Commodity speculation must be curbed

By Joe Lieberman, Susan Collins and Maria Cantwell

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The US Senate is now debating legislation aimed at cutting the cost of petrol and heating oil by ending excessive speculation in oil futures that financial-market experts and even oil company executives agree are driving up prices.

Among many proposals, we offered one: the Commodity Speculation Reform Act that directs and empowers the Commodity Futures Trading Commission to police more aggressively excessive speculation among all indexed commodities, including oil and foodstuffs, such as corn, wheat, and soyabeans. Many of its provisions were incorporated into a Senate bill spearheaded by Harry Reid, the majority leader, and which is the chief Senate vehicle.

We must act now to bring these prices down and get a bill to the president before we adjourn in August.

Here is the problem: The commodity markets perform a crucial function in our economy. They serve as a place where producers and consumers of specific commodities can enter into futures contracts that help hedge the risks of price fluctuations common to their industries, thus creating some measure of price predictability for their businesses.

But these real, physical commodity market traders – airlines, refineries, manufacturers and other users and producers of energy – actually intend to produce or take delivery of those commodities and have historically been the main participants in these markets.

Financial speculators have always played a valuable role in the past. Like banks that lend money to farmers to buy seed at the beginning of the growing season, speculators have helped provide liquidity to the commodity markets. In the last year, recognising that the world’s growing middle class is buying more food and oil, financial speculators such as pension funds, university endowments and other large institutional investors have poured billions of dollars into commodity markets. They are betting on rising prices -–and let us be clear that these are bets – without ever intending actually to own a barrel of oil or a bushel of corn.

The numbers speak for themselves. In just five years, the total value of institutional investors’ holdings in commodity index funds has swelled from $13bn to $260bn. The price of the commodities tracked in these funds rose nearly 200 per cent over that same period. These investors are increasingly competing with people who need these commodities or oil for the operation of their businesses. Today more than 71 per cent of the commodity futures contracts are owned by speculators – compared with 37 per cent in 2000. Some speculation does provide liquidity. But speculation at this level wreaks havoc on the economy – unnecessarily driving up prices and threatening both businesses and household budgets.

Combine the increasing commodity investments from private, state and local government pension plans, university endowments, insurance companies and other institutional investors, and the result is clear. Speculators are overwhelming our commodity markets and leading to substantial increases in food and energy prices for years to come.

In a series of hearings held by the homeland security and governmental affairs committee, we heard testimony that this kind of excessive speculation in the commodity markets may be adding as much as $40 to $60 to the cost of a barrel of oil.

Some say these figures are too high. We would say that even a single dollar increase due to excessive speculation is a dollar too much because of its inflationary effect.

According to the Air Transport Association, every $1 increase in the price of a barrel of crude oil adds $470m a year in jet fuel costs – almost half a billion dollars – to the US airline industry.

Speculators who want to invest in these markets can buy stocks directly rather than invest in commodity futures. That would funnel needed capital into means of production that could increase supplies and eventually contribute to lower petrol prices.

Unfortunately, the CFTC has ignored its mission as our front-line defence against rampant and unmanaged speculation. To this day, the commission has yet to recognise that speculation affects commodity prices.

Instead of acting the part of a regulator, the commission has delegated much of its regulatory authority to the commodity exchanges. Moreover, in contradiction with Congress’s original legislative intent, the commission views its mission as confined to a single purpose – preventing market manipulation. On the contrary, Congress fully intended the commission to regulate market manipulation AND excessive speculation.

The bill that is enacted should direct the CFTC to create a seamless system of speculative position limits that cap the size of any one investor’s holdings of a specific commodity. These caps should apply to commodity positions wherever they are – be it a US exchange, an over-the-counter holding, or a foreign exchange. A broad-based, uniform approach will discourage flight from the major US exchanges because all trading platforms will fall under one regulatory umbrella. And it is the only way we will rid the global markets of excessive speculation.

The legislation must also exempt bona fide hedging and ensure sufficient market liquidity so that participants in the physical markets for commodities can conduct their contracting and risk-hedging activities as our commodities laws originally intended.

This kind of legislation is not a radical intervention but, rather, a simple restoration of the standards that governed our markets before the recent explosion in speculative, over-the-counter trading.

Is excessive speculation the sole cause of rising oil and gas prices? Of course not! Global economic growth, particularly in emerging nations such as China and India, has put tremendous upward pressure on the prices of all commodities, including energy, food and raw materials. The weak dollar is also a key factor.

But there can be little doubt – even among people sceptical of this kind of legislation – that excessive speculation has had an effect on rising prices. Unlike weather or foreign demand, this is a factor we can control. Our bill will end excessive speculation and help create a more orderly market for the industries and producers who must deal in energy commodities as a matter of business. And all American consumers will benefit in the bargain.