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Reining In the Oil Speculators

Oil prices have subsided, but some in Congress say more regulation of the futures markets is still needed

Institutional investors drove oil prices to all-time highs this summer, and the same players are also responsible for much of the $44-per-barrel loss since then, according to a Sept. 10 report that is being used to bolster calls for greater trading regulation.

The report from a hedge fund investor who has grown prominent in the oil speculation debate, Michael Masters, comes as crude oil has staged a 28% retreat in the past two months. But Masters and backers of his report—including many congressional Democrats—say prices could return to previous highs if reform legislation isn't passed. "Americans won't stand for being held up at the pump by these Wall Street scoundrels every time they fill up their gas tank," Senator Maria Cantwell (D-Wash.) said on Sept. 10 at the report's release. She was joined by Masters, Adam K. White of White Knight Research & Trading, Senator Byron Dorgan (D-N.D.), and Representative Bart Stupak (D-Mich.).

According to Masters' report, an influx of "long-only" investors—large investors like pension funds and endowments that bet prices would rise—poured into the oil market in recent years. Their investments reached a peak on July 11, when oil prices hit an all-time high above $147 per barrel. Then, beginning on July 15, institutional investors "began a mass stampede for the exits" of commodities indexes like the S&P Goldman Sachs Commodity Index, according to Masters. Investors withdrew about $39 billion from the index, resulting in the selling of about 127 million barrels of West Texas Intermediate crude futures. The report says that crude futures have dropped by about $29 per barrel as a result of this selling.

Swaps Arrangements

The Commodity Futures Trading Commission (CFTC), the agency charged with regulating U.S. futures markets, declined to comment on Masters' report. CFTC Chairman Walter Lukken is scheduled to testify on Sept. 11 for the House Agriculture Committee about recent developments in commodities markets.

The agency also plans to release the results of its inquiry of the scope of commodity index trading in the futures markets by Sept. 15. The institutional investors Masters' report targets typically make their "long-only" investments through swaps arrangements with banks like Goldman Sachs (GS) and Morgan Stanley (MS). In June the agency announced it had issued "special call" requests to swap dealers requiring them to provide information on investments in commodity indexes.

Crude futures fell 68¢ to settle at $102.58 a barrel on Sept. 10 after touching $101.36, a five-month low. The drop came despite several bullish pieces of news: a surprise announcement by OPEC that it would cut output by 520,000 barrels per day, a sharp drop in U.S. crude and gasoline inventories announced by the Energy Dept., and reports that oil output from the Gulf of Mexico is currently less than 5% of normal. Two bearish headlines—a cut in projected oil demand by the International Energy Agency and a one-year high for the dollar—outweighed the bullish news.

Demand Is Faltering

Opponents of further futures regulation are battling Masters and his supporters at congressional hearings and in the press. The Smart Energy Policy Coalition, made up of financial industry lobbying groups like the International Swaps & Derivatives Assn., whose members oppose more futures regulation (, 7/14/08), criticized the report. "Volatile energy prices are the result of global economic conditions, the changing strength of the dollar, and supply-demand fundamentals, not speculative trading activity," Scott De Fife, a spokesman for the coalition, wrote in an e-mail. De Fife says oil prices have declined because demand is faltering. He cites a recent report by AAA that found Americans drove 53 million fewer miles this summer than in 2007, reducing demand by an estimated 1.25 million barrels a day. Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson have also said supply and demand are the main forces behind oil price movements.

But many oil market experts and analysts disagree. While acknowledging that demand may be slowing, they argue that oil's dramatic price decline is evidence that a speculative investment bubble is beginning to burst (, 9/2/08). "I think [Masters] is probably very close to the truth," says Dennis Gartman, editor and publisher of The Gartman Letter, a daily oil industry newsletter. He says he agrees that an influx of "long-only" investments in the Goldman Sachs Commodity Index helped push the price up. Now, he says, "a few well-placed phone calls" by regulators to large investors may be encouraging an exodus from the market, lowering prices.

Former CFTC regulator Michael Greenberger says that tougher policies and more oversight by the CFTC, initiated in May (, 6/9/08), have caused investors to flee commodities markets. "The only constant variable in the oil market since the spring has been tougher CFTC measures and more oversight," says Greenberger, a law professor at the University of Maryland and former head of the CFTC's Trading & Markets Div. "If actual supply and demand were at work, [oil] prices would have spiked with Russia's invasion of Georgia and the onset of hurricane season."

Join a debate about whether oil speculators are to blame for wild price swings.

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