Oil volatility sparks debate on big commodities bets

The US commodities-market regulator is poised to relax curbs on speculators, just weeks after sales by the largest oil-linked exchange-traded fund helped drive crude prices off a cliff.

A new rule proposed by the Commodity Futures Trading Commission would double position limits for investors in commodities including oil, natural gas, gold, corn and soyabeans. In addition, the Washington, DC-based agency would set limits on energy and metals contracts only during the final three days before they expire — abandoning an earlier effort to cap holdings in any contract, whether for delivery next month or next year.

Federal limits on the size of financial wagers on raw materials were mandated by the Dodd-Frank reform law of 2010, which came two years after speculators were accused of playing an outsized role as oil soared to a record $145 a barrel. The CFTC’s new proposal won praise from hedge funds and investment managers in public comments submitted before a deadline last week.

But the proposal is also raising questions after recent mayhem in the energy market that involved the United States Oil Fund (USO), an investment product that had absorbed $5bn from investors in less than two months.

For Dan Berkovitz, one of five CFTC commissioners, the disorder was a sign of the way in which big financial players can influence prices used as reference points by commercial businesses. He voted against proposing the position limits rule in January.

“Now what we’ve seen for the second time is when prices get volatile and the oil markets get volatile, whether its trending up as we did in 2008 or trending down now, we see an increase in interest in these funds exacerbating the trends that we’re in and even affecting the physical markets,” he told the Financial Times.

USO is an ETF that purchases oil futures to gain exposure to the price of crude. By mid-April, the fund had amassed a quarter of the West Texas Intermediate crude oil contracts for June delivery on CME Group’s New York Mercantile Exchange, equivalent to 147m barrels.

The rule proposed by the CFTC would not have covered USO’s position, leaving CME in charge of oversight under its own more flexible “accountability levels” for traders. The accountability level for crude oil is 10m barrels’ worth of contracts — a long way below USO’s peak holdings.

According to USO’s regulatory filings, CME “became concerned” about the size of the fund’s position in mid-April, sending it two letters ordering a cap and then a sharp reduction in its footprint in the June WTI contract.

Chaotic trading followed.

On Tuesday, April 21, a day after absorbing $900m of fresh inflows, USO’s managers sold 91m barrels equivalent of June WTI futures, accounting for most of a 120m-barrel decline in the contract’s open interest. June WTI dropped from $20.43 to $11.57 a barrel — a stunning move not easily explained by basic forces of supply and demand. 

“Oil ETFs appear to have played a significant role in recent oil price dynamics,” JPMorgan strategist Nikolaos Panigirtzoglou observed that week.

The tumult came a day after crude for May delivery had dived below $0 a barrel, in a first for oil futures markets. The CFTC has since warned CME and other exchanges to prepare for a repeat of negative prices and urged them to enforce existing position accountability levels.

Academics have long studied whether investment cash distorts commodity prices. But the debate is not just academic. When controlled by Democrats, the CFTC in 2011 passed an earlier version of position limits that would have set federal constraints on the types of contracts owned by USO. A judge struck down the rule, leaving the policy in limbo. 

Republican chairman Heath Tarbert took up the project after he arrived at the CFTC in 2019. He has said the agency will need to look at position limits through the prism of recent oil price turmoil, but is reluctant to squelch trading altogether.

“Derivatives markets need speculative traders to provide liquidity for the producers and end users using the markets to hedge,” he told an agency committee this month.

Chicago-based CME, the world’s largest exchange company, broadly supported the new rule on position limits in comments submitted last week. Similar sentiments came from investment managers such as Pimco and AQR Capital Management.

CME declined to discuss its recent actions on USO. John Love, chief executive of USO manager United States Commodity Funds, said the fund’s trades were less than 4 per cent of the volume of June WTI on April 21.

Americans for Financial Reform, a liberal advocacy group, criticised the CFTC’s proposal as “completely ineffective”, arguing it “delegates critical elements of the position limits framework to for-profit exchanges who face major conflicts of interest in making decisions that could limit demand for their own exchange services”.

Mr Berkovitz, a Democrat, said his colleagues needed to fully understand what took place in oil markets last month before ratifying the rule.

“Refiners want to know, should I produce gasoline? Producers want to know, should I shut down my well?” he said. “In a time of great uncertainty, the speculative money pouring in can really add to the uncertainty at the very least.”