There is some debate about the true causes of the extremely high oil prices of the last few years, and the corresponding trend in prices for petrol and diesel. Those who understand the movements of the markets point out that a major factor is speculation. Oil is traded on the commodity futures and derivatives markets (the so-called paper oil market). Futures markets were originally designed to give farmers some protection against short-term price fluctuations. The idea was that the buyer and seller could agree a price for foodstuffs many months ahead. This could be desirable for both producers and consumers, particularly in times of market uncertainty.
Futures markets for commodities have been in existence for many years. These have enabled large consumers (e.g. airlines) to agree prices with oil producers to reduce their vulnerability to large fluctuations. However, with deregulation of the oil and natural gas derivatives markets a decade ago, the US government allowed some new players to enter the futures markets. The supposed benefits of allowing new types of traders (e.g. hedge funds and index funds) into the futures and derivatives markets were thought to be increased competition and increased liquidity for comercial users.
Some commentators are now calling for much greater regulation of the energy futures and derivatives markets. The objective of regulation is to control hoarding and speculation which is harming the economy. It is also argued that better (i.e. more transparent) market information should be made available. Professor Michael Greenberger, a US expert in company law, is a particular advocate for stronger regulation. He argues that the market has been distorted by companies with no real interest in oil other than the profits to be derived from gambling. Position limits have been offered as a possible solution. These would limit the number of derivatives contracts that an investor can hold. In the US, the Commodity Futures Trading Commission (CFTC) is the key regulatory body but, of course, nothing is possible without political backing. The Commission of the European Communities has also been looking at adopting position limits to control price volatility.
An international approach is needed to prevent those who are trading in derivatives from avoiding regulation by simply moving to the least-regulated market. According to Greenberger, market commentators as diverse as Nouriel Roubini and George Soros have called for a check on excessive financial speculation in paper oil. Greenberger points out that the speculators have created a market that doesn’t function smoothly because the traditional supplier/consumer relationship is overwhelmed by price directional betting.
The price of oil is a major factor in the current economic downturn. Roubini believes that oil price volatility has severely damaged the global economy. Price instability creates rapid boom and bust cycles. Until alternative forms of energy are better-developed, the high price of oil increases transport costs and leads directly to inflation. It is important that politicans and regulators take back some control of the damaging speculation which is currently occurring on futures markets.
Reference: The Relationship of Unregulated Excessive Speculation to Oil Market Price Volatility, Professor Michael Greenberger, University of of Maryland School of Law, 2010.