July 8 (Bloomberg) -- Goldman Sachs Group Inc. and Morgan Stanley may never have the same leeway in commodities as they did when oil reached a record $147 a barrel last year.

The Commodity Futures Trading Commission will consider greater regulation of oil, gas and other energy markets at hearings this month. It plans to review exemptions to trading limits that since the 1990s allowed Goldman and Morgan to build multibillion-dollar ventures in futures, swaps and over-the- counter markets.

“They’re very significant swaps participants, and they’re very significant dealers for over-the-counter swaps in the commodities market,” said Dan Waldman, former general counsel of the CFTC and a senior partner at Arnold & Porter LLP in Washington. “If their ability to do some of that business was limited, they’d have to find other ways to reduce their risk or reduce the size of their commodity swaps books.”

Energy swaps are trades in which parties exchange the difference between two price payments, one fixed and one floating, for a specific commodity for a period of time.

Goldman Sachs and Morgan Stanley accounted for about half of the $15 billion in revenue that the world’s 10 largest investment banks generated from commodities in 2007, Ethan Ravage, a financial-services industry consultant in San Francisco, estimated last year, as energy prices neared records.

Spokesmen for both banks declined to comment, as did one from Barclays Plc. Spokesmen from JPMorgan Chase & Co. and Citigroup Inc. didn’t immediately return calls for comment.

Soaring Prices

Oil prices almost tripled to a record $147.27 a barrel in July 2008 from less than $50 a barrel in January 2007. It took less than five months for prices to peak after topping $100 a barrel in February 2008.

Crude oil for August delivery fell $2.79, or 4.4 percent, to settle at $60.14 a barrel at 2:42 p.m. on the New York Mercantile Exchange. That’s up 86 percent from a low of $32.40 in December. Oil touched $73.38 on June 30.

“A lot of what we’ve seen in recent years has nothing to do with the underlying fundamentals of the market,” said Tom Bentz, a senior energy analyst at BNP Paribas Commodity Futures Inc. in New York. “Something has to be done to reduce some of the speculation, no doubt about it.”

Exchanges regulated by the CFTC are allowed to set their own position limits or accountability levels which are designed primarily to keep one party from gaining too much control of a market. The limits are applied to futures that call for actual delivery of the commodity rather than settling in cash.

Financial Risks

Investment banks typically use commodity market transactions to protect themselves against financial risk from deals that have very little to do with the actual production or consumption of the commodity in question. That differs from hedging done by energy producers or consumers who have a direct stake in the price.

“It sounds like unless you’re a true hedger like Southwest Airlines, unless you are a producer in Texas, you’re going to lose your status to have nearly unlimited position size,” said James Cordier, portfolio manager and founder of OptionSellers.com in Tampa, Florida. “Right now, you can hold as many contracts as you like. You simply need to report them.”

The Nymex’s position accountability levels and limits restrict oil traders to 10,000 net futures for any one trading month, and 20,000 net futures for all months, though they can’t exceed 3,000 contracts in the last three trading days of the spot month, Anu Ahluwalia, a Nymex spokeswoman, said in an e- mail. Natural gas traders are limited to 12,000 net futures and 1,000 in the last three trading days.

Trading Limits

Traders can go above those levels, though such moves open them up to review by the exchange, which can tell them to reduce or freeze their position. Traders can often get around the Nymex limits via loopholes that allow them to invest in futures and swaps on other exchanges. The CFTC is trying to close some of those loopholes, which have been blamed for price fluctuations.

“The CFTC doesn’t want to see these wild swings occur,” said Peter Beutel, president of Cameron Hanover Inc., an energy consulting company in New Canaan, Connecticut. “I don’t think a lot of people in the industry would argue against imposing strict limits on investment funds.”

U.S. House Agriculture Committee Chairman Collin Peterson, a Minnesota Democrat, said position limits would be one way to keep speculators from distorting markets to the point where they’re no longer effective risk management tools for actual users of a commodity.

‘Pretty Hard’

“I think it’s pretty hard to argue there wasn’t some effect on markets last year” when index fund money flowed into commodities markets that were setting records, he said in an interview yesterday in Washington. Peterson’s committee passed a bill in February that limited positions a trader could hold.

U.K. Prime Minister Gordon Brown and France’s President Nicolas Sarkozy believe volatile oil prices have caused grave damage to the world economy and must be addressed urgently, they said in an article they wrote for the Wall Street Journal today.

“The oil market is complex, but such erratic price movement in one of the world’s most crucial commodities is a growing cause for alarm,” they wrote in the article, posted on the newspaper’s Web site.

They argued for more dialogue between producers and consumers through the Riyadh-based International Energy Forum, whose members account for more than 90 percent of global oil and gas supply and demand.

Aggregate Positions

“Politicians and regulators have to be careful what they wish for,” said Pierre Andurand, who manages the $1.1 billion BlueGold energy fund from London. “I don’t think many people would benefit from a few oil trading companies deciding what the price of oil should be and leaving very few tools and liquidity to companies to hedge their production and consumption.”

A big remaining question is whether the CFTC should have authority to impose position limits on energy speculators across all markets, so-called aggregate limits, Senator Peterson said.

“Hedge funds and banks are always an easy scapegoat for regulators when they see price increases that are detrimental to consumers,” said Christopher Peel, chief executive officer of BlackSquare Capital LLP. The London-based firm manages about $250 million in funds of hedge funds, including one dedicated to commodities.

Enforcing Limits

Critics say that enforcing position limits and driving the investment banks out of the market will hurt liquidity and cause prices to rise.

“These possible CFTC limitations are going to be a huge factor for prices for a lot of commodities,” said Matthew Zeman, a trader at LaSalle Futures Group in Chicago. “Speculators are being driven out of the market now as they get nervous about what limitations might be put in.”

Entities like Goldman Sachs and JPMorgan “are the market makers,” said Mark Lewis, a partner in the Washington law office of Paul, Hastings, Janofsky & Walker LLP in a telephone interview.

“Those are the entities that have the huge positions,” he said. “If the financial players, the banks, the hedge funds, et cetera, are limited to the number of trades they can take, it will lead to less trading. Less trading, I don’t think necessarily leads to lower prices.”

Senator Byron Dorgan, a North Dakota Democrat, dismissed as “absolutely absurd” talk that position limits will harm energy markets. “No one’s talking about changing the market that in any way denies the use of it for legitimate hedging purposes.” Financial players are “in the market to try to make a quick buck. That market was created for hedging, not gambling.”

Paul Zubulake, a senior analyst at Aite Group LLC in Liberty Corner, New Jersey, said “lack of liquidity is going to increase costs, which will be passed on to consumers. That’s what the political scene refuses to acknowledge.”

To contact the reporter on this story: Margot Habiby in Dallas at mhabiby@bloomberg.net.

Last Updated: July 8, 2009 16:39 EDT