Congress rushes to fill oil speculation loophole

Speculation can add $70 to the price of a barrel of oil, critics charge.

Call it Enron, the sequel.

In a scramble to find a fix for energy prices, Congress has tried (and failed) to strip tax breaks from Big Oil, to open protected sites for exploration and drilling, and to jump-start a new era in nuclear power.

Now, Capitol Hill 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.

"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) of Michigan, 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 more funding and regulatory mandates for the Commodity Futures Trading Commission.

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. On that point, there is no dispute.

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.

Many lawmakers, along with oil industry spokesmen, 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, says Rep. Bart Stupak (D) of Michigan, 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 says, citing data from the Commodity Futures Trading Commission (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," Representative Stupak said Monday.

Many lawmakers insist that such a surge cannot help but contribute to the surge in oil prices.

"The [commodities] market is broken. It doesn't work. It is full of speculators and what they're interested in is to drive up the price. They don't give a rip about the damage to the economy," says Sen. Byron Dorgan (D) of North Dakota, who is chairing another hearing on speculation.

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 blocks in bipartisan bills pending in both the House and Senate. (The Enron loophole to a 2000 law allows oil futures to be traded outside the jurisdiction of the CFTC.)

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.

Despite the surge in investment in commodities markets, the CFTC has only 448 staff, compared with 3,700 for the Securities and Exchange Commission.

"We are down 175 staff members from a high in 1992, despite a rising tide of hedge fund and pension fund investment in the commodities market," says Mr. Chilton.

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.

But at Monday's hearing, Michael Masters, portfolio manager of the hedge fund Masters Capital Management said: "This is an acute crisis. The time for studies and examinations is past."

A key witness in recent congressional hearings, Mr. Masters said in an interview that "even though speculators are not hoarding actual commodities, they have the effect of driving up the price for consumers around the world because of the linkage between the commodities market and the spot market."

"They have the same effect on price as if they were buying real physical commodities," he said.