When it comes to high energy prices, OPEC is quickly losing its status as Public Enemy No. 1. Alongside Big Oil, where profits are fattening as gas prices rise, a new bogeyman has emerged: the oil speculator. With the stock market in retreat so far this year and the dollar crumbling, these investors have flooded the commodities markets in hopes of cashing in on rising prices (BusinessWeek.com, 1/17/07). High oil prices are creating a ripple effect of inflation that's angering consumers; gasoline prices topped yet another new record on May 14, an average of $3.76 per gallon.
"We are witnessing a substantial influx of speculative money into energy markets," Senator Jeff Bingaman (D-N.M.) said May 12 on the Senate floor. "It is bidding up the price of oil beyond any reasonable level. Every consumer can see it at the pump. But we do not have any serious effort to regulate that speculation, or even to notice it."
Tighter Regulation on Onions
Now Bingaman and other members of Congress say they're ready to shed regulatory light on the international oil market. On May 7, Senate Majority Leader Harry Reid (D-Nev.), Bingaman, and others unveiled the Consumer-First Energy Act, which they say addresses the oil price spike at its root. The proposal would mandate higher cash collateral for energy-futures trading and call for greater oversight of overseas trading. The bill, which contains four other provisions, could come to a vote by Memorial Day.
Would U.S. legislation to curb oil futures accomplish its goal? With so little information not only on oil trading but also on global oil supply and demand itself (BusinessWeek, 5/14/08), it's impossible to say exactly what impact the legislation could have. But considering the vast size and scope of the global oil market, it's unlikely the bill would significantly rein in prices. Still, debate about the bill and Congressional investigations on speculation may offer more data on a market that is both poorly understood and immensely important to the global economy.
"We regulate the trading of onions much more closely than the trading of oil," says Mark Cooper, research director for the Consumer Federation of America, a nonprofit advocacy group, referring to federal rules covering agricultural commodities. "Regulation will bring some discipline to this raw speculation."
Changed Market, New Fundamentals
The explosion in the number of financial players in the energy markets has occurred especially in the past two years, which also happened to be a period of soaring energy prices. There are now 634 energy hedge funds, up from just 180 in October, 2004, says Peter Fusaro, founder of the Energy Hedge Fund Center, an energy-trading information firm. Of the total funds now, 210 are strictly energy commodity funds trading oil or oil futures and options, as opposed to the stocks of energy companies such as ExxonMobil (XOM) and Chevron (CVX). Large financial institutions such as Goldman Sachs (GS) and Morgan Stanley (MS) have also stepped up their participation in the energy markets.
More money has flowed into commodities as a hedge against the falling value of the dollar and as an investment alternative to a rocky stock market. These fund flows have influenced oil prices heavily, leading some analysts to conclude that the dollar's value and interest rates are the new fundamentals in the oil markets, replacing supply and demand.
Trading takes place on exchanges such as the New York Mercantile Exchange (NMX) and the London-based Intercontinental Exchange (ICE). The New York Mercantile Exchange is regulated by the U.S. Commodity Futures Trading Commission (CFTC), and ICE is regulated by the UK Financial Services Authority. Neither NYMEX nor ICE disclose the proportion of oil futures trades they oversee. Philip Verleger, an energy economist and president of Aspen, (Colo.)-based consulting firm PKVerleger LLC, estimates that the global futures market in petroleum is currently valued at about $500 billion. Trading also occurs in the electronic or over-the-counter (OTC) market, which neither the U.S. nor the U.K. regulates. Verleger estimates the OTC market for petroleum is valued at between $1.5 and $3 trillion.
The problem with the proposed legislation is that for the U.S. CFTC to monitor all global oil trades in this vast market, it would need the cooperation of other governments. More regulation of U.S. oil trades would "mean nothing without cooperation from all other countries," says Fadel Gheit, senior energy analyst for Oppenheimer (OPY). "You cannot close one window and leave the other windows open." Still, proponents of the new legislation argue that the U.S. should take the lead and clean up its own backyard, setting a precedent for others.
"A Fundamental Misperception"
Second, upping margin requirements—or the cost of taking positions on oil futures contracts—might not stop the speculators with the deepest pockets and could send investors to less regulated markets, which could send oil prices in any direction. The "substantial increase" in margin requirement would be adjudicated by the CFTC, and there have been suggestions that it would rise anywhere from the current levels of 5% to 7% to half of the value of the transaction.
Unsurprisingly, both the New York Merc and the CFTC oppose raising margin requirements. "Increasing crude oil margins on futures markets regulated by the U.S. CFTC inevitably will force trading volume away from regulated and transparent U.S. exchanges onto dark unregulated venues and onto less transparent overseas markets," the Merc said in a May 7 press release.
Wall Street analysts argue that it's misguided to think the U.S. can legislate global oil markets into submission. "We believe there is a fundamental misperception…that so-called 'speculators' are driving up the oil price to supposedly unjustified levels," wrote Goldman Sachs analyst Arjun Murti in a May 5 report predicting crude oil of $150 to $200 per barrel over the next two years. "Unfortunately, we do not think the energy crisis will be solved by finding and punishing the big, bad speculator."
Undaunted by Critics
Lawmakers and consumer advocates like Cooper disagree. Members of Congress are pressing on with the bill and with a series of hearings on the impact of speculators on oil and commodity prices. A second Congressional hearing on the role of speculators in bidding up commodity prices is scheduled for May 15.
"A key factor pushing up oil prices into the triple digits is a dysfunctional energy market," Bingaman told Congress on May 12. "[The bill] is aimed at bringing down the price of oil in the near term by having effective regulation of speculation. Some big hedge funds probably won't like it, but it will help the average consumer."
Consumer appeal aside, it's unclear how well such a bill will fare in Congress.