Streetwise Professor

I gave testimony on the role of speculation in energy markets before the House Agriculture Committee on Friday, 10 July. Here’s my written testimony. I will post a link to the transcript as soon as it appears.

It was an interesting experience. I doubt I changed any Congressional minds, but I think I did provide a framework that may help policymakers sort through the issues. The key lesson I tried to hammer home was that it is imperative to distinguish between the derivative markets and the physical markets. These markets perform different functions. Derivatives markets are markets for risk, and speculative and hedging activities in these markets will affect the price of risk. Absent any use of the derivatives markets to distort the physical market–as during a squeeze, for instance–even very large scale speculation in the derivatives market is unlikely to have an impact on the prices in the physical market (except insofar as that speculation is informed, and therefore influences expectations about future spot prices.)

The other point I tried to emphasize–and this is what I think made the biggest impression, at least on some–is that if “excessive” speculation truly screws up prices, these price distortions necessarily manifest themselves in the form of distortions in quantities; in inventories, in output, in consumption. The reason prices are important is that they direct the flow of resources. If prices are distorted, resource flows will be distorted too. Heretofore, there is no credible evidence of distortions in quantities. Hence, in my view, there is no credible evidence that speculation has been “excessive” in any meaningful (economic) sense of the word.