Regulating Oil and Onions...

By Lisa Margonelli

The US is reportedly considering regulating "speculative" trading in the oil and gas markets, according to the New York Times. This brings to mind recent discussions on onions and a very mysterious competitive ballroom dancer accused of Wall Street espionage.

The relevant quote from the NYT about the perceived need to regulate the oil futures market is here:

"Oil prices have swung wildly in the last year, hitting about $145 a barrel last summer, then plunging to $33 in December before rising to about $70.

Much of that gyration stemmed from chaos in the global financial system, as banks and much of Wall Street came perilously close to collapse last September and the global economy fell into the most severe recession in decades.

But a growing number of critics have blamed some of the extreme volatility on the role of purely financial investors -- those who are simply betting on the direction of energy prices, as opposed to those who actually use such products, like airlines."

While more transparency in the markets definitely seems like a great idea--and the Commodity Futures Trading Commission is hoping to make records of trades more accessible--I do wonder about discerning trader's intent and tying their hands in the markets. What if an airline decides to make money on their oil trades? The futures market trades such a small volume of paper barrels (in comparison to the full number of barrels of oil traded daily) that it functions more like an index, anyway. And what happens if Exxon, say, decides to use the futures market to hedge against currency changes? Arbitragers are another target, apparently, but we love them when they make prices lower, which they do whenever they transfer cheap oil to our hot market. 

Two thoughts come to mind: First, there's been a fascinating discussion of onion futures over at Platt's. Apparently onions are the only commodity that is prohibited from being traded in a  futures market. And yet! Onion futures prices are the very definition of wild gyration! 

From Platts Powerline: "The average price of a hundredweight of onions in the US swung from over $50 in April of 2007 to below $5 by that December. "Indeed, they lost 96% of their value between April 2007 and March 2008, before quadrupling in the following month," said Barclays analyst Paul Horsnell."  Be careful what you wish for. 

Secondly: Machine trading. There's a strange case of industrial espionage out of Goldman Sachs that suggests that they've been doing a lot of trading in stock markets (explicitly) and possibly also in commodities markets. Automated trading in which computers use calculations to trigger trading, which may in turn trigger trading among other machines may be a more relevant place to poke around than trying to figure out the intention of hedge funds and other oil traders. According to Bloomberg, machines made 28 percent of stock market trades in the fourth quarter. For the implications for possible market manipulations, see this post at ZeroHedge. (Hat Tip to Salon's Andrew Leonard, who also posts video of the alleged perp's ballroom dancing.) I'm going to have to poke around to see if there are numbers on automated trades in the oil market, though I've heard anecdotally that the numbers are growing.   The story is satisfyingly cloak, dagger, and mainframe, and it suggests that we need to figure out what is actually going on in the futures market before we start trying to regulate it.

This article available online at:

http://www.theatlantic.com/technology/archive/2009/07/regulating-oil-and-onions/20810/