Can't we just stop the oil speculators?

John W. Schoen Senior producer • Profile • E-mail

The spike in oil prices has led to a lot of speculation — about what’s causing the surge. One of the usual suspects is the oil speculator — who’s trying to make a buck betting prices will go even higher. So, a lot of readers are asking, why can’t we just put a stop to all this speculation?

Why is there no way to stop the speculation of oil futures in hedge funds? The NYMEX started trading oil futures in 1983. Certainly regulations had to be put in place to allow that...
- Tom, Cincinnati, Ohio

With the latest spike in oil prices, consumers and Congress have started taking names. For awhile there, Big Oil — raking in more profits than it invested in finding more oil — was the main culprits. Strong demand from the developing world took part of the blame. Then the weak dollar was in the hot seat. Lately, speculators in the oil futures markets are the bad guys. (Our e-mail inbox contains a number of more creative theories about why oil prices are rising, but this list includes the usual suspects.)

All of these factors are playing a part: the growth in demand is coming faster than new supplies are being found and developed. If that keeps up, we may face an actual shortage — one side of the equation has to give. But as the value of the dollar has fallen and inflation has perked up, there’s no question that investors have been flooding the oil trading oil pits with orders. Buying oil is a great hedge against both.

So if all this speculation is pushing oil prices higher, why don’t we just clamp down on the speculators? Congress is considering doing just that. One quick solution: make speculators put up more money when they buy futures contracts. Under current rules, you can buy large volumes of oil with relatively small amounts of money. By raising the “down payment” on oil futures contracts, the theory goes, you’d eliminate some of the buyers who are just there to place bets.

The problem, as with everything to do with oil prices, is that the oil market is global. So if you shut the door on the U.S. commodity market, speculators could turn to other oil markets — like the International Commodity Exchange in London — to place their trades.  If you got all the governments around the world to agree to clamp down (a neat trick if you can pull it off), traders would still figure out how to find each other. They could go on eBay.

That could make matters worse. One benefit of having a unified market, with the price of each trade made public, is that everyone can see what oil is trading for — right now. If you chase traders away from an open market, it’s becomes much harder to know what oil is “worth” at any given moment.  Prices would take bigger swings because you couldn’t get an accurate market price when it was your turn to buy or sell. If the seller demanded $200 a barrel, you’d have a harder time arguing that the price was too high.

Speculators get it wrong, too. The ones who paid $135 a barrel on Thursday paid too much —based on the closing price on Friday. If we begin getting news that demand is falling — which is what’s supposed to happen when prices get this high — those traders could stampede in the other direction. It’s happened before: there have been several major oil price crashes since supply and demand became an issue in the 1970s.

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