Speculators are behind rising oil costs, some say

In a scramble to find a fix for energy prices, Congress is zeroing in on speculators and the legal loopholes that some lawmakers say are adding as much as $70 to the price of a barrel of oil.

Michael Masters, portfolio manager of the hedge fund Masters Capital Management, told a congressional hearing on Monday that with greater regulation oil prices could drop to $65 or $70 a barrel within about 30 days.

"That's half of where prices are today, and gas prices would reflect that," he said, CNNMoney.com reported. Masters and other witnesses speculated that the price of gas could fall to around $2 a gallon shortly after Congress acted to limit speculation in energy markets, according to MarketWatch.com.

Pension funds, Wall Street banks and other large investors that have no intention of taking delivery of fuel have increasingly pumped money into contracts for oil and other commodities as a hedge against inflation.

Democratic House lawmakers said they intend to tighten restrictions on investors they blame for driving up fuel prices.

Many Republicans, analysts and regulators, however, say soaring oil prices are a reflection of larger economic factors, including the falling dollar, unrest in the Middle East and increased demand from countries like China and India.

"Energy speculation has become a fine growth industry and it is time for the government to intervene," said House Energy and Commerce Committee Chairman John Dingell, D-Mich., at hearing on Monday.

Fixes in the works on Capitol Hill range from new constraints on speculators — including a 50 percent margin requirement on financial speculators, full disclosure of all trading by investment banks in all markets, and prohibiting investment banks from holding energy assets — to a bigger role for the Commodity Futures Trading Commission (CFTC).

Crude-oil prices have doubled from last year, reaching a record $139.89 a barrel in trading on the New York Mercantile Exchange June 16. At the pump, gas prices dipped less than a penny overnight to remain at a national average of over $4.07 a gallon, more than $1 above the year-ago average, according to AAA and the Oil Price Information Service.

Lawmakers have cited the pain prices are causing airlines, trucking companies, farmers and consumers in calling for restrictions on speculative trading.

Tim Evans, an energy-futures analyst at Citigroup, thinks the spike in oil prices looks a lot like the Internet bubble of the late 1990s. And just as dot-com stocks crashed, oil, too, is headed for a fall, he predicts.

Evans said oil prices have become disconnected from the physical market for petroleum, just as dot-com stocks became unhinged from market fundamentals. Oil prices, too, have taken on a life of their own, as more and more investors pour billions of dollars into the commodities futures markets, speculating prices will continue to rise.

In fact, recent industry statistics show demand both within the United States and globally for petroleum has actually been falling and inventories have been rising as consumers, faced with escalating prices at the pump, use less fuel, said David Edwards, president and portfolio manager at Heron Capital Management.

But it doesn't seem to have any effect on the direction of prices. "The price pattern looks much like the Internet stocks index in late 1999, early 2000," he said.

On the supply side, Evans noted the Organization of Petroleum Exporting Countries pumped an average of 32.24 million barrels per day of crude oil in May, an increase of 370,000 from April.

The bottom line: Supply is up, relative demand is down, and yet the price of oil is soaring.

No one disputes that financial speculators — that is, hedge funds, investment banks, and other traders who do not take physical possession of the commodities — are surging into commodities markets.

But experts differ widely on the impact these new players have on prices. Treasury Secretary Henry Paulson and many financial-industry analysts say prices are still set by the fundamentals of supply and demand.

In addition to lawmakers, some in the oil industry, the Saudi oil minister and the International Monetary Fund say excessive speculation in the futures market is also a factor in the run-up of prices.

Since September 2003, traders holding crude-oil futures contracts jumped from 714 contracts traded to more than 3 million contracts traded in May 2008, said Rep. Bart Stupak, D-Mich., who chairs the House Energy and Commerce Subcommittee on Oversight and Investigation. His panel held its second hearing on energy speculation Monday.

Speculators now account for 71 percent of the oil-futures market, up from 29 percent in 2000, he said, citing data from the CFTC. Overall, commodity index speculation has jumped from $13 billion in 2003 to some $260 billion today.

"Given this imbalance, you have to wonder if the regulator [CFTC] is missing the forest for the trees," Stupak said Monday.

Many of these trades are exempt from CFTC oversight, and Congress is racing to pass laws to change that: The Enron loophole, the London loophole, the swaps loophole, among others, are on the block in bipartisan bills pending in both the House and Senate.

Before 2000, federal regulators limited the number of contracts that commodity traders could enter into as a way to prevent excessive speculation. But the "Enron loophole" — a provision that Congress wrote into the Commodity Futures Modernization Act in 2000 at the urging of the now-defunct energy trader — exempts electronic energy exchanges from most federal regulatory oversight.

As recently as December, CFTC acting Chairman Walter Lukken told Congress that "excessive speculation" was not a problem. But in response to mounting criticism, the CFTC this month launched a national crude-oil investigation to consider recent evidence on speculation. It also announced an agreement with the UK Financial Services Authority to expand the data received from institutions trading crude-oil products across borders — a bid to close the so-called London loophole.

"We've been slow to react and we're beginning to do what we need to do," said CFTC commissioner Bart Chilton in a phone interview.

But there is not yet a consensus within the CFTC that further steps to rein in speculation are needed.

"There's no evidence of speculative influence. Speculators are not contributing to the demand for physical oil as they almost always roll positions prior to delivery," says Craig Pirrong, a professor of finance at the University of Houston and a member of the CFTC energy markets advisory committee.

"Speculators are not the cause of high oil prices," said Representative Joe Barton of Texas, the senior Republican on the committee. Prices are driven by the lack of supply, he said.

Energy Secretary Samuel Bodman said June 21, while attending a meeting of oil producers and consumers in Saudi Arabia, there is "no evidence that speculators are driving prices."

Chakib Khelil, president of the Organization of Petroleum Exporting Countries, said at the meeting that speculators are driving up prices, along with the credit crisis and geopolitics.

"Every crisis needs a culprit," Sanford C. Bernstein analysts Andrew Keen, Ben Dell, Neil McMahon and Hugh Wynne wrote in a June 20 note. "Active speculation is a catalyst for market movements, not an underlying cause."

Compiled from The Christian Science Monitor, The Associated Press, Cox News Service, Newhouse News Service and Bloomberg News