Effects of Speculation and Legislation in the Global Energy Market
Overview
Amidst a substantial volume of energy transactions occurring in the “dark web,” facilitated through unregulated platforms or “over-the-counter” (OTC) channels falling outside the purview of the Commodity Futures Trading Commission (CFTC), regulatory oversight is either absent or insufficient. In an endeavor to address the challenges posed by OTC trading, Jickling et al. (2008) highlight pivotal regulatory measures, particularly within the context of Farm Bills on page 12. These measures, proposed by the CFTC, aim to enforce accurate reporting by OTC traders and to establish limits on “electronic trading facilities handling contracts.” Personally, I advocate for the endorsement of the CFTC’s bill, which could furnish them with additional resources to ensure continuous, round-the-clock monitoring of energy derivatives markets, effectively identifying any suspicious activities that could potentially impact energy prices and prevent illicit speculative endeavors. In instances where companies are found culpable, I endorse the notion that their profit margins should be negated and their trading positions liquidated.
Introduction
The manipulation of global oil prices through illicit methods, including the unauthorized retention of oil contracts known as “hedging” and speculative activities, has been identified as a significant concern according to Mustapha (2012). The literature emphasizes that the fluctuation in oil prices, rising from $16 per barrel in 1998 to $98 in 2008, cannot be solely attributed to the interplay of supply and demand forces. Fan and Xu’s research (2011), as referenced by Mustapha, points towards speculative actions as a predominant cause of energy price volatility, rather than fundamental market factors. Simkins and Simkins (2013) recommend the implementation of regulatory measures to counteract financial manipulations such as disguised bulk purchasing under the guise of hedging contracts, which artificially inflate oil prices.
Impact of Illicit Hedging and Speculation on the Global Energy Market
The global energy market operates on the basis of flow demands and stock demands (Inkpen & Moffett, 2011). Insights from Inkpen et al.’s study highlight that both hedging and speculative practices have the potential to adversely affect future oil prices. Ripple (2008) asserts that, despite risk mitigation costs being inherent to oil and gas production, certain scholars argue that speculation is being exploited for detrimental ends (Wang et al., 2013).
Cho (2008) delves into a case involving a Swiss energy company, unveiling the manipulation of the company’s records through the unauthorized retention of oil contracts by organized syndicates. This maneuver, executed by the Swiss entity “Vitol” Portfolio, exerted control over a substantial proportion (11%) of regulated oil contracts on the New York Stock Exchange (Inkpen & Moffett, 2011).
Notable figures such as Hungarian-American George Soros and US legislators criticized this practice, asserting that the illicit holding of contracts exacerbated global oil price volatility. Cho (2008) cites the incredulity of John D. Dingel regarding the Commodity Futures Commission’s (CFTC) apparent oversight of traders like Vitol, enabling them to engage in extensive oil hedging without verifying the physical commodities supporting the trades (Hamilton, 2009).
Legislative Approaches to Mitigate Energy Price Volatility
G20 governments have initiated measures to enforce regulations aimed at restraining improper actions by financial investors who exploit hedging to manipulate global energy prices (Fattouh et al., 2013). CFTC investigations, conducted under the mandate of G20 governments, did not ascertain supply and demand as the primary drivers of energy price volatility.
Rather, CFTC uncovered evidence suggesting that hedgers and energy futures traders were striving to counteract energy prices. To address this concern, Jickling et al. (2008) and Wang et al. (2013) suggest a legislative framework comprising the “Enron Loophole,” “Swaps Loophole,” and “London Loophole.” These regulations aim to introduce oversight mechanisms, restrict the use of foreign futures markets in contravention of US legislation, and eliminate the practice of retaining contracts without engaging in physical oil trading.
The objective is to safeguard and provide support for “bona fide hedgers” who genuinely engage in the trade of physical commodities without participating in energy price manipulation.
References
- Simkins, B. & Simkins, R. (eds.) (2013) “Energy Finance and Economics: Analysis and Valuation, Risk Management, and the Future of Energy.” Hoboken, NJ: Wiley.
- Inkpen, A.C. & Moffett, M.H. (2011) “The Global Oil & Gas Industry: Management, Strategy & Finance.” Tulsa, OK: PennWell [Online]. Available from: http://library.liv.ac.uk.liverpool.idm.oclc.org/record=b2632439~S8 (Accessed: 24 August 2018).
- Hamilton, J.D., (2009). “Causes and Consequences of the Oil Shock of 2007-08” (No. w15002). National Bureau of Economic Research.
- R. D. Ripple, (2008) “Futures Trading: What is Excessive?” Oil & Gas Journal.
- Cho, D., (2008). “A Few Speculators Dominate the Vast Market for Oil Trading.” Washington Post, 21, p.A01.
- Fattouh, B., Kilian, L. and Mahadeva, L., (2013). “The Role of Speculation in Oil Markets: What Have We Learned So Far?” The Energy Journal, pp.7-33.
- Jickling, M. and Cunningham, L.J., (2008). “Speculation and Energy Prices: Legislative Responses.” Congressional Research Service.
- Wang, Y., Wu, C., & Yang, L., (2013). “Oil Price Shocks and Stock Market Activities: Evidence from Oil-Importing and Oil-Exporting Countries.” Journal of Comparative Economics, 41 (4), pp. 1220-1239.
- Mustapha, U.M., (2012). “The Role of Speculation in the Determination of Energy Prices.” International Journal of Energy Economics and Policy, 2(4), pp.279-291.
