Last Friday such a notion was put to the senate bill S.3268 by Leader Harry Reid on ``Stop The Excessive Energy Act`` but has not generally been received well by many traders or institutions including The Coalition to Protect Competitive Markets. Made up of eight associations including the biggies CME, ICE, ISDA, NYMEX, FIA were not supportive of the bill stating that ``Restricting the ability of U.S. investors to participate in these global markets will make it harder for American citizens, including millions of baby boomers saving for retirement, to diversify their holdings and offset losses in equity and bond markets``.
They have a point and nicely put as such baby boomers would also implicate those who might pass the notion as being affected adversely by it. Where will such people put their wealth, on the volatile equities markets, perhaps US property or the deflated fiat US dollar itself, there is really nowhere to hide on US soil. Actually that is what would happen, commodity trading would be driven offshore reducing the liquidity in the US markets and making it more expensive for hedgers to seek cover from adverse price movements.
Such a bill has more serious implications. Firstly, when is a hedge not speculation and how difficult would it be to enforce such a stance. Businesses that use raw materials such as coal, oil and gas purchase forward contracts for delivery of a commodity or mostly settlement of cash differential in the future and that allows them to crystallize their price. If say a firm purchased such contracts long using privately borrowed funds and actually showed a profit from this action would that be a better investment than a firm that priced everything on the spot. If that firm was good at doing this, it might find more investors willing to assist; it might even share a spread with them. How can you regulate that?
A forward contract is a bucolic way of raw material planning, it becomes a lot more complex than this and businesses are using options (puts and calls), caps, collars, straddles, swaps and forwards all mixed together to reduce price volatility. Each one these or the structure of many could be speculation or a hedge depending on why the firm bought them in the first place.
Let`s ask a different question; don`t all option contracts have a component of speculation within them?
Well, the instrument has `asymmetry risk` which means the most the holder can lose is their premium yet, the most they can gain is limited by how far the market moves. Is this just like a ticket in a horse race, an important horse race.
Away from financial instruments for moment, the senate is not the only group people asking this question. Only a month before in June 2008, an Interagency Task Force on Commodity Markets chaired by the Commodities Futures Trading Commission carried out an assessment into the market factors affecting the crude oil market. The interim report found that fundamental supply, demand and the roles of various market participants to be the best explanation for the recent crude oil price increases.
So finally where did the Senate end up?
Well on Friday 25th July the motion to stop speculation was not passed with only 50 yes votes being accepted and 60 being the required bar for the bill to move forwards however, this may not be the last we hear of this. The House Agriculture Committee cleared its own bill that would impose position limits on the number of futures contracts that can be owned by speculators past a price-setting role and is again going to be difficult to implement. They are going to make it mandatory for the reporting of Over-The-Counter trading and look-alike energy products which is an incredibly nebulous task. They are also only going to grant hedge exemptions for commercial purposes and that will relegate such hedging strategies as less successful if open interest in the market diminishes.
Perhaps in the end the only way to address this problem would be to solve the demand and supply differential then speculators will be less attracted to what is easily available for what they are holding onto at present will become more valuable if it is difficult to trade.
