One Way to Tame Speculation in Oil Futures

The solutions recently floated in Washington and by the talking heads on CNBC to remove speculation premium in the oil markets won't work. I'm not advocating it, but there is one idea that would work in testing how much speculation is really in the market: mandating a "liquidation only" restriction, which has in fact been used in the past.

Let me tell you about this idea and why I believe this is going to happen and what it will mean for the oil markets and your portfolio.

I've been a strong advocate for the position that the price of oil, while under fundamental upward pressure, contains an enormous speculation premium, perhaps as much as 50% of the price. Being a believer in the speculation argument has gotten me in a little bit of trouble, because my points have been easily misunderstood. For one, I've always argued that the speculation in the market has not been manipulative but just a rush to improve gains in commodities when "regular" asset classes haven't performed as well (boy, is that an understatement).

The futures markets, however, were designed as simple price discovery mechanisms and were never intended to be used as large-scale investment vehicles. Because of this, the rush to invest in oil and other commodities has had a geometric effect in price that you would not witness with other asset classes. In previous columns we have discussed these subtle but critical market differences.

Another difficulty in pointing out the overarching price inflation of speculation has been the obvious follow-up: What to do about it? Everyone wants to save the world in 30 seconds. And while I am convinced that speculation is driving the price of commodities ever higher, I am far less convinced of the efficacy of any of the proposed solutions that I continue to hear coming out of Washington and elsewhere in removing that premium. Unfortunately, some problems do not lend themselves to simple solutions, and this is one of them. Let me tell you why.

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At the time of publication, Dicker had no positions in stocks mentioned, but positions can change at any time.

Dan Dicker has been a floor trader at the New York Mercantile Exchange with more than 20 years' experience. He is a licensed commodities trade adviser. Dan's recognized energy market expertise includes active trading in crude oil, natural gas, unleaded gasoline and heating oil futures contracts; fundamental analysis including supply and demand statistics (DOE, EIA), CFTC trade reportage, volume and open interest; technical analysis including trend analysis, stochastics, Bollinger Bands, Elliot Wave theory, bar and tick charting and Japanese candlesticks; and trading expertise in outright, intermarket and intramarket spreads and cracks. Dan also designed and supervised the introduction of the new Nymex PJM electricity futures contract, launched in April 2003, which cleared more than 600,000 contracts last year alone. Its launch has been the basis of Nymex's resurgence in the clearing of power market contracts over the last three years. Dan Dicker has appeared as an energy analyst since 2002 with all the major financial news networks. He has lent his expertise in hundreds of live radio and television broadcasts as an analyst of the oil markets on CNBC, Bloomberg US and UK and CNNfn. Dan is the author of many energy articles published in Nymex and other trade journals. Dan obtained a bachelor of arts degrees from the State University of New York at Stony Brook in 1982.