Oil Traders: Don't Fence Us In

Investment bank and hedge fund representatives tell the Commodity Futures Trading Commission the oil market doesn't need more oversight

Under mounting scrutiny from an election-addled Congress, the Commodity Futures Trading Commission (CFTC) held a public meeting of its Energy Markets Advisory Committee on June 10 to discuss why oil prices have doubled since last June.

For the first time in a public forum, representatives from investment banks Goldman Sachs (GS), Morgan Stanley (MS), and JPMorgan (JPM) explained their banks' involvement in the oil futures market. Elected officials and consumer groups have questioned whether banks' investment of pension and other institutional investors' funds could be bidding up oil prices (BusinessWeek.com, 5/21/08), even as the research arms of those same banks issue predictions that prices will surge.

Agency About-Face

Wall Street executives took pains to address the allegations that they are making money with one hand while stoking the oil-price fervor with another. "There is a clear separation between our research and trading departments," said Donald Casturo, managing director of Goldman Sachs. "[The firm] is acting within the terms of the law."

CFTC Acting Chairman Walter Lukken oversaw the meeting, which was attended by a range of energy market traders such as hedge fund Citadel Investment Group and consumer groups such as Industrial Energy Consumers of America. In an opening statement, CFTC Commissioner Bart Chilton questioned Treasury Secretary Henry Paulson's assertion June 10 that speculators aren't behind the runup in oil prices. "Perhaps the Secretary has a crystal ball, but I don't, and given what I'm seeing and hearing in the markets and from market users, that seems to me to be a premature determination, at best," Chilton said.

After months of asserting that speculative investment is not a leading cause of oil price spikes, the agency has recently done an about-face (BusinessWeek.com, 6/9/08) on the issue, stepping up public pronouncements of tougher oversight. Before the June 10 meeting, the CFTC announced that an interagency panel, consisting of the Federal Reserve, Treasury Dept., Securities & Exchange Commission, and Energy and Agriculture Depts., will examine commodities trading and price increases.

"Inherent Conflict?"

On May 29, the CFTC announced several initiatives aimed at boosting transparency in energy markets. The agency said it will work with British regulators to monitor large trades of the benchmark U.S. crude on the ICE Futures Europe (ICE) exchange in London and will for the first time require traders in the energy markets to provide monthly reports of trading linked to commodity indexes. The CFTC also announced it had launched a nationwide investigation last December into possible manipulation of the U.S. oil market.

The June 10 meeting was called in part to address the increasingly hot-button issue of commodity index fund trading. Investment in index funds tied to commodities, such as the Goldman Sachs Commodities Index (GSCI), rose from $13 billion in 2002 to $260 billion in 2007. These investors make long-term bets that prices will rise in the futures markets. Such funds tend to put upward pressure on commodities prices.

John Heimlich, chief economist of the Air Transport Assn., which represents the airlines, questioned whether the trading departments of investment banks like Goldman Sachs are benefiting from the oil-price forecasts issued by their firms' research divisions. Heimlich noted that recent forecasts calling for higher oil prices have been followed by a spike in such investments. "Don't [the banks] have an incentive to interpret the news through a somewhat bullish lens?" said Heimlich. "I am not suggesting impropriety…but isn't there an inherent conflict?"

Worries About Crimping the Market

Goldman Sachs' Casturo disputed that any such conflict exists. "We have every interest that futures contracts represent the true physical, fundamental price of the commodity," said Casturo. "Mechanisms [in place] ensure that supply and demand fundamentals inform the price being paid."

Nonetheless, several proposals to rein in speculation on commodities markets are circulating in Washington. Representative Bart Stupak (D-Mich.) says he plans to introduce legislation to target speculation through swaps, foreign exchanges, and over-the-counter trades. Last month, Senate Majority Leader Harry Reid (D-Nev.), Senator Jeff Bingaman (D-N.M.), and others unveiled the Consumer-First Energy Act, which would mandate higher cash collateral for energy futures trading and ban traders of U.S. crude oil from routing their transactions through offshore markets. And Representative John Larson (D-Conn.) is expected to propose legislation that would go a step further, effectively banning over-the-counter energy futures trading by those who don't take physical delivery of the commodity.

Traders worry that Congress' proposals to clamp down on speculation will gum up markets. "We have to consider the costs of regulatory actions," said Mark Stainton, head of Citadel Investment Group, a hedge fund with investments in energy commodities. "We now have a liquid and transparent market that benefits traders and the end consumer. …We don't want regulations to cripple the [commodities] industry."