Derivative markets: Regulate the regulators
Today's Financial News - Posted July 7, 2009
Washington is threatening to increase regulations once again. If it gets its way, the energy futures market may never look or act the same way again. It won’t be good for your wallet.
By Andrew Snyder, TodaysFinancialNews.com
Baltimore – (TFN): When oil prices climbed to $147 per barrel last year, investors were wary of the incredible surge, but cries of manipulation were received with as much concern as the Budweiser-toting redneck that claims to have witnessed a UFO hovering over his trailer.
After all, the economy was booming. Why wouldn’t oil be expensive?
But now that the economy has stalled and continues to drift backwards even as Obama tries to grind the nation’s economic engine back in gear, cries of foul play are getting more and more attention.
With oil cleanly surpassing the $70 level last month, regulators are threatening to take action.
Starting on the farm
Last week, a couple of bi-partisan senators told the Commodity Futures Trading Commission (CFTC) to get on the ball and track down irregularities in the wheat derivatives market.
Now they are focusing on the nation’s energy markets.
The nation’s wheat market is undoubtedly important, but the crude markets are in a league of their own. Sudden, large changes in energy prices impact the bottom line of just about every domestic company and have the power to jeopardize the nation’s growth and security.
If it is true the derivatives market is as manipulated as so many folks would like us to think, the CFTC will be forced to work overtime to fix the broken system.
If the agency makes good on today’s news, the energy markets will face increased regulations long before the jury reaches its verdict and rules on any true manipulation.
The CFTC plans to hold hearings over the next several months to discuss the notion of imposing trading restrictions “commodities of finite supply.”
This is not a new concept as limits are in place for other commodities, like wheat. But it will significantly impact the massive number of companies and investors that rely on energy derivatives to control costs and lower risk.
As this subject gets more press over the next couple of months, more and more investors will realize the importance of these financial investments that have wrongly been given a black eye over the past year or so.
They will realize the smart hedgers of the world, companies like Southwest Airlines (NYSE:LUV), are successful largely in part of their wise use of the derivatives markets. Stricter regulations will increase costs and lower profits.
Simple economics
More important than the financial management aspect of derivatives markets is an aspect our leaders will be forced to quickly understand; markets are two sided.
There are buyers and sellers, neither of which will make a move unless they believe it will be profitable to them.
Even with manipulation certain to at least some degree, it is impossible to believe it is large enough to significantly affect a market estimated to be worth more than $500 trillion.
More than a few investors would have to be duped into bad trades to stretch the market to that size.
Speculation plays a large role in the markets, there is no doubt, but those speculators need a long list of buyers and sellers to make things happen.
Nobody was ever forced to buy a futures contract against his will. As long as there are willing buyers and sellers betting their strategy is right and information flows efficiently and freely, the derivatives market will act naturally.
If that means crude soars to $2,000 or drops all the way to $13 per barrel, than that is what we will be forced to deal with.
No matter how strong Washington thinks it is or how many regulations it can devise, it will never be able to adequately control the markets.
If companies want to manage their risk, they will find a way, with Washington’s blessing or without it.
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July 7th, 2009 at 9:20 am
Yes and one company with millions of dollars couldn’t effect the market. Say a company that places its own “bets” and speculates and hedges all in one. You get two or three of these large company’s (banks…whatever) and it will sway the whole thing. You tell me i’m wrong and I will point the finger right to the one…one and I say again one man that made oil go up 2-3 dollars in one day by buying more oil than there was on the market creating this “Peak Oil” out look. The big boys take over the street and we have $150 oil again. Don’t fool yourself. This is needed and yes it will cause problems, but not for the consumer, but for the wall street people that are making more money off of us.