OIL SPECULATION….Yesterday the Senate voted 94-0 to proceed with debate on a bill designed to reduce speculation in the oil futures market. Megan McArdle calls the bill “monstrous,” which, admittedly, would be my first guess too for any bill that passes a test vote unanimously. (There’s gotta be something wrong with a bill that every single U.S. senator likes.) But what does the bill actually do?

The details are a little murky, but basically it cracks down on the enforcement of “position limits” in oil futures markets. Position limits are widely used on financial exchanges as a way to limit the maximum size of the position that any single dealer can take in a particular financial instrument, usually as a way of reducing risk and smoothing market volatility. However, there are ways to evade position limits, and the Senate bill does several things to tighten things up in the oil market: it places responsibility for setting position limits with the CFTC instead of the exchanges themselves, extends these rules to offshore exchanges, and eliminates a “loophole” that allows some large institutional investors to evade position limits.

Now, the CFTC itself doesn’t believe that speculation is the reason for high oil prices. Over at The Oil Drum, Nate Hagens has a summary of a CFTC interim report released this month on the subject, and the chart on the right tells most of the story. The CFTC folks, like most other analysts, believe that the fundamental story is simple: supply is constrained and demand keeps going up. Result: higher prices. Speculation has little or nothing to do with it.

I’m pretty strongly inclined to agree. On the other hand, it’s not immediately clear to me that there’s really anything wrong with the Senate bill. Position limits are a common feature of commodity markets, and allowing the CFTC to tighten up and enforce position limits on oil contracts probably does little harm. In fact, it might even do some good simply by maintaining public faith in the price discovery function of the market.

Now, I’m willing to be educated on this. Maybe there’s more to this bill than I realize. But for now, it seems relatively harmless, if probably also unnecessary. Any trading wizards out there who want to chime in?

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