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Regulation Could Zap Energy Markets

Stocks in this article: USO DBE

NEW YORK ( TheStreet) -- Over the past few months, the Commodity Futures Trading Commission has been watching the energy markets with a microscope and contemplating imposing position limits to curb the effects of speculation.

This is unfortunate, because more regulation will likely do more harm than good.

Position limits control the amount of market share that any one player can amass. Currently, exchanges such as the CME set position limits for energy futures and options. But the CFTC would enforce its proposed limits, which would cover positions in a contract for a single month as well as positions over multiple months in a specific product.

These limits would be in addition to the existing hard position limits during the last three trading days before expiration. The tighter restrictions would likely result in energy traders going to international markets to execute trades or utilizing swap contracts, which would impede market transparency.

Another consequence of energy traders looking elsewhere would be a lack of liquidity. That could impair the ability of market participants to mitigate price risks. After all, a benefit of having speculators in the marketplace is increased liquidity.

Lastly, extensive research suggests that it is the basic economic principles of supply and demand, not speculators, that cause the volatility and price swings in the energy markets. Therefore, adding regulations and regulatory bodies is completely unnecessary.

The key to the energy markets is understanding backwardation, contango and market forces, not imposing additional position limits.

Some equities likely to be hurt by position limit regulations are:

The United States Oil Fund (USO), which is up 77% after a February low of $22.86 to close at $40.55 on Wednesday.

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