I am an economist, not a legal expert. In the present article I won’t comment on whether the individual traders “manipulated” markets in violation of the Commodity Exchange Act. Rather, I will argue that penalizing “manipulation” of markets is actually economically counterproductive. Furthermore, even if these allegations are true, these particular traders had little to do with the huge run-up in oil and gasoline prices in the first half of 2008. As the government’s case itself alleges, the defendants pushed oil prices up and then back down a few weeks later.

The Allegations

As reported by the New York Times:

The suit says that in early 2008 [the defendants] tried to hoard nearly two-thirds of the available supply of a crucial American market for crude oil, then abruptly dumped it and improperly pocketed $50 million.

In the case filed Tuesday, the defendants — James T. Dyer of Australia, Nicholas J. Wildgoose of Rancho Santa Fe, Calif., and three related companies, Parnon Energy of California, Arcadia Petroleum of Britain and Arcadia Energy, a Swiss company — have told regulators they deny they manipulated the market.

The commodities agency says the case involves a complex scheme that relied on the close relationship between physical oil prices and the prices of financial futures, which move in parallel.

In a matter of a few weeks in January 2008, the defendants built up large positions in the oil futures market on exchanges in New York and London, according to the suit….At the same time, they bought millions of barrels of physical crude oil at Cushing, Okla., one of the main delivery sites for West Texas Intermediate, the benchmark for American oil, the suit says. They bought the oil even though they had no commercial need for it, giving the market the impression of a shortage, the complaint says.

At one point they had such a dominant position that they owned about 4.6 million barrels of crude oil, estimating that this represented two-thirds of the seven million barrels of excess oil then available at Cushing, according to lawsuits.

The traders in mid-January cashed out their futures position, and then a few days later began to bet on a decline in oil futures, with Mr. Wildgoose remarking in an e-mail about the “inevitable puking” of their position on an unsuspecting market, the federal lawsuit says.

In one day, Jan. 25, they then dumped most of their holdings of West Texas Intermediate oil, and profited by the drop in futures.

The traders repeated the buying and selling in March 2008, and were preparing to do it again in April but stopped when investigators contacted them for information,the suit says.

What Goes Up, Must Come Down

The most obvious problem with blaming these particular traders for any large moves in the oil market is that they held their position for less than a month. Even if the allegations are perfectly accurate, then the traders began accumulating the physical crude for a few weeks in January, reversed their position in the futures markets (to position themselves to profit from a fall in price), and then dumped most of their physical holdings on January 25. They apparently repeated the process in March, and shied away from trying again in April because of heat from investigators.

The crucial point about the alleged scheme is that it was self-reversing. The strategy worked by (a) buying futures contracts at low prices, (b) hoarding physical oil in order to drive up the futures price, (c) cashing out the futures contracts and even taking a net negative position, and finally (d) driving the futures price back down by dumping the physical oil. In other words, the traders allegedly made money both driving oil prices up and then back down. Since they had more insight into the large swings in inventory to which other traders would react, these particular traders were allegedly able to make money both ways.

Therefore, even if these traders behaved just as the government claims, their actions can’t possibly explain the jump in crude prices from about $92 per barrel in December 2007 to a whopping $134 per barrel (average monthly price) in June 2008. Hoarding and then dumping physical oil—in bursts of a few weeks—at worst can make oil prices more volatile; it can’t drive them systematically higher for months at a time.

If anything, these lawsuits demonstrate just how difficult it would be for speculators to drive up oil prices significantly above the level justified by the “fundamentals,” especially if they wanted to make it a “sure thing.” Even though they apparently gained control of two-thirds of the excess Cushing inventory, these traders only made $50 million from the scheme. That’s a lot more money than I made in 2008, to be sure, but it can hardly explain giant movements in the world price of oil.

Speculators Perform a Useful Function in Markets

As I have explained in previous posts, speculators perform a useful function in markets. To the extent that they correctly anticipate future price movements, they actually dampen the volatility in the spot price. This is obvious: Speculators earn profits when they buy low and sell high (or short-sell high and cover low). So if a commodity such as oil will have a price rise in the near future, speculators start pushing up the price now in anticipation. Conversely, if a commodity is current overvalued (in the sense that it will drop in the near future), then successful speculators start the process right away by selling.

The twist in the current story is that (allegedly) the traders were dabbling in both the physical and futures markets. So it’s true, their “speculative” trades smoothed out prices. However, one could argue that their buying and selling in physical crude actually introduced far more volatility in the spot price than their futures trading softened.

This may seem a pedantic point, but it’s important for people to understand the role of futures markets. To say it in other words: It was not their “speculating” on futures prices that actually caused the volatility in oil prices, but rather their accumulation and then dumping of the physical crude. (Of course, the reason they allegedly acted this way in the physical market, was because it allowed them to earn speculative profits in the futures market.)

Now for the tough question: Was there something illegitimate economically about hoarding and then dumping physical crude inventories? According to the various press accounts, I have not seen any allegations of actual fraud on the part of the traders. For example, they didn’t buy the oil, blow up one of their warehouses, and then falsely tell the police, “We lost all of our oil in the blaze.”

No, it appears (on the basis of the press accounts) that they simply purchased large holdings of physical crude, and others in the market assumed that the oil was being used for refining or other purposes. It was thus a surprise when the oil was dumped back into the market at the end of January, a few weeks later.

To repeat, to the extent that this “trick” really worked, it didn’t change the long-term price of oil (or gasoline). The $50 million profit reaped by these traders would have come largely at the expense of other oil traders (not average consumers) who were caught with their pants down both on the way up and on the way down in the futures market.

Going forward, savvy competitors presumably would have tried to avoid such a trick in the future. If they saw an apparent tightness in the Cushing physical market, they would think twice before pushing up the futures price, since it might come crashing down a few weeks later. People can’t simply make $50 million automatically, month after month, in the commodities and futures markets, the way the critics seem to think. Other speculators would adapt and quickly stamp out such opportunities.

The problem with giving government regulators the task of stamping out such “anti- social” trading is that they will mute the ability of the market to respond to genuine threats of crude shortages. Because of the lawsuits, oil traders will be less willing to acquire physical inventories even if they believe the fundamentals justify a rising price over time. Such traders would be afraid that the government would accuse them of causing the movement in prices, even if they were genuinely just trying to anticipate it.

Conclusion

So long as they don’t use violence or fraud, people in a market economy generally make profits by serving others. This is easy to see in the cases of successful entrepreneurs like Bill Gates or Oprah Winfrey. It’s not as easy to understand when it comes to successful traders in the futures market, but the presumption is still present. Whether or not the defendants in the recent CFTC case actually broke the law, the charges against them will weaken the market’s ability to adapt to future supply and demand conditions in the oil industry. Finally, people should always keep in mind that speculators drive prices down in response to good news. When President George W. Bush announced the end of the Executive Branch moratorium on offshore drilling, oil futures prices fell $9 during the speech.

Speculators are characterized as cogs in the Wall Street greed machine who seek to make a quick buck off betting on oil commodity futures, an idea that many are all too happy to entertain in this post-financial meltdown age. However, the argument that speculative activity has caused this most recent escalation in gas prices ignores the fact that there has been speculation on commodities for centuries, and as Stossel writes, the players are “no more greedy or clever than they have been all along.”

The answer is, in fact, much more simple than politicians want you to believe as they lay blame at the feet of oil companies and speculators. It’s a straightforward matter of supply and demand. World crude oil and liquid fuels consumption grew to the highest level ever in 2010, with 86.7 million barrels per day (bpd) consumed in total. Most of the increase can be attributed to countries outside the Organization for Economic Cooperation and Development (OECD)—China, Brazil, and those in the Middle East—where rapid economic growth and quality of life improvements have led to increasing amounts of energy being used. Fatih Birol, chief economist at the International Energy Agency, said growth in worldwide oil demand is exceeding growth in new supplies by 1 million bpd per year, with much of the new demand coming from China. Factor in Organization of the Petroleum Exporting Countries (OPEC) production restraints that seek to maintain favorably high oil prices, anticipated losses in Gulf of Mexico production, and recent global disruptions, it is unsurprising that oil commodity prices have spiked.

Furthermore, the U.S. Federal Reserve’s second round of inflationary monetary policy (QE2) has prompted investors to flee a devalued dollar in favor of non-income generating real assets, like oil and precious metals, and makes crude cheaper for investors using foreign currencies. As in 2008, when the first round of the Fed’s inflationary monetary policies began, oil prices have steadily risen since Federal Reserve Chairman Ben Bernanke’s announcement that the easy money policies may continue past the end of QE2 this June.

Speculators are merely a symptom of oil spikes, not the cause. Birol, in an interview with CNNMoney, said, “Speculators are only responding to what is going on in the markets… We don’t see enough oil in the markets. The major driver is supply and demand.” Furthermore, speculation even serves as a stabilizing function in a market that would otherwise be exceedingly volatile. In his op-ed, Stossel writes:

“Speculators help keep prices stable. When they foresee a future oil shortage—that is, when prices are lower than anticipated in the future—speculators buy lots of it, store it and then sell it when the shortage hits. They know they can charge more when there’s relatively little oil on the market. But their selling during the shortage brings prices down from what they would have been had speculators not acted.”

To reinforce the point that speculation is a legitimate economic function and that federal intervention would ultimately prove to be worse than the status quo, Stossel cites the 1958 Congressional action to ban speculation on onion prices. That’s right, Congress passed a law, amid mass public outcry, to ban speculative activity on the price of onions. The end result? Onion prices are actually some of the most volatile of all goods, and a study by the Financial Times found that the ban actually did the opposite of the intended effect.

Instead of trying to meddle with the market, Washington should focus on removing the roadblocks to domestic energy exploration to give America more leverage in the oil game. When President Bush finally lifted the U.S. embargo on its own offshore oil in July 2008, the price of oil dropped $9.26 per barrel while he was giving the speech. Crude oil traders and speculators believed that oil supplies would increase in the future, reducing prices. However, it is interesting to note that the market had a fairly apathetic response to President Obama’s recent proposals to increase domestic production.

The only marginal decrease in oil prices since the President’s announcement is indicative that players in the market do not anticipate that the proposals—which are simply reversals of policies implemented during the Obama Administration—will significantly increase the supply of oil. To impact oil prices on the scale of what happened when the Outer Continental Shelf (OCS) moratorium was lifted in 2008, the Administration will need to adopt an energy policy that includes exploration in ANWR, more of the OCS, and more than the current 3 percent of onshore federal lands that are available for leasing. Until the Administration takes these major steps to produce more oil at home, its recriminations against speculators and shadowy market manipulators hold little water.

Although it might provide emotional relief, punishing speculators is a classic case of shooting the messenger. And whatever the merits of restructuring the tax code, surely raising liabilities for oil producers won’t make them increase activity.

If President Obama really wants to get to the heart of rising oil (and food) prices, he should have a long talk with Ben Bernanke, whom he reappointed as Chairman of the Federal Reserve. By flooding the world with dollars, Bernanke has driven up commodity prices across the board as the dollar depreciates.

Speculators Are Doing Their Job

As I explained in a previous post, speculators in the commodities markets are doing exactly what we want them to do, in light of the events in the Middle East. To understand (partly) why oil has risen so much in recent months, I can quote from Obama himself:

The problem is … speculators and people make various bets, and they say, you know what, we think that maybe there’s a 20 percent chance that something might happen in the Middle East that might disrupt oil supply, so we’re going to bet that oil is going to go up real high. And that spikes up prices significantly.

To reiterate, this is the textbook function of socially beneficial speculation. If there is a possibility that prices will rise sharply in the near future, then current prices should rise to reflect that reality. The higher price leads to more careful usage of the resource, while it simultaneously prods other producers to ramp up their output.

The current configuration of oil prices—both in terms of the spot market and the “futures” prices at various dates—give the incentive to pump oil as fast as possible[1] (to earn the high prices while they last) and to stockpile the excess production. In the event that extraction capacity is impaired because of the Libyan war or some other political event, we will be glad to have extra inventories.

It’s true that sometimes speculation can get caught in a self-fulfilling prophecy, and push an asset up into an unsustainable bubble. (This is what happened with real estate prices in a few years ago.) Nobody is claiming that people in the financial sector are infallible. The point, however, is that speculators are only bidding up the price of oil today, because they anticipate—and with good reason—that it will be higher in the near future. To blame high oil prices on speculators is akin to blaming winter on thermometers.

If President Obama wants to harness the forces of financial speculation the other way, all he needs to do is announce policies that favor increased domestic production of oil. When President Bush ended the executive moratorium on offshore drilling in 2008, the financial markets pushed down the price of crude oil by $9 per barrel during the speech.

Since When Do Tax Hikes Lead to Lower Prices?

The issue of simplifying the tax code is full of nuances. For those who favor a free market, where the government doesn’t pick winners or losers, the best tax code (if we must have a tax code at all) is one that has low marginal rates and a wide base. The objective is to raise the desired amount of revenue with as little distortion to what the market would have done in the absence of such taxation.

Unfortunately, we are not designing a tax code from scratch, but are taking the current, convoluted creature as the starting point. In this context, the twin goals of “eliminating tax loopholes” and “reducing the burden on the private sector” conflict with each other. Economists and other policy wonks can have honest disagreements about the desirability of removing this or that “tax subsidy” to energy companies or any other group.

However, what should not be in doubt is that raising taxes on a particular industry will decrease output and raise prices for consumers. It is therefore nonsensical when President Obama, Dennis Kucinich and others suggest that a proper remedy for high gas prices is to saddle Exxon and others with higher tax bills. Yes, the high price of oil has a lot to do with the high profits of oil companies, but it doesn’t follow that taxing away more of the oil companies’ profits will therefore reduce oil prices.

Ironically, the environmentalist left should understand this principle quite well. What do they recommend to get people to use less carbon-intensive goods? Why, they recommend imposing a tax on such activities. In the context of a carbon tax, the left understands basic economics: If you want to discourage people from doing something, you impose a tax on it.

Turn back to oil prices. If the government wanted to reduce oil production and thereby increase oil prices, it should impose higher taxes on oil producers. If the goal instead (as Obama and Kucinich claim) is to lower oil and gas prices, then they should be calling for tax breaks for those companies in the business of producing and refining oil.

In another ironic twist, it turns out that historically, high oil prices go hand-in-hand with higher effective tax rates on oil companies. In other words, given the complexities of the current tax code, the actual percentage of the oil majors’ income going to Uncle Sam is higher, when the price of oil is high. For example, in 2008 the effective rate was 42.3 percent, but in 2009 (when the average price of oil was far lower) the effective tax rate had plummeted to 26.3 percent. In this respect, people who want the oil majors to “pay their fair share” should actually be rooting for high oil prices.

The Role of the Federal Reserve

Beyond the short-term price hikes due to the political situation in the Middle East, the price of oil has risen along with other commodities because of Ben Bernanke’s monetary policies. The graph below shows the changing fortunes of the US dollar and crude oil prices, quoted in dollars:

As the financial crisis set in during the fall of 2008, the price of oil (red line, right axis) collapsed from its all-time highs. At the same time, the dollar (blue line, left axis) appreciated strongly against other currencies, as investors sought a safe haven in U.S. Treasury securities. (When foreign investors want to buy American assets, they have to sell their own currencies to buy dollars.)

But these trends reversed in early 2009, when Ben Bernanke announced the first major round of “quantitative easing.” Since its 2009 peak, the dollar index has fallen about 15 percent against other currencies, while the price of crude oil has more than tripled. So some of the price rise in oil (quoted in dollars) is directly due to the falling dollar itself, as oil is traded on world markets and must be the same price to all buyers (quoted in their own currencies).

However, it would be wrong to conclude that most of the rise in oil is due to the its “fundamentals.” Investors around their world are rushing into commodities (in part) to hedge themselves against the possibility of significant future price inflation. The Fed and other major central banks have been creating money at full tilt since mid-2008, and many investors want to avoid getting wiped out by a possible flood of price rises. Because the economy is so awful, many investors are heading into things that will always be useful, namely commodities.

To underscore that this isn’t merely an issue of the “fundamentals” of crude oil, note that gold is hitting all-time highs while silver has more than doubled in the last 12 months alone. Yes, in one sense all of these moves are caused by “speculators,” but they are speculating with good reason: Bernanke and other central bankers are injecting more liquidity into the financial sector than has ever been done in world history.

Conclusion

Markets are complex and there are many reasons for particular price movements. However, when it comes to high oil prices, we can be fairly confident in saying that new tax hikes will not fix the problem, while tighter Fed policy would.

The following excerpt captures the essence of the entire segment:

And [last July] when oil doubled to more than $147 a barrel, no one was more suspicious than Dan Gilligan.

As the president of the Petroleum Marketers Association, he represents more than 8,000 retail and wholesale suppliers, everyone from home heating oil companies to gas station owners.

When 60 Minutes talked to him last summer, his members were getting blamed for gouging the public, even though their costs had also gone through the roof. He told Kroft the problem was in the commodities markets, which had been invaded by a new breed of investor.

"Approximately 60 to 70 percent of the oil contracts in the futures markets are now held by speculative entities. Not by companies that need oil, not by the airlines, not by the oil companies. But by investors that are looking to make money from their speculative positions," Gilligan explained.

Gilligan said these investors don’t actually take delivery of the oil. "All they do is buy the paper, and hope that they can sell it for more than they paid for it. Before they have to take delivery."

"They’re trying to make money on the market for oil?" Kroft asked.
"Absolutely," Gilligan replied. "On the volatility that exists in the market. They make it going up and down."

The Benefits of Futures Markets

As we explained in an IER study issued last summer, the commodities futures markets perform a vital function by allowing parties to “lock in” a price of oil months or even years in advance. By removing their exposure to huge price swings, both oil producers and major consumers (such as refiners and airlines) can more confidently plan their future operations.

For example, the owner of an oil field might be willing to sink new wells if he expects oil prices to average at least $50 per barrel in 2010, while an airline might expand its service area to include a new city, but only if it can buy oil at less than $75 per barrel throughout 2010. If there were no futures markets, the oil producer and airline might decide to play it safe, rather than investing millions in projects that could prove unprofitable if oil prices move the wrong way. But fortunately with sophisticated financial markets, the two enterprises can hedge away this risk with futures contracts. The oil producer can sell (“go short”) futures contracts, agreeing to sell his output in 2010 for, say, $65 per barrel, and the airline can take the other side of the contracts. Both parties benefit by locking in the price of $65, rather than being subject to the volatile spot price of oil.

Successful Speculation Reduces Price Volatility

Just about everyone agrees on the benefits of futures markets when the buyers and sellers are those who physically deal with oil by the nature of their business. But even non-traditional “speculative” buyers—who plan on unloading their futures contracts before taking physical delivery—perform a useful service if they accurately forecast price moves.

The motto of the speculator is to “buy low, sell high.” (Or a more sophisticated version is to “short-sell high, cover low.”) But these actions reduce the volatility in the market, because the speculator’s buying pulls up prices when they are too low, while the speculator’s selling pushes down prices when they are too high. This is exactly what consumers want speculators to do. When the price strays from where they “ought” to be, an astute speculator comes along and knocks it back into line.

Now it’s true that many investors piled into commodities through the summer of 2008, thinking they would move ever higher—and then they had the rug pulled out from them in August and September. But we don’t need the government to impose penalties on such faulty speculation (which pushed prices the wrong way), because these investors lost their shirts! The market itself provides the appropriate reward and punishment for wise or foolish forecasts.

People often forget that for every speculator who “went long” on oil futures contracts, there was another party who had to go short. Indeed, after the 60 Minutes piece aired, investment manager Kevin Duffy reminded us of his warnings to clients over the summer that oil was overpriced. His hedge fund, Bearing Fund, shorted futures contracts and made money from the accurate call.

Another wrinkle in the typical complaint against speculators is that the statistical evidence shows the causality ran in the opposite direction. According to the CFTC’s analysis of confidential data, it was far more typical for a price change in oil to precede a change in investors’ holdings, rather than vice versa. Yes, big investors were enlarging their clients’ exposure to commodities in 2007 and 2008, but this was often because these sectors were outperforming others. So it wasn’t that a bunch of pension funds rushed into oil, and pushed up its price. Rather, the rising price of oil led to more and more investment in oil futures, by fund managers who were trying to shield their clients from skyrocketing energy prices. The process was mutually reinforcing, but the line between hedging and speculation is blurred. After all, soaring oil prices were hurting stock performance. By diversifying holdings to include commodities, fund managers were trying to limit the volatility in their clients’ returns.

A final point is that the presence of large, institutional investors provides more liquidity to the futures markets, allowing the traditional hedgers (such as producers and airlines) to use these contracts more flexibly. New regulations that restricted the ability of “speculators” to enter these markets would ironically hurt even the non-speculators because of higher bid-ask spreads.

Was It Speculators, or Supply and Demand?

A recurring theme in the 60 Minutes segment was that the price swings in oil weren’t due to the fundamentals of supply and demand, and so they must have been the fault of the insidious speculators:

If anyone had any doubts [about whether oil markets were being manipulated], they were dispelled a few days after that hearing when the price of oil jumped $25 in a single day. That day was Sept. 22.
Michael Greenberger, a former director of trading for the U.S. Commodity Futures Trading Commission, the federal agency that oversees oil futures, says there were no supply disruptions that could have justified such a big increase.

"Did China and India suddenly have gigantic needs for new oil products in a single day? No. Everybody agrees supply-demand could not drive the price up $25, which was a record increase in the price of oil. The price of oil went from somewhere in the 60s to $147 in less than a year. And we were being told, on that run-up, ‘It’s supply-demand, supply-demand, supply-demand,’" Greenberger said.

A recent report out of MIT, analyzing world oil production and consumption, also concluded that the basic fundamentals of supply and demand could not have been responsible for last year’s run-up in oil prices. And Michael Masters says the U.S. Department of Energy’s own statistics show that if the markets had been working properly, the price of oil should have been going down, not up.

"From quarter four of ’07 until the second quarter of ’08 the EIA, the Energy Information Administration, said that supply went up, worldwide supply went up. And worldwide demand went down. So you have supply going up and demand going down, which generally means the price is going down," Masters told Kroft.

"And this was the period of the spike," Kroft noted.

"This was the period of the spike," Masters agreed. "So you had the largest price increase in history during a time when actual demand was going down and actual supply was going up during the same period. However, the only thing that makes sense that lifted the price was investor demand."

The true situation is far more nuanced. Part of what happened on Sept. 22 was that the dollar fell sharply against other currencies; recall that these weeks involved the bailout of AIG and the collapse of Lehman Brothers. Because oil is traded internationally but quoted in U.S. dollars, a fall in the dollar translates into a higher quoted price for oil, which is perfectly consistent with “fundamentals.”

Moreover, Sept. 22 was the last trading day before the expiration of the October futures contracts. There were investors who had shorted oil—they were pushing down its price, betting that it would fall further—and they needed to unwind their positions, because they didn’t actually have physical barrels to deliver to the holders of the contracts. According to oil economist James Williams, the Nymex contracts had a delivery point of Cushing, Oklahoma, but the inventories in Cushing were low because of the hurricane drawdown. The situation led to a “short squeeze” where short-sellers were trying to buy back their positions and were scrambling for the unusually tight supplies. Thus the 60 Minutes piece is right that speculation was involved that day, but it’s the opposite of their interpretation: The people pushing down oil prices hit a temporary snag, caused by a physical bottleneck, and so the price popped back up briefly.

Masters’ analysis of the EIA data is also misleading. It is true that world oil supply had been steadily increasing every quarter since the beginning of 2007, while world oil demand finally peaked in the fourth quarter of 2007 and then began falling in 2008. But what Masters neglects to mention is that world oil demand was always higher than supply, up until April 2008, as the EIA data (XLS spreadsheet) show.

The market price of oil during this period did exactly what consumers would want. Starting in 2006, the world began consuming more barrels of oil per day than producers could deliver to market. The deficit was covered by drawing down on previously accumulated stockpiles. In this environment of a supply crunch, the market price needed to rise rapidly in order to call forth greater supply and curtail demand.

Even as late as the first quarter of 2008, on average there was more than a million barrel a day deficit, where world oil demand exceeded supply. Of course the “fundamentals” would drive higher prices in this environment. And then, after years of rising oil prices in this deficit environment, the situation finally reversed in April 2008. From that point on, world oil output had finally caught up with and overtaken demand. A few months later, the price of oil crashed back down. The presence of large investors definitely influenced the movement of prices, but ultimately the explanation based on supply and demand is accurate.

Even the sudden collapse of oil prices may be partially or completely attributable to “real” forces in the economy. The economic outlook changed considerably in the late summer of 2008, meaning that oil consumption will not grow nearly as quickly over the next few years as forecasters previously believed. The dollar has also strengthened tremendously because of the “flight to safety” by investors around the world. The rising dollar translates into lower oil prices, quoted in U.S. dollars.

Conclusion

Institutional investors rushed into the commodities futures markets as oil prices steadily rose from the fall of 2007 through the summer of 2008. This correlation led many analysts to conclude that the hedge funds were causing the prices to rise. But a more careful analysis shows that the situation was more nuanced, with price rises (fueled by legitimate, fundamental supply and demand) leading rational investors to diversify their holdings by gaining exposure to the energy sector.

In any event, it is wrong to assume that giving government bureaucrats more power will somehow make financial markets more transparent or efficient. Masters and the folks at 60 Minutes should read up on how the SEC ignored letters about Bernie Madoff’s Ponzi scheme that a suspicious analyst in the private sector began sending them back in 1999. In the private sector, speculators who make bad forecasts lose money, big time. In contrast, the SEC will probably see its budget increased even though it ignored a reputed $50 billion swindle for 9 years.

Many investors overshot the rise in oil prices, and the market punished them accordingly. But record oil prices really were driven by the fundamentals of supply and demand. Futures markets, and large institutional investors who use them, provide a valuable service to consumers by actually reducing volatility in the long run. It’s too bad that 60 Minutes seems to have overshot in their finger-pointing, but there won’t be any market correction for them.

WASHINGTON, D.C. – The Institute for Energy Research (IER) today released a study authored by its resident economist, Robert Murphy , on the role speculators are playing in the global oil market. The report, Speculators Fixing Oil Prices? Don’t Bet On It , separates fact from fiction as consumers continue their struggle with soaring energy prices.

“American consumers are demanding answers about the skyrocketing costs of energy, as they should,” Murphy said. “Unfortunately, that means it’s finger-pointing season in Washington and speculators appear to be the new scapegoats for the imbalance between supply and demand. My analysis demonstrates that there is simply no hard evidence to support such a conclusion, but there is plenty of evidence to prove that government ‘solutions’ would just make matters worse. Consumers would be better served if their elected leaders spent less time talking about new regulations and more time addressing the law of supply and demand.”

Among Murphy’s key findings:

• Record-high oil prices demand a target, and some politicians are increasingly pointing the finger at speculators in the commodities futures markets. But high oil prices are due to restricted supply , booming demand, and a weakening dollar.

• There is no hard evidence that speculators are responsible for high oil prices. If the price of oil truly were above the level that the fundamentals could support, we would see growing inventories of crude. But inventory levels show no such pattern.

• Speculators provide a vital function. By buying when prices are low and selling when prices are high, they actually make oil prices less volatile. Large investment funds provide liquidity to the commodities futures markets, and allow producers and consumers to concentrate on their core businesses.

• Government restrictions on investment in the oil futures market will only hurt consumers by making the oil market less efficient. New regulations will do nothing to ease oil prices in the long term.

Click here for the IER report, Speculators Fixing Oil Prices? Don’t Bet on It .

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The Institute for Energy Research (IER) is a not-for-profit public foundation that conducts intensive research and analysis on the functions, operations, and government regulation of global energy markets. Founded in 1989, IER is funded entirely by tax deductible contributions from individuals, foundations and corporations. No financial support is sought for or accepted from government (taxpayers).