Governments take aim at speculators as the scapegoat for high energy prices

As the impact of high energy prices have hit the frontpages, speculators have caught the ire of policymakers looking for a scapegoat. In Europe attention has focused on the role that speculators in the EU’s carbon market. The Spanish government has issued a protest to the European Commission arguing that current “[electricity] price levels and volatility are politically unsustainable”, calling the current crisis, “a threat to carbon cutting initiatives.” In the document they call on the European Commission to adopt measures to prevent financial speculation in its carbon market, the EU Emissions Trading Scheme (EU ETS):

A bubble on EU ETS is the last thing we need; EU ETS should be a market for energy and industrial companies. We are also of the position that the EU ETS trading should not be available to all agents, especially not to speculators with market power. There is significant correlation between increasing price levels and the increased presence of non-incumbents in the market, especially after July 2020. ETS prices should signal relative scarcity of CO2 emission rights for producers and incentivise energy intensive industries to switch to less-polluting technologies. If financial speculation rather than real factors drives prices up too quickly, it threatens the smooth transition to an industry powered by clean energy.

Speculators who expect natural gas to be in short supply and see gas prices rising in the future can back their hunches by purchasing natural gas (NG) futures contracts on a commodity futures exchange. Futures contracts represent claims on natural gas to be delivered at a specified price and at a specified date and place in the future. But remember, buying a NG futures contract does not reduce the quantity of natural gas that is available for consumption. If many speculators share the view that shortages will worsen and prices will rise, then their demand for NG futures will be high and, consequently, the price of natural gas for future delivery will also rise. This then provides the incentive for producers to expand production to serve this demand or consumers to reduce their demand or look for alternatives. The same principles apply in the carbon market. High carbon prices encourage innovation in low carbon technologies and encourage consumers to switch to less carbon intensive energy.

Interfering in the normal functioning of the energy and carbon markets by subsidising consumers, bailing out producers and preventing speculators from price discovery is shooting yourself in the foot. Instead of resources being allocated to where they are most efficiently used the measures proposed will make it even more difficult to meet the EU’s climate change targets. Tying the hands of natural gas speculators means that shortages are actually more likely since forward looking speculators are unable to express their view. Tying the hands of carbon market speculators means that low carbon innovation is less likely since forward looking speculators are unable to express their view of the price that will be required to incentivise these innovations to be introduced.

The EU isn’t the only place where policymakers are drawing the connection between the nasty market and high energy prices. In the US President Biden has tried to direct consumer anger towards supposed “bad actors” in the oil market, where gasoline prices have risen by 50% since the start of the year.

Last month, the director of the National Economic Council (NEC), Brian Deese, issued a request to the Federal Trade Commission (FTC) to “monitor the U.S. gasoline market and address any illegal conduct that might be contributing to price increases for consumers at the pump.”

Both statements by European and North American governments and agencies follow similar but less aggressive statements from the Chinese. In May this year the NDRC said that “relevant regulatory authorities will closely follow the trend of commodity prices, strengthen the joint supervision of commodity futures and the spot market, ‘zero tolerance’ for illegal activities, continue to increase law enforcement inspections, and investigate abnormal transactions and malicious speculation.”

The debate about speculators, futures markets and commodity prices is nothing new. The humble onion holds significant lessons. Back in 1957, a group of traders and farmers in the US cornered the onion market and sent the onion futures price rocketing. The onion price eventually plummeted and pressure grew from those who had lost money in the boom for futures trading in onions to be banned. The ban is still in force today. However, numerous studies have found that volatility actually rose after the ban was introduced.

The same bulbous root has also brought tears to people’s eyes in India, because of high and volatile prices. Again, as in the US, the introduction of a futures market that could dampen volatility is seen as too politically sensitive. The lesson from the example of the onion is that like other commodities it is easy to blame the anonymous, invisible speculator, rather than addressing the fundamental reason for why a market may be failing. Quite often the market failure lies at the door of the policymakers. No wonder they want to deflect attention.

Related article: Who is getting crushed by higher natural gas prices?

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