COMMODITY MARKETS OVERSIGHT
OVERSIGHT COALITION
An Alliance of Commodity Derivatives EndEnd-Users and Consumers
Speculation in the Commodity Markets:
MYTHs vs. FACTs
Revised June 4, 2012
MYTH: The idea of “excessive speculation” is new.
FACT: The idea is actually older than the commodity exchanges and concerns have been a matter of public record even
before the first major exchange still in operation, the Chicago Board of Trade, was established in 1848. For more than
160 years, commodity exchanges functioned as a meeting place for bona fide commercial hedgers (i.e., farmers and
grain merchants) looking to shed risk associated with commodity prices and speculators eager to profit from that risk.
Over time new and increasingly complex trading practices and financial instruments were deployed. As the commodity
markets grew and attracted more and more interest from financial traders, so did concerns over the role of unchecked
speculation which farmers argued was jeopardizing their ability to manage commodity price risks, distorting market
fundamentals and resulting in unwarranted price swings.
Following decades of volatility in the agricultural markets, then-President Roosevelt enacted the Commodity Exchange
Act of 1936. The new law allowed regulators to establish position limits to “diminish, eliminate or prevent” undue
burdens on interstate commerce caused by “excessive speculation.” Position limits were also applied to energy futures
when they were introduced forty years later. Only legitimate commercial hedgers such as famers and oil producers were
given exemptions from these limits. Decades of stability and confidence resulted from the position limits regime.
However, since the early 1990s, financial industry lobbyists have been relatively successful in watering down oversight
and exempting their Wall Street clients from position limits and other requirements that ensure transparency and
competition and prevent fraud, manipulation and excessive speculation. Today’s reform advocates are simply calling for
a return to stable, open and competitive markets that serve the needs of bona fide hedgers over speculative traders.
MYTH: Restraining financial speculation is against American principles and free market ideals.
FACT: Even America’s Founding Fathers worried about financial speculation and feared its excesses. In a letter to
President George Washington on May 23, 1792, Thomas Jefferson wrote that “all the capital employed in paper
speculation is barren and useless, producing, like that on a gaming table, no accession to itself” and said that it
“nourishes our citizens’ habits of vice and idleness, instead of industry and morality.” He went on to warn of its
“corrupting” influence on politics and feared that speculators would control the legislature and render “honest voters”
essentially voiceless. His fears may have indeed come to pass (see the next “myth”). Stable, competitive and productive
markets are American. Reckless gambling on the backs of American businesses, consumers and the economy is not.
History has shown that completely opaque markets encourage fraud, manipulation and disruptive trading practices that
endanger consumers, businesses and economic well-being. Furthermore, it is important to note that commodity
markets were never meant to be financial markets. They were created as hedging tools for commodity-dependent
businesses such as farmers and truckers, not as a playground for Wall Street investors. Speculators may serve a purpose
by taking on risk and providing necessary liquidity. But these markets were never created to serve speculators.
MYTH: Commodity markets have been and continue to be well regulated.
FACT: They were… once upon a time. As we mentioned above, thanks to Depression-era laws, generations of
Americans enjoyed relatively stable, transparent and competitive commodity markets. The Commodity Exchange Act of
1936 required prudent regulation of futures markets and authorized limits on speculation. The Glass Steagall Act of 1933
prohibited banks from using federally-insured deposits or government loans in risky speculative trading activities. But
towards the end of the 20th Century, things began to change. The financial services industry had quadrupled its share of
Speculation in the Commodities Markets: Myths vs. Facts (Rev. 3.5, 6/4/2012)
Compiled by Jim Collura – [email protected]
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U.S. GDP and accounted for close to $1 trillion in wealth generation. Flush with cash, the industry flexed its lobbying
muscle in Washington to undo what it considered to be archaic laws that restrained “innovation” and growth.
The financial industry was successful in obtaining some trading exemptions from the Bush-era CFTC in the 1990s. But the
most sweeping and dramatic deregulation came with the Commodity Futures Modernization Act (CFMA) of 2000 also
known as the “Enron Loophole” as the now-defunct energy trading firm had vigorously lobbied in favor of the bill. The
law was passed in response to efforts by then-CFTC Chairman Brooksley Born. Born had worried that the growth of
unregulated derivative trading was a threat to U.S. economic stability and urged Congress to regulate it. Opposition from
fellow regulators friendly to Wall Street, including then-Fed Chairman Alan Greenspan, frustrated her into resignation.
Worried someone might take up Born’s torch, Wall Street lobbyists succeeded in sneaking the CFMA into 1,100 pages of
a must-pass spending bill during the final days of the Clinton administration. The new law exempted huge swaths of the
commodities markets from oversight, exempted speculators from prosecution under state gambling laws and weakened
the CFTC’s authority to police the markets. It would also be legal for Wall Street to create complex new over-the-counter
derivatives in a variety of markets, including (infamously) the sub-prime housing market. Speculative trading in
commodities boomed. In the ten years that followed the law consumers saw some of the most dramatic and volatile
price swings in history, culminating with the unprecedented and unwarranted energy and food spikes of 2007 and 2008.
The joy-ride did not last forever. The market crisis of September, 2008 was the worst any living American had ever seen.
Policymakers were reminded why their predecessors had ensured consumer protections and Wall Street regulations in
the 1930s, many of which were no longer on the books. As part of the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010, Congress attempted to reverse some of this deregulation and bring renewed stability and
confidence to the commodities markets by requiring across-the-board data reporting, mandatory clearing, and acrossthe-board limits on speculation. Since the law’s enactment, however, the financial industry has fought to delay and
water-down Dodd-Frank Act rules in the rulemaking process, challenged them in the courts and strip them of funding
…or repeal them outright in Congress. As a result, American consumers remain as vulnerable as ever.
MYTH: All of the academic studies have proven that market fundamentals alone drive prices.
FACT: Completely false. Nearly 100 recent studies, reports and analyses by market experts, academics and
governmental organizations have found market fundamentals alone do not explain wild price swings in oil and other
commodities. They have concluded that opaque trading and excessive financial speculation are having a harmful effect
on the commodities markets, despite what some Wall Street-backed “studies” have concluded. Even a recent study by
the Federal Reserve Bank of St. Louis found that speculation “played a significant role in the oil price increase between
2005 and 2008 and its subsequent collapse.” You can access the entire list online at http://bit.ly/100studies.
FACT: Academics and other experts are severely handicapped by the lack of adequate market data. Data on off-shore
markets has improved as the CFTC signs information sharing agreements with foreign regulators, but much of that data
is still not public. Even the data that is currently available in the weekly CFTC Commitment of Trader (COT) reports is not
detailed enough to draw definitive conclusions. This issue is well explained by John Kemp, Senior Market Analyst for
Commodities and Energy at Reuters, online here: http://reut.rs/JbFEPg.
MYTH: A 2008 report by the CFTC proves fundamentals, not speculation, drives prices.
FACT: This report contained insufficient data to draw such conclusions and was accused of being politically-motivated.
Then-Acting CFTC Chairman Walt Lukken, a recognized opponent of reform, released a preliminary staff report in
September of 2008 that determined market fundamentals to be the driving factor in the 2008 commodity price run-up.
However, it is important to note that CFTC Commissioner Bart Chilton and others had strong objections. Many called its
release premature. Most information utilized on off-exchange trading activity was (and much of it still is) inaccessible to
regulators, after all. Additionally, many questioned the motives behind the release of the interim report. Despite these
objections, CFTC Chairman Lukken opted to released the incomplete report just as members of Congress began debating
comprehensive new legislation to reform the markets and restrain speculation.
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MYTH: Low natural gas prices prove that increased production, not reining in speculation, is the real “silver bullet”
that will help bring relief to consumers of gasoline, jet fuel, and other commodities.
FACT: Natural gas is actually a case study in what should be done to enhance price stability. Between 2000 and 2008,
the natural gas markets experienced extraordinary volatility. In 2005, natural gas had reached a high of $15 per therm.
Several House Republicans proposed strengthening speculation limits but the House Energy Committee was skeptical of
the CFTC’s enforcement of such authority. They opted to empower the Federal Energy Regulatory Commission (FERC)
with concurrent jurisdiction and since then, they have exercised that authority. Consider the case of Amaranth Advisers.
In 2007 the FERC charged and later convicted the hedge fund with manipulation in natural gas after it had taken a
massive NYMEX position that was well in excess of the exchange’s “accountability limits.” They were ordered to reduce
their holdings. Rather than comply, they moved their position to an electronic exchange exempt from limits under the
“Enron Loophole.” In September of 2006, a bad bet forced Amaranth’s position to collapse and the nation’s artificially
natural gas high prices along with it. Many bona fide natural gas hedgers were harmed by these events. Following the
Amaranth fiasco, there was consensus in Congress that the natural gas market needed even tougher oversight. In 2008,
Congress expanded CFTC authority over certain markets that were exempt under the Enron Loophole. The natural gas
contract used by Amaranth to evade oversight was one of the first to be regulated under the new law. All of these new
“cops on the beat” discouraged harmful speculation, including passive index fund speculation. Today, natural gas is only
4% of the Goldman Sachs Commodity Index while crude oil is 65%. Greater oversight and transparency of natural gas
trading combined with increased production and export restrictions have resulted in today’s record-low natural gas
prices. If such a comprehensive policy were applied to crude oil, we would certainly see a similar result.
MYTH: Futures prices do not affect spot/cash market prices that are paid by businesses and consumers.
FACT: Actually, futures prices directly affect spot prices. Many large purchases of commodities, both in the U.S. and
around the world, are made using the nearest-month’s futures price as the basis. There is perhaps no better and more
conspicuous example than retail gasoline prices. When futures prices surge, downstream petroleum refiners,
wholesalers and retailers must adjust prices for gasoline accordingly. In other words, even though they may have
purchased said gasoline at a lower price today, they must consider the higher anticipated costs of replacing it in the
future. This is part of the reason behind daily or weekly price changes at your local gas station. Of course other factors
also influence the “price at the pump,” such as production and refining costs, transportation costs, motor fuel taxes and
credit and debit card processing fees. Still, crude oil prices make up over 70% of the cost for a gallon of fuel, and crude
oil prices are set by commodities traders on the commodities markets.
MYTH: Limiting commodity speculation will decrease liquidity and drive-up hedging costs.
FACT: Today’s markets are subject to unprecedented levels of liquidity and leverage, and a growing percentage of
open interest is speculative. According to CFTC Chairman Gensler, “the vast majority of trading volume in key futures
markets – up to 80% in many markets – is day trading or trading in calendar spreads.” This means that only 20% of
trading is done by “traders who bring a longer-term perspective to the market on the price of the commodity.” Hedgers
are increasingly being pushed out of the market as risk mitigation becomes more and more difficult and even costly
thanks to extraordinary market instability. Some hedgers have sought refuge in the over-the-counter swaps markets.
However, these markets are (1) opaque, which discourages competition and makes it difficult to compare swaps
products and prices; (2) much riskier, since mandatory clearing requirements and other important financial safeguards
are not present; and (3) are not as vigorously policed for fraud and manipulation. The solution: limit financial speculation
while also bringing transparency, competition and oversight to the over-the-counter markets.
MYTH: Greater oversight of the commodity markets will drive activity off-shore to foreign exchanges.
FACT: This assumes that speculators can trade in a given commodity without the presence of legitimate commercial
hedgers, who are unlikely to want to trade on un-established, illiquid and unregulated off-shore exchanges that lack a
determined point of delivery (i.e., West Texas Intermediate Crude delivers to Cushing, Oklahoma). So, the transparent
market with real prices determined by supply-and-demand fundamentals and offering greater consumer protections will
Speculation in the Commodities Markets: Myths vs. Facts (Rev. 3.5, 6/4/2012)
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be where bona fide hedgers choose to trade. These are the only markets that need exist. Any other trading environment
exists solely to game the markets, e.g., to evade regulations for the purpose of profit or to trade free of any requirement
that the trader be able to make or take delivery of product. Thankfully, the Dodd-Frank Act requires that off-shore
exchanges seeking access to U.S. markets must have comparable regulations, including transparency requirements and
speculation limits. Many foreign regulators including European and Asian authorities are considering new regulations
that are similar to if not stronger than in the U.S. And finally, the CFTC and SEC have been working hard to negotiate
issues of jurisdictional overlap and harmonize regulations with their overseas counterparts. In conclusion, international
regulatory cooperation and the desire of market participants to transact in a stable, transparent and competitive
environment make this argument moot.
MYTH: Republicans are universally opposed to policies that would rein-in commodity speculation.
FACT: Actually, this has been a bipartisan issue. Just look at the voting record. In a 2008 floor vote, forty-four House
Republicans still in office today voted in favor of a 2008 bill that would have enacted comprehensive oversight and
regulation of the commodities markets - including speculative position limits. Current House Agriculture Committee
Chairman Frank Lucas (R-OK) and Energy & Commerce Committee Chairman Fred Upton (R-MI) were among them.
Many Republicans serving in Congress in the last six years have introduced or cosponsored pro-reform legislation, voted
in favor of them in committee or made public statements calling for action. Several sitting Republican Senators have
been openly concerned about the role of unrestrained financial speculation in energy and agricultural markets, including
Senators Olympia Snowe (R-ME), Susan Collins (R-ME) and Chuck Grassley (R-IA).
MYTH: Nothing can really be done about speculation.
FACT: Not true... a lot can be done. The President, Congress and federal regulators can renew confidence, stability and
competition in these markets by fully implementing reforms included in the Dodd-Frank Act. This includes meaningful
position limits and margin requirements on speculators, mandatory clearing and data reporting requirements, and
prohibitions on dangerous proprietary trading activities. Regulators at the CFTC, Department of Justice and other
departments and agencies also vigorously police fraud and manipulation and prevent disruptive trading practices from
distorting the markets; and they cooperate with foreign and international regulators in this regard. Regulators and
lawmakers should also enact measures to ban harmful speculative trading by index funds, which have been proven by
dozens of academic and governmental studies to drive up the cost of oil and food without regard for supply and demand
fundamentals. And finally, Congress must fully fund the CFTC and reject new legislation that would delay, weaken or
repeal vital trading reforms needed for market stability, transparency and accountability.
FACT: Immediately following each earnest discussion of meaningful reform and renewed oversight by federal regulators
and/or Congress, commodity prices took a tumble. It happened in September, 2008 when the Senate debated
comprehensive legislation to address commodity speculation. It happened in January, 2009 after the CFTC proposed for
the first time across-the-board limits on speculation. And following a recent, nationally televised speech by President
Barack Obama on April 17, 2012 in which he promised to root out and prosecute manipulation, increase transparency
and limit speculation, gasoline prices fell 28 cents per gallon, from a national high of $3.90 to an average of $3.62 (as of
May 31, 2012), saving Americans $103 million per day.
Speculation in the Commodities Markets: Myths vs. Facts (Rev. 3.5, 6/4/2012)
Compiled by Jim Collura – [email protected]
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