April 21, 2011

Ending the Speculation on Rising Gas Prises

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Since the collective bargaining dispute between the National Football League Players Association and the NFL owners has delayed many of the usual NFL offseason headlines, I have refocused my attention to perhaps more important social issues such as the rising gasoline prices and their possible cause(s).  Having changed my Google alert settings from “NFL free agent signings” to “energy price activities,” I was fortunate enough to learn about President Obama’s very recent and perhaps slightly questionable criticism of oil speculators in relation to the rising gas prices.

Among the many reports from other financial journalists, James Herron of the Wall Street Journal reported the criticism of oil speculators by the otherwise charismatic politician on Wednesday. However, even if we assume the truth of Obama’s claim that “what’s driving oil prices up right now is not the lack of supply … there’s enough supply,” it seems unfair to criticize, without qualification, speculators for the run-up in prices.

Firstly, if oil speculators are basing trades upon their reasonable beliefs that “there’s a 20 percent chance that something might happen in the Middle East that might disrupt oil supply,” as Obama suggested, then they are not only legally justified in their acts but they are also morally justified, for the exact role of any rational market participant is to act upon his or her individual expectations of price movements (i.e., expectations that are generally derived from sophisticated econometric forecasting models). The activities of a speculator can then be said to efficiently communicate information to other market participants, whom can inferentially compute respective valuations for the same commodity. So Obama’s general criticism of speculators seems undeserving, as they serve a fundamentally important role in energy markets by not only disseminating objective information to other market participants about their expected price forecasts but also by providing market liquidity.

It is very possible that, when Obama generally blamed oil speculators for the rise in gasoline prices, he had intended to qualify his criticism to market manipulators. Besides, when U.S. retail gasoline prices escalated from 2005 to 2007, Michael Greenberger (now a Professor at the University of Maryland School of Law) and Mark Cooper (now a Senior Research Fellow for Economic Analysis at the Institute for Energy and the Environment) both alleged before the United States Senate manipulation in wholesale petroleum and futures markets. In order to ensure that the petroleum wholesale markets would function properly, Congress soon thereafter authorized the Federal Trade Commission under the Energy Independence and Security Act of 2007 to regulate manipulative conduct in these markets.  So, if Obama had in mind market manipulators when he instead criticized speculators, then any trader partaking in manipulative conduct may soon find himself as the subject of an enforcement action. Actionable manipulative conduct involves the communication of inaccurate information to other market participants. With the FTC, the Commodity Futures Trading Com­mission, under Congress’ 1974 enactment of the Commodity Exchange Act, shares concurrent jurisdiction in the regulation of petroleum futures markets. Therefore, both Commissions may theoretically bring separate enforcement actions for one single act (or a pattern of acts) involving a trader who either placed uneconomic trades (e.g., by placing trades outside of market established bid/ask spreads) to benefit other market positions or disseminated verbal/written misinformation into the marketplace.

The overlapping oversight of petroleum markets would seem to shrink the probability that any manipulative conduct in itself may cause shocking escalations in gas prices. Surely the FTC and the CFTC will continue to vigilantly and fairly oversee these markets. Market experts ranging from academics to former Wall Street talent have staffed the Commissions. Moreover, the FTC and the CFTC employ esteemed legal staffs, as many of their lawyers bring with them years of experience from some of the most selective corporate law firms. So if gasoline prices do in fact reach $5.00 per gallon, as some forecasters are predicting, then maybe we should fairly delay our criticisms of speculators until we are certain that other causes (e.g., “the lack of supply”) are not in play.

Adam Garnica is pursuing a joint graduate degree candidate in Law and Biological and Environmental Engineering. Adam has conducted laboratory research focused on the production of bioenergy from industrial wastes in the Angenent Laboratory at Cornell University and has also worked in a legal capacity at the Federal Energy Regulatory Commission, researching energy derivative markets and manipulative trading practices. He may be reached at adg68@cornell.edu. Barely Legal appears alternate Fridays this semester.

Original Author: Adam Garnica