As has been well-publicised, the Commodities Futures Trading Commission (CFTC) is considering increasing position limits in energy commodities trading, on the perception that large speculative inflows may have contributed to last summer’s epic oil price-moves.
Whether speculators were indeed to blame, however, is still being hotly debated — as, for that matter, is the question of how effective position limits on non-commericial entities might actually be in curbing volatility.
Yet there is a precedent to look to.
Between June-December 2005 the Chicago Board of Trade and the CFTC increased position limits on non-commercial players in corn, wheat, soybean and oat-futures markets, also on fears that speculators were disconnecting prices from supply and demand, and hence increasing volatility.
In November 2006, the University of Illinois department of agricultural and consumer economics looked to see just how effective those position revisions had been in simmering volatility. Here are some of their findings (our emphasis):
The analysis of price volatility revealed no large change in measures of volatility after the change in speculative limits. Only a small number of observations are available since the change was made, but there is little to suggest that the change in speculative limits has had a meaningful overall impact on price volatility to date. The limited change in volatility points to markets that were sufficiently developed prior to the change in limits to allow for the influx of new trading activity without altering their basic daily volatility.
On the issue of convergence between cash and futures prices — an indication of how closely futures are indeed tracking supply and demand:
The analysis of convergence revealed differences in the degree of convergence before and after the changes in speculative limits. Non-convergence was observed in some delivery markets for corn and soybeans beginning as early as July 2005, but non-convergence was most prominent in March, May and July 2006. A return to more normal convergence was observed in September 2006, particularly for corn at Illinois River locations. The difference in convergence before and after July 2005 was likely only partially related to the change in speculative limits. Other factors included higher futures values, higher barge rates, and a large carry in the market that impacted the delivery process.
Non-convergence in the wheat market was also observed for the Chicago and Toledo markets after the change in speculative limits. The difference in convergence before and after July 2005 was likely only partially related to the change in speculative limits. Inflated values of Chicago futures associated with the small supply of wheat in classes other than soft red winter wheat and a large carry in the futures market likely contributed to the period of weak basis and poor convergence. However, unlike corn and soybeans, basis levels during delivery remained extremely weak for an extended period of time and became weaker over time. The analysis of interior basis for corn, soybeans and wheat revealed a period of weaker basis after the change in speculative limits (less so for hard red winter wheat). That difference likely reflected the same factors that resulted in poor convergence. Conditions in early October suggested that interior basis levels were returning to more normal levels for corn and soybeans, but not for soft red winter wheat.
The key recommendation from the report, meanwhile, was one that still very much applies to today — the need to clarify the blurry definition of what constitutes a speculator anyway:
Finally, there is a clear need for the CFTC Commitment of Traders reports to provide more transparency relative to the trading activity of various groups of market participants. The report was originally designed to reflect trading activity of large hedgers, large speculators and small traders. Over time, the classifications of large commercial and non-commercial traders have become less reflective of the original intent. That trend has been accelerated by the recent, sharp increase in trading activity of non-traditional funds. The report needs to more clearly reflect the nature of trading of market participants.
View the whole report in the Long Room.