A new paper by Ken Medlock and Amy Myers Jaffe of Rice University on oil speculation attracted a lot of unquestioning attention late this week. In the study, Medlock and Jaffe accuse the CFTC of missing the way rampant speculation may have driven up oil prices earlier this decade.
But after reading the paper, it’s pretty clear that Medlock and Jaffe don’t have anything resembling a smoking gun. They largely rely on one correlation to support their case: That volume in oil futures contracts increased sharply at the same time that oil prices did. Further, the rise came after the passing of the Commodity Futures Modernization Act in 2000, which limited regulation on futures contracts for energy and metal products.
While correlation does not imply causation, the trends evident in the open interest data are impossible to ignore. It is striking that only after the CFMA was enacted did the composition of players in the market significantly change and oil prices rise to unprecedented highs.
But Medlock and Jaffe never even consider other factors that might affect oil prices – especially a couple details known as "supply" and "demand." For example, there's no mention of the role of China, a possible supply crunch, or robust global GDP growth during the period in question. It would be a big stretch to describe this study as a thorough inquiry into the impact of speculative activity in futures markets on oil prices, as some have.
A much better (thought not necessarily easier) read on the subject is this Fed paper I wrote about last month. In it, George Korniotis looks at metal prices, which were also subject to lax regulation as a result of the CFMA, and found little evidence of speculation impacting prices. This doesn't mean that it's impossible for speculation to influence oil prices, but hard evidence has been very difficult to come by.