A Great Answer To A Great Question.

There seems to be something wrong with the way oil is trading these days -- at least wrong if you believe it should trade based on supply and demand. Obviously, the fundamentals aren't changing as fast as the wild price swings. Much of this seems to be because the trading pits are dominated by trades of paper (financial) barrels of oil and not real barrels of oil.

Yet, you seem to be generally opposed to limitations on oil speculation. Why? And is the current method of pricing oil the best one we can come up with? Can't we come up with a better system? When I go to the store to buy other goods, the price doesn't fluctuate so wildly. Why do we have to price oil this way?

Stephen Schork (The Globe & Mail 13/07/09): I certainly agree that oil speculators impact the pricing of oil (and other commodities) in the short-run. Therefore, at times the price path does indeed decouple from the underlying fundamentals. However, in the long-run, markets will regress to the fundamentals. hence the Wall Street adage. markets fall faster than they rise.

I do favor certain new regs on speculative trading in commodities. For instance, there is a tremendous amount of derivative contracts linked to U.S. markets that are traded on the ICE exchange in London that do not come under the purview of U.S. regulators. For price transparency reasons I think that ought to change.

On the other hand, I do not like the idea of limiting oil speculation. Why?

The most important reason is that speculators provide an outlet for producers to sell risk. If you hamper the speculators ability to buy that risk then all you are really doing is forcing this systemic risk back onto the books of the producers.

Therefore, they will in turn become apprehensive when it comes to increasing their risk exposure to the market, i.e. it will retard their ability to increase their plant and equipment or said another way. it will hamper their ability to increase supply when demand warrants.

Thus, in the long-run, limiting speculation might decreased short-run volatility in the market. But it will only serve to increase it for all of us in the long run.