The New York Times' Dealbook blog alerts us to a superb paper from Amy Jaffe and Kenneth Medlock at the Baker Institute for Public Policy at Rice University: Who Is in the Oil Futures Market and How Has It Changed?"
Medlock and Jaffe do not discount the role that speculators provide in creating a liquidity that allows future markets to function efficiently for the physical producers and consumers of a given commodity. But they zero in on one all-important point: Just how large, exactly, should the market presence of speculators be to "facilitate the smooth functioning of markets"?
The bottom line: Limits on speculative activity used to be much tighter, but since the passage of the Commodity Future Modernization Act in 2000, regulatory supervision and control has dramatically weakened.
"In the review of the data in this brief paper, we find that noncommercial players now constitute about 50 percent of those holding outstanding positions in the U.S. oil futures market, compared to an average of about 20 percent prior to 2002. The change in market composition was driven by the rapid entry of noncommercial participants and was the principal factor behind the increase in total open interest. It is also highly correlated with the run-up in oil prices. Moreover, as will be expounded below, there appears to have been a substantial change following the passage of the Commodity Future Modernization Act (CFMA) in December 2000.
HTWW has been exploring the impact of lax regulation on commodity speculation for several years, with particular focus on the impact that Enron's successful lobbying of Congress had on energy trading. Medlock and Jaffe's paper adds some important detail to this story.