Examining the “Masters Hypothesis” about the role of index funds in the 2007-2008 price spike

Michael Giberson

From the most recent (January 2012) edition of Energy Economics: “Testing the Masters Hypothesis in commodity futures markets” by Scott Irwin and Dwight Sander.

The “Masters Hypothesis” refers to claims by investment manager Michael Masters (in testimony before a Senate committee -included in this collection- and on the TV program 60 minutes, among other places) that significant flows of cash into commodity index funds drove the commodity price spike of 2007-08. Masters made a big splash with his claims, at least among the easily impressed (i.e. the TV program 60 minutes).

In brief, Irwin and Sander test the idea against market data and find no support for Masters’ claims. See a related discussion at the Big Picture Agriculture blog.

Here is the article abstract:

The ‘Masters Hypothesis’ is the claim that long-only index investment was a major driver of the 2007–2008 spike in commodity futures prices and energy futures prices in particular. Index position data compiled by the CFTC are carefully compared. In the energy markets, index position estimates based on agricultural markets are shown to contain considerable error relative to the CFTC’s Index Investment Data (IID). Fama–MacBeth tests using the CFTC’s quarterly IID find very little evidence that index positions influence returns or volatility in 19 commodity futures markets. Granger causality and long-horizon regression tests also show no causal links between daily returns or volatility in the crude oil and natural gas futures markets and the positions for two large energy exchange-traded index funds. Overall, the empirical results of this study offer no support for the Masters Hypothesis.

WSJ says EIA says natural gas prices could jump 54 percent with exports

Michael Giberson

Yesterday the Energy Information Administration released the results of its analysis of possible price effects from increased natural gas exports, and the Wall Street Journal finds the drama (“Gas Prices Could Rise With Exports”):

Increased exports of U.S. natural gas could drive up domestic gas prices as much as 54% in 2018, federal officials said Thursday, in a projection that could complicate efforts by more than a half-dozen companies hoping to spend billions of dollars on new export terminals.

Sounds like a disaster for U.S. natural gas consumers, and that is the impression that some U.S. manufacturing companies would like you to form about possible natural gas exports.

If you read through the article, you pick up the slimmest bits of context: the 54 percent number is from just one of several scenarios studied, that scenario one assuming the lowest level of increased gas production and the fastest imaginable increase in exports; and current gas prices are below $3 per million BTU, the lowest in a decade. Also, the 54 percent is the peak price effect in the scenario, for 2018, but prices retreat after 2018 as the higher price sparks additional production.

I’d count the WSJ article as overly dramatic and misleading. (I haven’t had time to examine the EIA report in detail. It is available online, along with lots of data and context: “Effect of Increased Natural Gas Exports on Domestic Energy Markets.”)

EIA expects prices to recover over the next few years, even without exports, to just under $5 by 2018 in mid-line cases and to $6 for low gas production scenarios. Worst case prices (from consumers’ viewpoint) could average around $9 in 2018, then prices fall back toward $6. More likely scenarios have much more moderate price effects.

The EIA makes another interesting point in the report introduction. For all practical purposes, the export licensing requirement is only a big issue for trade with countries for which we are not in a free trade agreement. Under our free trade agreements, any proposed export is already deemed to be in the public interest and so satisfies the export licensing review standard.

So, let’s imagine the most successful anti-natural gas export political scenario: LNG export licenses get denied, Canada stops exporting gas to the U.S. because of low U.S. prices (already happening) and then starts importing gas from the U.S. Canadian companies build LNG export facilities on the Pacific and Atlantic coasts, buy low cost U.S. gas and exports high priced LNG to Asian and European markets. We already are net natural gas exporters to Mexico, and Mexican companies could provide the same kind of import/export service.

Else domestic industrial natural gas consumers – the primary interest group raising objections to potential LNG exports – will have to take on amendments to our current free trade agreements. I’d judge that unlikely, at least for now.

SOPA/PIPA protests and the economics of content market power

Lynne Kiesling

I found some things striking in yesterday’s SOPA/PIPA protests. One was Jim Harper’s clear and cogent statement that the Internet is not a thing, it’s a set of protocols stipulating how computers communicate with each other. That set of protocols is a platform, and those protocols are not the government’s to regulate.

Jim’s Cato colleague, the ever-reliable Julian Sanchez, points out that if you estimate the profits/surplus at stake from piracy relative to the lost value all of the other Internet activities that would be stifled under SOPA/PIPA, the cost of piracy is just not that large. Sure, it’s concentrated in the hands of politically-powerful entertainment content companies, but relative to the rest of the vibrant, dynamic value creation that would “be disappeared” it’s small. Moreover, domestic and international legal institutions already exist to deal with piracy; like any other human institution they are imperfect, but as a consequence of them the losses from piracy are small relative to what would be lost if Congress imposed SOPA/PIPA. Here’s a good, short video from Julian covering some of the basics:

At Digitopoly, Joshua Gans makes an analogy near and dear to my heart: consider how SOPA/PIPA would make the Internet more like the arbitrary, intrusive, Constitution-free zone that is our airports:

But the notion that enforcement and prevention matters will be put in place that create massive harm to the lives of innocent individuals while being unlikely to really actually led to less of the activity targeted is not unprecedented. You can think about this every time you go through a US airport and think about who is winning there. …

So the scenario that US people should be concerned about is if publishing on the Internet becomes like airport security. That is, if copyright enforcers are able to automate enforcement without due process. That will raise the costs of publishing and will deter many. As is often the case with over-reaching laws, the problem is that it creates too few incentives for enforcers to enforce discriminately rather than indiscriminately.

These contributions to the discussion have all been outstanding, but the most useful one in my estimation is this TED video posted yesterday from Clay Shirky on the issues at stake in the SOPA/PIPA debate:

It really is a must-watch video, well worth 10 minutes of your time. Shirky describes the technological issues clearly for non-techies and delves helpfully into the legal history of copyright in media, but then makes the crucial economic point when he says “Time Warner wants us all back on the couch and not creating our own content”. In all of the justifiable furor about censorship, this is the economic point that gets a bit lost. For the past 70 years the entertainment companies have had a lot of market power, because entertainment was essentially an oligopoly. They profited handsomely from their market power over content. But with the decentralization and edge content generation now possible due to technology, and with the way that their content provides an input into that edge creation, we now have many more substitutes for their content. They are using the piracy red herring (which is not as large as they claim it is, as Julian points out above) to try to retain the viability of their decades-old business model and market power over content. That’s the real economic issue here — they want us back on the couch and in the movie theater.

This is a fight that is not new with SOPA/PIPA and the Internet, nor will it end with the Congressional retreat from these ill-designed pieces of proposed legislation. Yesterday raised a lot of awareness of the issues, but it’s going to have to happen over and over and over …

I’m going to give the last word to my friend Sarah, who makes a useful analysis of language and its use in the context of both SOPA/PIPA and the recently signed into law National Defense Authorization Act, complete with its provisions that allow extralegal detention of American citizens without due process on suspicion of terrorist activity. Sarah offers an analysis of Orwellian Newspeak language, and identifies disturbing parallels with our current environment:

It struck me today that the combination of SOPA/PIPA and the NDAA move us terrifyingly close to an Orwellian world where people, language, history, and information can disappear at any time. Forever. As if they never were. And worse than that, our primary way to discuss/protest/remedy that disappearance–the Web–will be taken from us as well. …

Newspeak as a language, then, mirrors the political system that creates it, and serves to support it and perpetuate it by creating an agreed upon reality where meanings are strictly limited, the possibility for unorthodox thought is all but eliminated, and an agreed upon “reality” allows Ingsoc to have been always in control. Winston’s friend Syme is correct that “Newspeak is Ingsoc and Ingsoc is Newspeak.”

I leave further connections to the contemporary political situation as an exercise for the reader.

Regional transmission efforts good for re-routing information flows to regulators

Michael Giberson

Peter Behr, at ClimateWire, describes the U.S. Department of Energy’s efforts to rework its electric transmission study processes, created in the 2005 Energy Policy Act but stalled by adverse court decisions and political missteps. I’m not so sure that the new approaches will be any better received than the old, but I noticed in the article one salutatory effect from the broad regional transmission studies that the DOE has supported: state regulators are getting better access to competing viewpoints, which make them less dependent on the information provided by their incumbent regulated companies.

From the article:

[DOE's Lauren Azar] said some interactions among state regulators, utilities, grid managers and interest groups were eye-opening.

“One state came into the process saying, literally, ‘We need absolutely no transmission,'” Azar said, declining to name the state.

“During this process, it became quite clear there was pretty significant congestion in that state. That state is now talking with its neighbors about how best to build transmission across state lines and into its state to bring renewable resources into its state. That did not happen before this process.”

Asked why that state’s regulators happened to be misinformed about congestion issue, Azar sounded her often-heard concern about the need for more competition in the power sector.

“One of the problems that I’ve seen in this industry is market power issues. Some folks that have less competitive generators actually don’t want to see more transmission, because what that does is bring a cheaper commodity into their area, and it threatens their use of their less efficient generators. I think that might be one of the reasons they didn’t get the information they needed.

“It was euphoric for me to be with the regulators and see the light bulbs go off when they realized some of the information they hadn’t been getting,” she said. “This process helped to give them that data.”

I think she meant “light bulbs go on.”

Michael Graetz’s “The End of Energy” surveys 40 years of energy policy making. It isn’t pretty.

Michael Giberson

Michael J. Graetz, "The End of Energy." (Book cover)

Michael J. Graetz, "The End of Energy," MIT Press, 2011.

Michael Graetz’s The End of Energy is a fascinating run through 40 years of U.S. energy policy making. Engaging and at times even entertaining if you are at all interested in energy issues. In Graetz’s telling it is mostly a story of 40 years of failure, though he notes a few successes along the way.

I absolutely loved that the first chapter began with President Nixon’s decision to impose wage and price controls on August 15, 1971. If you think that wasn’t energy-policy relevant, then read that chapter (the publisher will let you read it free). Just note that the Arab oil embargo just over two years later caused barely a hiccup in U.S. oil imports; the gas lines and shortages were mostly due to the remaining Nixon oil price regulations. (Yet, 40 years later we still blame OPEC!)

Graetz proceeds to pull us through the swamp of 1970’s energy policy. President Ford joined Congress in giving us automobile fuel economy regulations. President Carter pushed an astounding range of proposals, succeeded on some but failed on others,  and lectured Americans for their supposed consumerist excesses. The book does a good job of surveying the problems created by interstate natural gas price regulation and the difficult politics of casting off that burden.

Reagan’s presidency doesn’t get much attention. Oil and gas price decontrol seemed to work, but these policies were initiated by Carter. After Reagan comes a decade and a half of relatively low energy prices, but for the spike around the Iraqi invasion of Kuwait in 1990. Not much to report, Graetz suggests, as the urge for new energy policy rises and falls with energy prices.

Energy prices pick up again in the mid-2000s, and after a few words on the Energy Policy Act of 1992 we find ourselves in the middle of climate change discussions and the massive difficulties that come with finding reasonable policy. Graetz devotes a late chapter to Congress and the attempted making of a cap-and-trade law. It is enough, perhaps, to turn the most die hard advocate of cap-and-trade into a carbon tax proponent (excepting that, had Waxman-Markey pushed a carbon tax, then a look into the sausage factory likely would have produced the opposite impulse). The book winds down contemplating the BP oil spill in the Gulf of Mexico and the Obama administration’s efforts in response.

The book mostly covers domestic federal coal, oil and gas, environmental and some nuclear power issues. Relatively little attention goes to electric power beyond nuclear or to  international issues, except when discussing climate change politics. Not much on ethanol and just a little on solar and wind power. Still – coal, oil and gas, the environment – these are where the big money is and so that is where the politics have focused. One lesson of the book seems to be that lobbying expenditure is a product of policymaker ambition and the size of government, and not the other way around.

The hazard of writing a current events-type book is that the book must end even as events continue. So Graetz laments that 40 years of energy policy making hasn’t put a dent in our “energy dependence,” and practically at the same time we have begun importing less oil for the first time in decades. Domestic oil and gas production is up in recent years, and what is more, it is a development that has come about mostly without the attention of federal energy policy makers. (Or perhaps in part due to their lack of attention, even admitting some federal R&D support for oil and gas drilling technology.)

Well, we can’t blame Graetz because history continued after his book ended. It is a strength of his book that is gives us some idea of what to expect of the next few years, as the politicians and regulators in Washington DC begin to take notice of this domestic energy development. I wouldn’t score all of the wins and losses quite the way he does, and I’m not sure where his interest in more grand energy policy comes from given the fairly damning assessment of the federal energy policy system. Still, the book offers its readers a fair view of and deeper insight into the last 40 years of federal energy policy.

Commemorating Martin Luther King and liberty

Lynne Kiesling

For the past couple of years, I’ve commemorated Martin Luther King day by rereading his Notes From A Birmingham Jail, which I recommend to you as an eloquent articulation of, among other things, the values of liberty and of equality before the law.

It’s interesting to reread it this year,as our awareness of increasing encroachment and violations of our civil liberties grows. The juxtaposition of “Birmingham Jail” with Jonathan Turley’s analysis of the top ten ways in which the United States is no longer the land of the free is striking and thought-provoking. We lose such liberties incrementally, and King’s reminder of the importance of disobeying unjust laws is important to remember as we consider Turley’s list and how to regain our freedom. Note also the juxtaposition with the Economic Freedom of the World report from 2011, in which the US fell in stature due to increasing regulatory invasiveness to accompany the civil liberty invasiveness.

Bad news for the natural gas suppliers, but good news for natural gas consumers

Michael Giberson

I’ve been meaning to remark on natural gas prices for several days, especially since a regular reader pointed out that natural gas prices have reached their lowest levels in a decade. But now, in what may be a first, I’ll just outsource the discussion by favorably linking to a post on the Climate Progress blog.

By the way, note that the prices shown in the post’s graphic (from EIA) are average prices over 2011. Current prices for natural gas are about $1 below what is shown there. (In January, typically peak demand time for natural gas!)

In the post Stephen Lacey worries about the effects of low natural gas prices on renewable power, and it is a problem if you want to roll out more renewable power capacity anytime soon, but for consumers it is a win-win. Low gas prices push down now on (non-transportation) energy prices, particularly power prices. The delay in new installations of renewable power means that, when natural gas prices recover in a few years, the power plants built will have better technology than exists today. Meanwhile, the subsidies avoided will have a very small but beneficial effect on the federal government budget.

And if your primary concern is greenhouse gas emissions, note that natural gas-fuels power plants will continue to displace coal-fired power even as the additions of renewable power plants are slowed.

EPA fines companies for not doing the impossible

Michael Giberson

If you read Jonathan Adler’s post at the Volokh Conspiracy (and reposted at PERC’s Percolator blog), it makes the EPA seem a little silly for insisting on fining companies when it would be impossible for companies to comply with the law.

But don’t blame the EPA, which is just implementing a law that Congress passed and President G. W. Bush signed, the Energy Independence and Security Act of 2007. Here is Bush at the signing ceremony:

The bill I sign today takes a significant step because it will require fuel producers to use at least 36 billion gallons of biofuel in 2022. This is nearly a fivefold increase over current levels. It will help us diversify our energy supplies and reduce our dependence on oil. It’s an important part of this legislation, and I thank the members of Congress for your wisdom. (Applause.)

Blame the younger Bush president, blame the members of Congress for their wisdom – or more precisely, for their failed insights in trying to drive the path of technological progress at consumer and taxpayer expense AND, a special note for anyone involving themselves in electioneering this year, failing to sweep this destructive nonsense out of the law any time in the last four years – but the EPA is only the messenger of this madness.

More from the former President:

The legislation I’m about to sign should say to the American people that we can find common ground on critical issues. And there’s more we can accomplish together. New technologies will bring about a new era of energy. So I appreciate the fact that Congress, in the omnibus spending bill that I’m going to sign later on, recognizes that new technologies will help usher in a better quality of life for our citizens. And so we’re going to spend money on new research for alternative feedstocks for ethanol. I mean, we understand the hog growers are getting nervous because the price of corn is up. But we also believe strongly that research will enable us to use wood chips and switchgrass and biomass to be able to develop the ethanol necessary to help us realize the vision outlined in this bill.

With these steps, particularly in the bill I’m about to sign, we’re going to help American consumers a lot. We’ll help them by diversifying our supplies, which will help lower energy prices. We’ll strengthen our security by helping to break our dependence on foreign oil. We’ll do our duty to future generations by addressing climate change.

And so I thank the members of Congress. I appreciate the fact that we’ve worked together, that we can show what’s possible in addressing the big issues facing our nation. This is a good bill and I’m pleased to sign it.

(The bill was signed.) (Applause.)

Ah, yes, “we also believe strongly that research will enable us to use wood chips and switchgrass and biomass to be able to develop the ethanol necessary to help us realize the vision outlined.” Turns out that the “vision” was a bit off.

By the way, yes it was the Energy Independence and Security Act of 2007 that gave us the standards blocking the sale of 100 MW 100 W incandescent light bulbs, beginning in 2012. Also, coincidentally, the EISA bill was signed in December 2007 and later the business cycle folks at the National Bureau of Economic Research identified December 2007 at the end of a 73-month long economic expansion and the beginning of the recession.

SEE ALSO: Kenneth Green’s post at AEI’s Enterprise BlogFill ‘er up with rainbows and unicorn sweat!, and the Matthew Wald New York Times article cited by both Green and Adler.

[EDIT: As a commenter hints, the reference to 100 MW light bulbs was in error. -MG]

Giberson calls for one-year moratorium on hospital admissions pending analysis of risks associated with nosocomial infection

Michael Giberson

I read recently that as many as 99,000 deaths per year in the United States are linked to nosocomial infection (also known as hospital-acquired infection).

I’m outraged, obviously, and relying on the precautionary principle I am calling for a minimum one-year moratorium on hospital admissions so the healthcare industry can bring an end to nosocomial-linked deaths and engage in further scientific study. Answers to the questions about the human and ecosystem health impacts involved will only come from scientific research.

The following statement is made available to news and media outlets:

“When it comes to hospital admissions,” Giberson said, “our guiding principle for public policy should be the same as the one used by physicians: ‘First, do no harm.’ There is a need for scientific and epidemiologic information on the health impacts of hospital admissions. Frankly, no one should admit even one more more patient before we have the scientific facts. There are health care needs in our communities that must be met safely. The reality is that the healthcare industry has not done nearly enough to finance the needed research effort.”

[Yes, I am mocking this announcement, see news story here. N.B., I'm not mocking their concerns for potential health issues, I'm mocking the idiotic recommendations. -MG]

Loss of ethanol subsidy boosts gasoline prices a little, E85 prices a lot

Michael Giberson

The basic math is pretty simple: most gasoline in the U.S. has about 10 percent ethanol, so the the 45 cents/gallon VEETC subsidy reduced the price of gasoline about 4.5 cents. The subsidy expired at the end of 2011, so one reason gasoline prices have gone up a few cents since New Year’s Day comes from the loss of the subsidy. (World crude oil prices are up a bit, too.)

Normally, a subsidy would be shared by producers and consumers, so the loss of a subsidy would be shared. But the Renewable Fuels Standard quantity mandate protects producers from taking a hit. The main effect here is that the consumers’ mandated purchases of ethanol will no longer be subsidized by taxpayers, and therefore the price rises.

But lest you gasoline consumers feel too bad, consider the plight of the drivers relying on E85, a blend of 85 percent ethanol and only 15 percent gasoline. The math here is simple, too: 85 percent of 45 cents meant that E85 was receiving about a 38 cents/gallon subsidy, and now that subsidy is gone.

The Minneapolis, MN Star Tribune reports, “The Road for E85 Just got Rougher“:

The high-ethanol fuel known as E85 has gained a small foothold in Minnesota in recent years, thanks in part to a subsidized price advantage and the presence of major producers and blenders in the state.

Now, the federal tax credit that boosted the industry is gone, raising questions about the fuel’s future.

Without the 38-cent-per-gallon subsidy that went away Jan. 1, E85 prices are moving up. It’s still cheaper than gasoline, but the shrinking difference may not be enough to compensate drivers who get fewer miles per gallon because of the fuel’s lower energy content.

[Recall that ethanol has a lower energy density than gasoline, so drivers get fewer miles per gallon with E85.]

The post-subsidy era also brings tough choices for owners of flexible-fuel vehicles, including the state of Minnesota, which has more than 3,000 vehicles capable of burning E85, and in 2010 used 963,000 gallons of it.

They must decide whether to support a fuel that is 85 percent home-grown ethanol even it it’s no longer competitively priced. Minnesota is the nation’s fourth-largest ethanol producer, and leads the nation with 364 retailers selling E85.


Last week in the Twin Cities, E85 was 16 cents to 40 cents lower than regular gasoline, which also rose in price. That’s as little as a 5 percent price difference. E85’s price advantage has sometimes been more than four times better and averaged 17 percent last year, according to the state Commerce Department.

At Lerum Auto, the only E85 dealer in Richfield, owner Dean Lerum had another 1,000 gallons of E85 delivered on Wednesday — at the new, unsubsidized price.

“I am going to let the market decide,” said Lerum, for whom E85 once represented 25 percent of fuel sales, but now accounts for 5 to 7 percent. “If it drops a whole lot more, I will get rid of it.”

Two more related stories from around the web

Kevin Drum at Mother Jones makes the call: “Ethanol Subsidies: Not Gone, Just Hidden a Little Better

As the Congressional Budget Office wrote back in 2010, “In the future, the scheduled increase in mandated volumes would require biofuels to be produced in amounts that are probably beyond what the market would produce even if the effects of the tax credits were included.” [Italics mine. -KD] In other words, the mandates have grown so large that the tax credits barely made a difference anymore. Demand for ethanol is driven by the mandates, not by the tax credit. When you take away the tax credit, nothing happens: Demand stays high because the law says so, corn prices go up accordingly, and corn farmers stay rich. The subsidies were a nice little fillip on top of that, but at this point it’s basically chump change.

The RFS mandates are the real reason that buffoons can ramble on about the history-making public policy magnanimity of the ethanol lobby. Drum cites Aaron Smith, of UC-Davis, writing in the American Enterprise Institute’s American.com: “Children of the Corn: The Renewable Fuels Disaster

[W]hy did the powerful corn ethanol lobby let [the subsidy] expire without an apparent fight? The answer lies in legislation known as the Renewable Fuel Standard (RFS), which creates government-guaranteed demand that keeps corn prices high and generates massive farm profits. Removing the tax credit but keeping the RFS is like scraping a little frosting from the ethanol-boondoggle cake.

And Smith is just getting started, so if want more reasons to hate ethanol policy then read the whole thing.

ADDED, Here is a more complete analysis of the relationship between the Renewable Fuels Standard mandates and the (now expired) tax credit, and also see the list of readings at the end of the commentary: de Gorter and Just, “The Forgotten Flaw in Biofuels Policy: How Tax Credits in the Presence of Mandates Subsidize Oil Consumption,” RFF Weekly Policy Commentary (June 9, 2008).