In the last 5 years, the volatility in the price of oil has led to debate, accusations, and a great deal of confusion about the role of the financial markets in determining the price of a gallon of gas. This has included congressional investigation, consumer group accusations, and finally new regulations for the commodity trading industry.
So what is the basic issue? Critics allege that traders can artificially manipulate the price of crude by artificially creating demand through purchase of futures and other financial derivatives. Once the price increases, these can be offloaded for a profit. Last year the Commodity Futures Trading Commission (CTFC)—the primary government agency tasked with regulating the commodities market—filed a major suit against 5 traders alleging that they cornered the market on oil futures by obtaining such a dominant position that they owned 2/3rds of all the available oil at the Cushing, O.K. exchange. Subsequently, the CTFC was given the authority through the Dodd-Frank financial reforms to limit the supply that any one trader can own, which it voted to enact beginning in 2012.
2 weeks ago, at the UT-Energy Forum, students heard from a panel of financial industry experts on the topic of movement in oil prices. Panel member Jason Schenker, of Prestige Economics, strongly rebuffed the idea that financial speculation is a key driver of oil prices. Instead, Schenker cited basic macroeconomic principles of supply and demand, which was supported by other panel members. This assumption is essentially the energy industry’s institutional answer, supported by major groups such as the American Petroleum Institute (API). Research by the EIA in 2008 backed this finding, concluding that it was unlikely that inflows of investment or hedging in the commodities markets could increase prices.
Ultimately, this question remains unresolved. In the wake of the global financial crisis, it is unsurprising that the public and consumers are wary of traders and investment bankers. While the congressional report states that “Addressing excessive speculation offers the single most significant opportunity to reduce the price of gas for American consumer,” it is too soon to tell gauge the impact of new regulations imposed by the CTFC. However, given the amount of conflicting evidence and disagreement over the role of speculators in the oil market, regulators should proceed cautiously.