Here we go again. Some lawmakers want to enact stricter position limits on speculators to try and stem the oil price rise. It’s stupid logic that won’t go away. Bart Chilton advocated for position limits on all commodities and by a 3-2 margin, the CFTC enacted them. Recently, Morningstar analyst Adam Bailin confirmed my supposition that the position limits were bad for markets.
For the untrained in the market place, position limits are hard and fast rules that regulate how many contracts you can buy or sell in commodity marketplaces. The incorrect supposition is that speculators are buying and holding thousands of contracts that drive the price of oil higher. What regulators and lawmakers forget is that it’s a zero sum game. For every buyer, there is a seller. All positions net out and open interest is never an odd number when you include options positions.
When a regulator artificially curbs the amount of trading that can take place, bad things happen. First, there is less liquidity in the marketplace. Commodity marketplaces exist to transfer risk from one party to another. Speculators help to transfer that risk. They are the grease that lubricates the engine. Having transactions occur in a transparent marketplace like an commodity exchange($CME, $ICE, $NYX) is good! Regulators can see who is doing what, positions are margined so there is actual cash behind the activity. If there is a problem, they can spot it almost immediately and in real time since all trades are cleared that day. All accounts get debited and credited each and every day, sometimes in volatile markets twice a day. Speculation is actually a good side effect of a healthy marketplace because of the extra price transparency it provides.
What happens to the market when speculation is checked? The risk of undertaking business still exists and needs to be managed. Risk is ever present. Government regulators may be able to stop trading, but they can’t stop the cycle of risk that happens when companies do business.