CFTC undercuts crude prices

Sam Fletcher
OGJ Senior Writer

It was more than a resurgence of economic pessimism that slashed the August contract for benchmark US light, sweet crudes by $11.60/bbl through seven of eight trading sessions to a $59.89/bbl close July 10 on the New York market, said Paul Horsnell, a managing director and head of commodities research at Barclays Capital in London.

Market fears that a faltering global economy will further reduce demand for oil probably couldn’t have taken the price below $65/bbl, especially against a background of tightening crude supplies, determination of members of the Organization of Petroleum Exporting Countries to raise prices to a sustained $75/bbl, and “broadening fears” that inadequate investments today in exploration and development threaten potential mid-term market stability, Horsnell said.

No, what kicked a hole through the previous price bottom and dropped crude another $5 plus change was Commodities Futures Trading Commission (CFTC) Chairman Gary Gensler’s announcement that his group will consider imposing position limits on energy commodities for speculators and will review whether swap dealers, index traders, and exchange-traded fund managers should be exempted. “Faced with somewhat imprecise statements suggesting a series of possible regulatory actions, a strong incentive was created for market participants of all types to draw back…particularly from the long side of US markets,” Horsnell said.

He warned, “All traders, regardless of whether they might be classified as speculative or not, were likely to view the CFTC chairman’s statement as the renewal of a regulatory wildcard. The most likely belief, again by all types of traders, would be that action would likely be more damaging for holders of longs rather than shorts, and hence an immediate reaction was to close out or scale back longs, or even to open shorts, in response to the reappearance of concerns about the potential instability and unpredictability of the US oil regulatory regime.”

Horsnell said, “Regulators are rarely short-run market neutral in the implementation of their actions, and when they speak of potential actions well in advance of specifying and implementing any regulatory changes, the scale of their involvement in the market as an indirect but active part of price determination becomes greater.”

In London, the InterContinental Exchange’s August contract for North Sea Brent closed at $60.52/bbl on July 10, 64¢ more than the price for benchmark US crude on the New York market, which it usually trails. That price difference “is in effect almost a Gensler risk discount” against US crudes, Horsnell claimed, even allowing for continued tightness in Atlantic crude markets and production outages in Nigeria.

‘Regulatory McCarthyism’
The primary market risk is politicians attempting a quick and easy fix for complex medium and long-term financial issues. “Quixotically attacking a perceived but unproved speculative problem may play very well to the galleries in the short run, but it risks diverting policy attention from the real issues; it may increase the volatility it is supposedly trying to reduce, and it may result in the consumer paying more in the long run. In particular, a period of regulatory McCarthyism in relation to the operation of oil markets is unlikely, in our view, to be a good substitute for effective domestic and international energy policies,” Horsnell said.

Gensler “seems to hint at a potentially prolonged period of regulatory uncertainty, which is rarely a good factor to increase in any market. In particular, those worried by the extent to which investment is falling behind that necessary to balance the market at reasonable prices are likely to be alarmed by the additional volatility and short-term price weakness caused by regulatory uncertainty,” Horsnell said.

Like the trickle of water down a hillside, financial markets tend to follow courses of least resistance. If blocked in one market, traders likely will move naturally to more favorable exchanges abroad. Therefore, Horsnell said, “The ultimate price impact of regulatory decisions…is likely to be very limited indeed. However, in the short run, oil prices do now seem to have an additional determining factor, namely market concerns about the risk of clumsy regulation and implementation.”

To prevent escapes to other markets, Sens. Maria E. Cantwell (D-Wash.) and Olympia J. Snowe (R-Me.) asked CFTC to revoke exemption of ICE’s US crude contracts from direct US oversight.

House Financial Services Committee Chairman Barney Frank (D-Mass.) suggested that any market reform legislation also authorize bilateral sanctions against any country that tries to attract commodity trading business with looser regulations. It is not clear how that would affect private exchanges competing for business in countries that simply maintain their current less-stringent regulations, however.

(Online July 13, 2009; author’s e-mail:

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