Did BP Manipulate the Markets?

The Commodities Futures Trading Commission is probing BP's practices. But the bigger issue may be how speculation by many is pushing up energy prices

BP, already beset with a leaky pipeline, a federal investigation into a refinery fire, and litigation over its activity in the propane market, is facing yet more scrutiny—but this time it might have company.

According to news reports, federal authorities are investigating whether the energy giant manipulated crude-oil and unleaded gasoline markets. BP (BP), according to the same reports, said it is cooperating with both probes.


  The investigations come at a time when banks and other financial institutions are rushing into the sizzling energy sector—both snapping up hard assets and pouring money into commodities markets—with the hopes of making big profits. Meanwhile, members of Congress, facing November elections and a restless electorate, are looking at whether energy companies and speculators are partly responsible for pushing up energy prices.

In the crude-oil case, the Commodities Futures Trading Commission is investigating whether BP used proprietary information about its own distribution and storage network to manipulate oil and gasoline prices.

Making commodity trades based on information about company operations isn't new, nor is it illegal, which is one reason banks and other big financial institutions in recent years have been snapping up chunks of the nation's energy infrastructure, including pipelines, storage tanks, and refineries. In 2003, the Federal Reserve helped fuel the trend by allowing commercial banks to take possession of physical assets such as oil in storage tanks.


  Now everyone is doing it. Goldman Sachs (GS) is a leading example, with a stake in a Kansas oil refinery and a natural gas pipeline running through New York and Connecticut, among other holdings. In hedge fund circles, a Ritchie Capital fund owns 25% of SemGroup, a Tulsa energy-services company that operates pipelines, terminals, storage tanks, and processing plants. Banks, pension funds, and insurers also are getting in on the act: John Hancock Life Insurance, for example, has invested in Boston-based ArcLight Capital, which has large holdings in energy storage and distribution facilities.

Fuel storage tanks, pipelines, and the like are highly regulated and generally can't always be counted on to yield whopping returns. But they hold enormous value nonetheless, because they give their owners and investors access to proprietary information on oil and gas deliveries, storage capacity, and other critical market data that can be used to make smart commodities trades.

"Having control or ownership over that kind of transmission or distribution infrastructure is really key to helping feed profits in your energy trading," says Tyson Slocum, director of the energy program at Public Citizen, a Washington (D.C.)-based watchdog group. "Significant conflicts of interest can arise."

And, says Peter Fusaro, a principal with the Energy Hedge Fund Center in New York, "There's a lot of value to owning physical energy. If you make more money trading it, even better. You make money on both sides of the equation, so to speak."


  Critics say that equation has fueled speculation by relatively new entrants into energy markets. Senators Norm Coleman (R-Minn.) and Carl Levin (D-Mich.), chairman and ranking minority member, respectively, of the investigations panel of the Homeland Security and Governmental Affairs Committee, blame escalating oil and gas prices in part on an "explosion" of speculative energy commodity trading on unregulated, over-the-counter electronic exchanges.

In Washington circles, that lack of oversight has a specific name: The Enron Exemption. It refers to a longstanding regulatory loophole that was written into law in 2000, when Enron and other big energy traders convinced congressional lawmakers to codify an exemption for over-the-counter electronic exchanges from the Commodity Futures Modernization Act, a law that was designed to bolster regulatory review of commodities trades.


  Since then, unregulated trading has flourished in the U.S., most notably with the growing reach of the London-based Intercontinental Exchange, or ICE, a leading operator of electronic energy exchanges that, until recently, trafficked only in European commodities. That changed in 1999, when U.S. commodities regulators gave ICE permission to install trading terminals in the U.S. In January, the London exchange went one step further, initiating trading for West Texas Intermediate crude, a type of oil produced and delivered in the United States. And in April, ICE began allowing U.S.-based traders to trade U.S. gasoline and heating oil futures on the ICE exchange.

The upshot: U.S. speculators now can avoid all federal oversight or reporting requirements by routing their trades through London's ICE instead of the highly regulated New York Mercantile Exchange. Both exchanges have had voluminous growth In recent years. "What's transparent is huge," Fusaro says. "What's not transparent is even bigger."

Still, Congress isn't likely to make much headway in regulating energy markets, and the ICE offers a key reason why. The London exchange, with servers in Atlanta and trading terminals on several continents, is a global operation that defies domestic regulation. Any attempt to crack down on trading could push the whole operation offshore. "The issue," Fusaro says, "is how do you regulate cyberspace?"

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