Record High Oil and Gasoline Prices in 2008 Were Due in Part to Excessive Financial Speculation

Trading Commission Proposes Curbing Speculation in Oil Prices

January 14, 2010

McClatchy Newspapers - In a move aimed at limiting financial speculators' ability to drive up oil prices, the Commodity Futures Trading Commission on Thursday proposed restrictions on the number of energy contracts that any single investor can hold and new limits on the trading activities of Wall Street banks.

The commission staff proposal comes amid growing research that suggests that the record high oil and gasoline prices in 2008 were due in part to excessive financial speculation. Much of that speculation came from Wall Street powerhouses such as Goldman Sachs and Morgan Stanley.

"Today's meeting is an important step," commission Chairman Gary Gensler said.

Before 2001, there were limits on how much control any one investor could have in the energy markets, a term called position limits. The limits disappeared amid an era of deregulation, and by 2004 oil prices were climbing sharply as the global economy grew. Crude oil prices peaked at $147 a barrel in July 2008, then crashed along with the economy later that year, to $56 a barrel. Oil is trading at just under $80 a barrel this week.

The Commodity Futures Trading Commission seeks to establish a limit on how many contracts an investor could have across all regulated markets in which oil and natural gas are traded. This would broaden the limits that existed before 2001, since it would apply not only to contracts for future delivery of oil, but also to markets that involve the physical delivery of oil and natural gas.

That's important, because several Wall Street firms got involved not only in the speculative futures market but also in the physical markets, giving them tremendous potential for market manipulation. Morgan Stanley, as a player in the physical market, controls an estimated 15 percent of the home-heating oil supply in New England. Goldman Sachs owns shares of companies that own pipelines and refineries.

Gensler and fellow commissioners said they weren't trying to regulate prices, but rather restrict the possibility for heavy market concentration by big investors, which could lead to price manipulation.

Many analysts think that the huge flow of Wall Street money into oil and other commodities in the last decade raised the price for a range of commodities, from barrels of oil to bushels of corn.

One leading proponent of this view is Michael Masters, a hedge fund manager who warned Congress repeatedly about the impact of excessive speculation in oil markets. He called Thursday's commission proposal "an interim step, but a very good first step."

"You don't have to conclusively prove that excessive speculation is an issue. That's not their job. It can be circumstantial, or the belief that there's speculation," Masters said in an interview. "I feel strongly that we have had a significant bout of excessive speculation, and I'm glad to see the CFTC taking action that is reflective of that."

Commissioner Bart Chilton, a Democratic appointee, welcomed the limits but said that they "err on the high side," meaning that he'd prefer to see them lower. He added that "should the limits prove inadequate, the agency can, and I hope will, recalibrate" them.

A difficulty in proving excessive speculation is the fact that two-thirds of oil trading happens in unregulated or "dark" markets called over-the-counter exchanges, which now are getting congressional scrutiny and probably face reporting requirements.

On these "dark" exchanges, Wall Street firms enter into private bets, called swaps, with another party on what will happen to the price of oil. These Wall Street banks are called swap dealers.

Swap dealers face market concentration limits on their bets on contracts in regulated markets, but they've been free from position limits when they're hedging against their "dark" market bets on the regulated New York Mercantile Exchange.

McClatchy reported in September 2008 that the Commodity Futures Trading Commission had discovered that some Wall Street speculators had, in the unregulated markets, exceeded the limits they faced in the regulated markets. That's one reason that critics such as Masters argue that Wall Street speculators have pushed up the price of oil and other commodities.

Under the commission's new proposal, which is being put out for comment for 90 days, Wall Street firms could keep their exemptions from position limits on their "dark" market bets, but their names would be made public and they'd be forced to supply the commission with monthly data that they've never reported before, along with other reporting requirements.

"That's meaningful," Masters said.