Measures have recently been proposed to restrict trading in crude oil and gasoline. This proposal is based on the presumption that market speculators are artificially raising the prices of these products; in other words, that the market is being manipulated.
Anti-manipulation rules for futures markets are based on the belief that these are susceptible to manipulation and control by large traders. However, no significant guidance has been provided by the Commodity Exchange Act on how to define manipulation. The definition may seem straightforward, though:Â adapting or changing (accounts, figures, prices, volumes) to suit one’s purpose or advantage. But applying this definition to commodities markets can be challenging, since all participants trade to earn profit: In such a setting as commodities markets, there is no generally accepted definition of manipulation, the result for the applicable law being, as a leading treatise puts it, a murky miasma of questionable analysis and unclear effect., Lacking so much as a definition within any statute, rule, or case, the concept of commodities manipulation is profoundly confused. Scholars are varied in their advice; no scholarly consensus even exists as to the existence of manipulation, let alone to its precise definition or any avenues for prevention.
What emerges from the confusion is an almost unwinnable set of burdens for the regulatory agencies. The Commodity Futures Trading Commission (CFTC) has won only one manipulation case in 37 years. It remains to be seen whether last year’s dramatic reforms on commodities manipulation law requiring lower standards of proof will enhance the CFTC’s prosecutorial success of these cases. And if the problem is fundamentally conceptual, then it is not clear that applying more resources as recently called upon will somehow make it easier to prove market manipulation.
Judge Easterbrook’s 1986 comments on manipulation seem especially pertinent in the context of today’s oil price debate. Easterbrook notes:
An effort to isolate which ˜forces of supply and demand’ are ˜basic’ and which are not is doomed to failure. What is a ˜basic’ demand?Â Economists think of supply and demand as givens. People demand what they demand, and never mind the reasons why¦There is no way to say what demand is real and what is artificial.
Someone who buys long positions because he understands the supply of the commodity better than other traders is engaged in normal economic behavior; his actions drive the price in the direction it should move. Someone who is betting on his ability to conceal his own position from others and to profit solely from that concealment, is engaged in fraud¦the person who seeks profit solely from concealment makes today’s price less, not more accurate as a predictor of future prices.Â The decrease in accuracy is a source of economic loss.
Following Easterbrook, the question then becomes whether oil prices are moving towards a new legitimate equilibrium of naturally higher prices or whether they are being artificially pushed away from equilibrium. If we expect today that supplies will be relatively dear tomorrow, then it may be appropriate for the futures market to reflect higher prices today. This is distinct from an illegal manipulation of the futures market, even if the end result”higher prices”appears the same.
To further confuse the oil price debate, we commonly see the terms manipulation and speculation used interchangeably”but these are actually very distinct concepts. Manipulation is illegal and distorts market prices by creating a price that is artificial and not reflective of market fundamentals. Speculation, on the other hand, is a perfectly legitimate and indeed useful market activity that provides liquidity, allows market participants to hedge certain risks, and generally enhances price discovery.
There is little empirical evidence that speculators induce higher volatility in commodities markets. Several recent academic studies have found this claim unsupported by the data.Â Instead, these studies found that price swings have been driven by economic fundamentals, meaning changes in the demand or supply of the commodities.
Theoretically, speculation should reduce price volatility. When speculators correctly guess the direction in which prices should be moving in the future, they start acting upon their beliefs immediately and smooth out the availability of supplies between the present and the future, consequently smoothing prices. If we see today that supplies of a commodity will be reduced in the future, the price begins to rise in the futures market and the supply of the commodity begins to shift away from today (when it is relatively more abundant) and towards tomorrow (when it is relatively dear). This transfer of supplies across time is precisely what we want to happen. And the result is a smoother price trajectory than otherwise; the spot price is somewhat higher than it otherwise might have been today, but it is somewhat lower than it otherwise might have been tomorrow.
Additionally, there is no empirical evidence that I am aware of supporting the claim that changing margins, as has been proposed, will reduce price volatility. We may even expect the opposite, that a hike in margins may induce higher price volatility, as it would reduce the amount of liquidity available to absorb fluctuations in hedging demand. The link between lower liquidity and higher price volatility is well established in empirical finance.
A recent study by Professor Mark Perry (2012) from the University of Michigan sheds some light on this argument. He compares price volatility of onions to that of crude oil. Futures trading in onions was banned many years ago, and subsequently the volatility in onion prices increased. Professor Perry also finds that crude oil price volatility is relatively small compared to onion price volatility.
Price manipulation is genuinely harmful. Price manipulation is already illegal. Perhaps crude oil markets are being manipulated, but perhaps not. It is, as we have seen, difficult to define, identify, and prove commodity price manipulation.
There is certainly speculation in crude oil markets, but that is not the same thing as manipulation.Â Speculation, properly understood, adds liquidity, permits hedging, and generally reduces price volatility. We must remember that for everyone speculating that prices will rise, there must be someone speculating that they will fall, or at least not rise as much. Speculators have historically been blamed when prices rise, but they have rarely been credited when prices fall.
It is worth considering whether policy proposals intended to constrain manipulators, but which are actually directed against speculators, may ultimately prove counterproductive. Historically, where speculation and futures trading have been restricted (or even prohibited), spot prices have become more volatile, not less. Preventing price discovery in the futures market almost surely inhibits price discovery in the spot market. It would seem to be a classic case of shooting the messenger because we don’t like the message.
 Williams, Jeffrey, Manipulation on Trial “ Economic analysis and the Hunt silver case, p. 4 (1995).
 Id. at 5.Â See also Thomas A. Russo, Regulation of the Commodities Futures and Options Markets, (1983-93), Ch. 12 at 5.
 R. Abrantes-Metz & Andrew Verstein, Revolution in Manipulation Law: The New CFTC Rules and the Urgent Need for Economic and Empirical Analyses, Univ. Pa. J. Busin. L. (2012, forthcoming), also available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2025166.
 See, Andrew N. Kleit, Index Manipulation, the CFTC and the Inanity of DiPlacido, Working Paper, 2011. (The CFTC charged NYMEX floor broker Anthony DiPlacido and traders with Avista Energy with manipulation and attempted manipulation of settlement prices of the Palo Verde and California-Oregon Border electricity futures contracts traded on NYMEX from April through July of 1998.) Note, however, that the CFTC has settled many claims.
 Frank H. Easterbrook, Monopoly, Manipulation, and the Regulation of Futures Markets, (59) J. Busin. S103-27, at S117 (1986).
 Id. at S118; see also Markham for a discussion of secrecy on the Chicago Board of Trade, at 301.
 See M. Bohl & P. Stephan, Does Futures Speculation Destabilize Spot Prices? New Evidence for Commodity Markets (2012) available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=197960); see also B. Fattough, L. Killian, & L. Mahadeva, The Role of Speculation in Oil Markets, What Have We Learned So Far? (2012), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2034134.
 M. Perry, What Can Onions Teach Us About Oil Speculators?, (April 22, 2012), available at http://mjperry.blogspot.com/2012/04/what-can-onions-teach-us-about-oil.html.