Regulation Could Zap Energy Markets

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.

The PowerShares DB Energy ( DBE), up 60% from its February low of $16.43 to close at $26.25 on Wednesday.

A good way to mitigate the inherent risks involved with commodities is through the use of an exit strategy. According to the latest data at www.SmartStops.net, an upward trend in the previously mentioned ETFs could come to an end at the following price points: USO at $38.07 and DBE at $24.57. These price points change with market fluctuations and updated data can be found at www.SmartStops.net.

Written By Kevin Grewal in Laguna Niguel, Calif.

At the time of publication, Grewal had positions in equities mentioned.

Kevin Grewal is an editorial director and analyst at SmartStops.net where he focuses on mitigating risks and implementing exit strategies to preserve equity. Prior to this, he was an analyst at a small hedge fund where he constructed portfolios dealing with stock lending, exchange-traded funds and alternative investments. He is an expert at dealing with ETFs and holds a bachelor's degree from the University of California along with a MBA from the California State University, Fullerton.

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