U.S. Strategic Petroleum Reserves a Weapon Against Price Spikes and Speculators

Here's an interesting bent on the role of energy speculators and last summer's skyrocketing oil prices: using government-controlled strategic petroleum reserves to limit the power of speculators.

According to a paper released Thursday by Rice University's James A. Baker Institute for Public Policy, (reported by Dow Jones via Rigzone and in the Financial Times) the government should consider using their strategic petroleum reserves as a tool to limit speculation in the oil market.

The Baker Institute paper acknowledges this idea is not exactly new. The report's authors, Kenneth Medlock and Amy Myers Jaffe, noted the Clinton administration used sales from the U.S. Strategic Petroleum Reserve to "calm markets and discourage speculative activity during a sudden disruption or severe imbalance of markets." The strategy, the report said, discouraged future markets players -from holding long positions above the $39 a barrel mark.

But a lot has changed since the 1990s, most notably, the passage of the Commodity Future Modernization Act in December 2000. The paper argues CFMA accelerated the entry of noncommercial players -- traders who do not use futures contracts to hedge, as opposed to producers -- and was "the principal factor behind the increase in total open interest." Noncommercial traders make up about 50 percent of those holding outstanding position in the U.S. oil futures market. That's compared to an average of about 20 percent before 2002.

The Baker Institute report couldn't be more timely. The Commodity Futures Trading Commission has recently investigated the oil market it regulates with a particular focus on the role of speculators. CFTC Chairman Gary Gensler said in a Bloomberg report this week, he is "seriously looking" at position limits for energy traders and expects legislation addressing the derivatives market to succeed.

The Baker report doesn't exactly blame the government for last summer's spike in oil prices. But it does say the government's decision to continue to put oil into the country's strategic petroleum reserve may have encouraged speculators, who were betting prices would continue to rise, to hold onto positions in the oil futures market. And by the time the government stopped adding to the reserves, prices were above $100 a barrel, which the paper's authors argued was too late to step in.

All of this leads back to the ultimate question of government regulation and control. Even if the government can step in and use its strategic reserves as a tool to control prices, should it?