A New Plan to Curb Oil Price Volatility

The bill proposes a number of changes to ensure that prices at the pump reflect the fundamental supply and demand for oil, and not short-term price bubbles created by speculators and financial traders. More specifically, in a summary provided by the Senator's office, the bill:

• Clarifies one of the fundamental objectives of the Commodity Exchange Act is to ensure that the commodity markets "accurately reflect the fundamental supply and demand for commodities."
• Defines "excessive speculation" and creates legal presumptions that would give rise to a determination that excessive speculation exists.
• Establishes individual speculative position limits for energy futures, options, and economically similar contracts, wherever they are traded (on-exchange or over-the-counter). The position limits would be set at five percent of deliverable supply in the spot month and five percent of open interest in the out-months. The speculative position limits would not apply to bona fide hedging transactions. No single trader could hold more than five percent of the oil futures market, thereby greatly reducing the risk that any trader will be able to corner, squeeze, or otherwise manipulate oil and gas prices.
• Establishes aggregate speculative position limits in energy contracts that would apply to speculators as a class of traders. The aggregate position limits would cap the overall level of speculation in the market at its historic, 25-year average. The effect would be to reduce oil speculation from the 45 percent of the total market to 20 percent of the market. The aggregate speculative position limits would not apply to bona fide hedging transactions.

Much of this legislation is aimed at commodity index funds, which have experienced explosive growth and are estimated to hold $300 billion in commodity positions. There are those that contend that the commodity index funds are "liquidity takers and not liquidity providers" and they deprive bona fide hedgers sufficient market liquidity and at the same time disrupt commodities futures markets and physical markets in ways that distort price discovery. Commodity markets exist for the purpose of providing producers and purchasers of physical commodities to hedge their risks, while financial speculators provide commodity markets participants with sufficient liquidity. Historically hedgers have made up about 70 percent of the market and financial speculators about 30 percent. With the advent of the commodity index funds, financial speculators have overwhelmed the commodity markets and have driven out bona fide physical hedgers. The percentage of participant position holders has reversed and speculators now hold 70 percent of the open interest while physical hedgers have declined to hold only 30 percent.

While the likelihood of passage for the Nelson bill is low (due to partisan politics) the CFTC needs to provide rules in response to the Dodd-Frank Act that restore the integrity of the commodity futures markets and ensure a level playing field for many of the financial contracts that trade on unregulated exchanges.