Discuss may not be the proper term for the hearings as it appeared a foregone conclusion that hard positions limits will be applied to U.S. energy futures markets. CME Group CEO Craig Donohue stated in his testimony that the CME Group was prepared to accept such limits though he also warned of their danger.

CFTC Chairman Gary Gensler said he was happy to hear that the CME was prepared to accept spec limits indicating that he has reached a conclusion.

On the eve of the first hearing the Wall Street Journal and other media outlets, reported that the CFTC plans to issue a report next month that would place the cause for last summer’s run up in crude oil markets on speculators in contrast to previous reports by the agency that indicated the run up was due to supply/demand factors and which pointed out that index fund allocations to crude oil actually dropped during the run up. It is only worthy of note because there appears to be dual realities competing: those that believe speculators in the form of investors in long-only commodity indexes undoubtedly where the cause of the 2008 run-up in crude oil and those that believe fundamentals—albeit not the simple supply and demand fundamentals typically examined—were the cause. 

It seems counterproductive to hold hearings and debate policy among people with competing views of reality. You could come up with the perfect solution to a problem that doesn’t exist or create a new problem trying to fix something that is not broken.

The deeper question the hearings addressed is, if limits would be applied by the exchange or the CFTC — as is done in the agricultural markets — and what will happen with the hedge exemption that allows swap dealers and index traders to hedge long cash exposure in the futures markets. That discussion goes a little deeper and was discussed more in depth on the July 28 panel where mainly traditional commercial players in the futures markets complained about the affect the growth of commodity index funds have had on energy prices.

The arguments have become somewhat common. Crude oil has rallied despite bearish fundamentals: rising inventories and falling demand. Sean Cota of Cota and Cota Inc. made this point speaking on behalf of the Petroleum Marketers Association of America. He also stated that crude oil has risen precipitously in the last three months despite the dollar being flat over the same period; which indicates the importance of doing your own due diligence as crude oil and the dollar has been nearly perfectly negatively correlated.

While Cota is correct that the market appeared to defy other traditional fundamentals during this summer’s rally, that is not unique. If markets behaved a specific way based on a group of known facts everyone would make money—though they would have a hard time finding someone to take the other side of their trades.

The idea that someone could walk into a government agency and state something completely false is disturbing, though I may be being naïve. We have seen this with the current health care furor. I do not want to weigh in on that debate other than to say, if this is so bad why not make cogent arguments against it rather than conspiratorial rantings of government run death panels. Unfortunately this approach has precedence and produces results. As noted here before, Congress appeared to be herded into TARP by vague warnings of impending doom by so called experts who failed to spot the problem and seemed afraid to ask those experts for specifics. 

Perhaps this is because fear moves people to act while logic may invite more analysis. Though we hope the CFTC acts according to evidence and not the rantings of certain Congressmen who jumped on the speculators are responsible bandwagon and don’t appear capable looking beyond that.

Despite a Commodity Futures Trading Commission (CFTC) study released last September that disputed consistent and relentless arguments that speculators caused last year’s spike in crude oil, several members of Congress have persisted in pinning the blame on the large index funds that track various commodity indexes. There are several efforts to take away the hedge exemption that allows index traders hedging their cash exposure to commodity markets with futures to trade beyond speculation limits.

Those blaming speculators for price volatility would like to limit hedge exemptions to the traditional commercial participants who actually make or take delivery of a commodity.

Phil Flynn, senior energy analyst for PFGBest Research, who provided an outlook on crude oil at the panel, said it would be a mistake to restrict participation in commodity markets. “Liquidity always lowers volatility,” Flynn said, “[markets] have gotten more volatile because of the economy, not because of more participants.”

Stephan Platt, commodity futures strategist for Archer Financial Services, took a different view, noting that the size of the various commodity indexes has created big problems as various commodity futures markets rolled from month to month. “Commodities are finite and need to be treated differently,” Platt said.

Jack Scoville, vice president at Price Futures Group, said that the spike in wheat prices in 2008 was a “Cash market led rally, not a spec index funds rally.”

This goes counter to the report (Levin Report) recently released by the U.S. Senate Permanent Subcommittee on investigations regarding the wheat market. CFTC Chairman Gary Gensler in testimony before that subcommittee today noted, “The Subcommittee’s wheat report found that index traders were one of the primary causes for the large price spreads that inhibited convergence [in the wheat market]. The report recommended that the CFTC limit the positions of index traders to the standard speculative position limits for wheat futures. The CFTC is seriously considering this recommendation and will examine it in its upcoming hearings.”

Scoville said, “I am waiting for someone to show me how the funds have done this,” adding that if prices get to a level they should not reach, they will not remain there very long.

  Flynn added that restrictions on participation in the oil futures market could do damage to the market as large traders would hedge in the physical market. “They would be buying product and taking it off of the market…it would make trading less transparent,” Flynn says.   

The Dow Jones-UBS Commodity Index is up 3.74% in 2009 and there was approximately $27.5 billion tracking their group of indexes as of the end of the first quarter.