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Oil Speculation

In January of this year, the Commodity Futures Trading Commission proposed a new rule that would set limits on who can trade futures in the oil market.  The CFTC has rightly determined that the sudden increase of oil contract futures in Mid-2008 was caused by speculators who did not have a “legitimate commercial interest” in buying oil contract futures other than to enrich themselves by playing a market.  As a result, oil contract futures shot rapidly upward to $150/barrel.

Under the CFTC rules a Speculator is defined as an individual or group who is trading in a commodity that has no legitimate commercial interest in that commodity who is purchasing that oil contract future as an investment with no real intention of taking possession of the oil.  As an example, those who do have a legitimate commercial interest would be trucking companies, airlines, ship owners, taxicab companies, etc.  A trucking company may choose to buy oil contract futures at a given price to hedge against a future rise in prices.

What happened in the Summer of 2008 was rampant excessive speculation set the price in the oil contract futures market causing irreparable damage to thousands of trucking companies who were forced into insolvency since they could not afford to fill their tanks with fuel as the price rose faster than they could collect on their accounts receivable.  This affected the balance of loads vs. capacity and shipping rates rose dramatically.  Airlines that were on the verge of profitability (for once) suddenly were hit with quickly rising fuel prices that they could not pass back to their passengers who had already prepaid for their tickets.  Everyone suffered—except the Speculators! So the proposed new rule by the CFTC would put position limits on the amount of trading that speculators are allowed to make for a given commodity such as oil.

This is not a new law but only a proposed rule.  Some people are saying that it is about time.  Others are concerned because the comment period for everyone to submit their comments to the CFTC ends on April 26th and the proposed new rule has limits that would only affect the top ten traders and leave a host of smaller traders untouched as long as they did not speculate beyond certain limits.  When asked by critics why the limits were so high, a spokesman for the CFTC said that the reasoning behind keeping the limits high was the concern that by setting the limits low, most traders would go to the unregulated markets.  This, of course, poses the question:  What will keep the top 10 speculators who the proposed new rule is supposed to keep from over-speculating from doing the same thing in the unregulated markets?

The system is still broke! Oil contract futures are also bought and sold in the international market place.  Although the proposed new rule might help if the top 10 speculators agree not to go to the unregulated markets (ie, the unregulated world markets not controlled by the CFTC), we are still at risk to the same thing happening again and oil suddenly rising to $150 barrel in the future.

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