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Oil Price Speculation: With oil at more than $140 a barrel, the real fireworks in Washington resume this week…

The Wall Street Journal Home Page

Commodities Regulator Under Fire

CFTC Scrutinized 
As Congress Looks 
Into Oil-Price Jump
July 7, 2008; Page C1

With oil at more than $140 a barrel, the real fireworks in Washington resume this week on one of the hottest issues in the global economy: whether speculation is contributing to the past year’s doubling of crude-oil prices and should be curbed.

The House Agriculture Committee will host hearings examining whether the Commodity Futures Trading Commission has a strong-enough grip on the fast-growing, $5 trillion futures market for oil and other commodities or needs other tools. It also will examine how that market is affected by the $9 trillion “over-the-counter” market that has mushroomed outside CFTC regulation.

[Walter Lukken]

The committee has asked lawmakers to outline competing bills that could significantly reshape the commodities markets.

In addition to calling for the collection of more-detailed trading data, some measures seek to ban pension funds from commodities; sharply increase the collateral required to make a trade; or limit the size of some investors’ trades.

Meanwhile, the CFTC is scrambling to collect data from Wall Street firms by mid-July to rethink the question of whether a speculative rush into commodities is causing a bubble. It plans a report by September.

The CFTC has maintained for years that an influx of investor cash into commodities has not distorted prices but instead provided liquidity, or greater numbers of buyers and sellers. The acting chairman of the CFTC, Walter Lukken, a Republican, says supply-and-demand fundamentals still are driving prices, but in recent weeks, has taken a more-aggressive stance on oversight at an agency known for a free-market culture.

The CFTC is overhauling its information-reporting requirements, increasing regulation of electronic energy trading and using its “special call” authority to require new data about over-the-counter trading. The CFTC says it will significantly expand international surveillance by requiring more information sharing from the London oil-trading arm of Atlanta’s IntercontinentalExchange Inc. It also announced it will condition access by U.S. traders to London markets on limits to the size of their positions.

But the CFTC is not moving fast enough for Congress, whose members do not want to tell voters furious about gas prices that there is nothing Washington can do. Late last month, the House voted to force the CFTC to use emergency powers to curb “excessive” speculation. The Senate will take up the measure this summer.


•  The Issue: The high price of oil and other commodities has prompted Congress to ask regulators whether growth in speculative investments is contributing to the price run-up.
•  What’s at Stake: Some say speculators add $15 to $70 a barrel to oil, but many economists contest that; they say driving away financial players may bring higher, not lower, prices.
•  What’s Next: Congress is debating bills that could overhaul markets and restrict speculators, but the likeliest change may be more trading disclosure.

“Don’t tell me you have to study,” Rep. John D. Dingell of Michigan groused to Mr. Lukken at a June 23 hearing. Prices have been on a steady march, the Democrat said, and “you have been idly sitting by twiddling your thumbs.”

A CFTC representative says “the futures markets are continually evolving, and a smart regulator should evolve with change. That’s exactly what this agency has been and is doing.”

Still, as Wall Street lobbying interests hit the Hill to decry the potential chaos that could result from too-drastic measures, some lawmakers have started to grow uneasy about major overhauls to the market.

Some congressional aides say it is looking harder to push through and pass the tougher steps, such as the pension-fund ban. Then again, if oil hits $150 a barrel, anything is possible.

Until recently, a lightly equipped regulator appeared to be what Congress, the White House and Wall Street wanted. Last year, the CFTC had a staff of 437, 12% fewer than it employed in 1976, shortly after it began operating. Its fiscal 2007 budget was $98 million, about a quarter less than President Bush had requested and roughly one-tenth of what Congress gave to the Securities and Exchange Commission. The CFTC’s budget has since risen, but not by much.

Yet the CFTC must oversee and referee U.S. futures exchanges that now handle contracts valued at $4.78 trillion a year, more than 1,000 times the value traded in the mid-1970s.

Economists warn of serious unintended consequences if Congress drives away speculators. Without as many traders, for example, energy companies might have a harder time locking in prices for future oil production and may curtail exploration.

Also, there are holes in the argument that speculation is producing higher prices. Investment in commodities actually slowed in the second quarter, according to Barclays Capital.

Still, even some Wall Street analysts whose firms benefit from the status quo contend that the investment influx has changed market dynamics and could be making raw-materials prices higher or more volatile.

“We are seeing the classic ingredients of an asset bubble,” says Edward Morse, chief energy economist at Lehman Brothers. He says that for every $100 million in new investment since 2006, oil prices have risen 1.6%.

Plaguing both sides of this debate is a shortage of data about a thriving sector of the market: the customized market for derivatives known as swaps. Wall Street banks such as Morgan Stanley and Goldman Sachs have developed swaps to allow pension funds, hedge-fund traders and commodity companies to bet on prices among themselves, largely outside the regulatory surveillance of the CFTC.

Investors can make larger trades through swaps dealers than they could make directly on a futures exchange. Until this month, the CFTC has not required Wall Street swaps dealers to routinely provide more detail on who these customers are.

“We’re trying to get our arms around the market…before we make hard-and-fast conclusions,” Mr. Lukken told a Senate committee June 24.

The CFTC defends its data as the best global futures markets have to offer. Gregory Mocek, CFTC enforcement chief, said in a recent speech that the agency can identify, with the press of a button, who had the most profitable trades in a particular market going back three days, three months or three years.


Still, Mr. Mocek did not advocate expanding surveillance to swaps. “It is my personal opinion that, given the size of that segment of the marketplace, the cost would be far too great.”

The CFTC and Congress long ago gave blessings to the development of this market. In 1993, then-Chairwoman Wendy Gramm sided with energy companies and pushed through a rule change to exempt from CFTC regulation customized energy derivatives that did not trade on registered exchanges. In 2000, Congress firmed up this “swaps exemption” with passage of the Commodity Futures Modernization Act.

Swaps have grown so popular that they are the primary means by which institutional investors have made massive bullish bets since 2002, totaling an estimated $260 billion in indexes linked to the price of a basket of commodities. At a hearing in early June, the CFTC said 85% of index investing is done outside of regulated futures exchanges.

The Bank for International Settlements, a global body that surveys central banks, puts the notional value of all over-the-counter commodity instruments at $9 trillion.

Because an estimated 50% or more of this market consists of instruments related to crude oil, a report from research company ISI Group says over-the-counter oil trading could be as much as 18½ times larger than the total oil bets outstanding on the main regulated energy-futures market, the New York Mercantile Exchange.

CFTC commissioner Bart Chilton says the lack of deeper data on this key market calls into question the CFTC’s previous conclusions about speculators. “We didn’t have the data that we needed to make the statements that we made,” Mr. Chilton says. “And the data we did have didn’t support our declarative statements. If we were so right, why the heck are we doing a study now?”

As oil kept rising this year, the agency’s chief economist, Jeffrey Harris, continued to argue that speculators did not appear to be pushing up prices. He emphasized in May 20 testimony to Congress that the CFTC has seen as much growth in commercial traders such as oil companies, utilities and airlines as it has in “noncommercial” traders, or those it typically considered speculators.

Mr. Harris said his office has “studied the impact of speculators as a group” and found that noncommercial traders are not making moves that precede big price changes.

But congressional witnesses, among others, say that the CFTC misses trends involving large trades by swaps dealers acting on behalf of index investors and hedge funds because it lumps what little data it gets from Wall Street swaps dealers into a “commercial trader” category also encompassing airlines and oil refiners.

A CFTC study released last year showed that while commercial traders as a whole are net sellers, swaps dealers were typically net buyers of the near-term futures contracts that are quoted as the Nymex benchmark.

Write to Ann Davis at [email protected]

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