for Starbucks (NASDAQ:SBUX) and coffee just as it used to be for dentists and the silver they used for fillings, for example.
Speculators, on the other hand, are those who profit from the price changes against which hedgers are trying to protect themselves. They are not interested in taking delivery.
Speculators serve a very important function in that they bridge the gap between higher and lower prices often buying and selling when hedgers can’t or won’t.
If speculators are taken out of the picture, prices become less liquid and more jumpy.
Instead of moving smoothly from $100 to $120 a barrel, for instance, oil prices might simply gap higher because hedgers will be forced to trade directly with each other or through intermediaries who have effectively got their financial hands tied.
This would back all the way through the gasoline refinery process to the pump.
And investors who are dumfounded by the price increases we’ve seen so far, may be absolutely gob fobbed when things jump $1 or more at a time. Then there really would be a link.
Shutting down speculators would be like banning ice cream delivery trucks in July.
The President is Chasing a Ghost He Can’t Catch
To think that oil companies will not shift to other pricing mechanisms is naïve. If U.S. markets are restricted, traders will simply shift to London or Shanghai and conduct business as usual using new contracts structured specifically to avoid additional U.S. regulation.
They will also create trading entities that act as a proxy for the “speculators” the White House has targeted in this latest gambit.
This is exactly what many did with credit default s waps after the United States clamped down on them.
Why do you think funds shunted to London are at the heart of the MF Global fiasco or Goldman’s most aggressive traders are located there? Because money goes where it’s treated best. There are more accommodative regulations in the land of crumpets.
We don’t need more regulation. We need to enforce what we have. This is another misguided political con job drawn from the well of bad ideas.
The p resident says he wants cheap gas, yet he kills the Keystone Pipeline, stymies drilling and allows the Fed to engineer a bailout of that put trillions into the system over the past four years – every dollar of which makes gas more expensive.
He says he wants to rein in speculators while not drawing a line between what constitutes legitimate speculation (as a function of free markets) and already illegal manipulation.
If anything, the f ederal government is the biggest manipulator in the history of manipulators.
Quantitative easing has done more damage to gas prices and the wallets of millions of consumers than a few speculators ever could. Frankly, it’s a miracle prices aren’t $10 a gallon at the pump by now.
I say let the markets work. Prosecute the true oil price manipulators but otherwise quit meddling. Piling on more regulation will only detract from economic activity, not create it.
Oh…and by the way, investors need to stay long energy especially in growing economies using more fuel.
Higher oil prices mean higher oil profits and there is a link between rising fuel consumption and GDP growth.