Oil Traders Take More Heat

At another hearing on speculation and oil prices, Congress debates measures for stronger regulation

by Moira Herbst

A hedge fund manager suggested in a June 23 congressional hearing that lawmakers could cut oil and gasoline prices in half by further regulating oil futures trading and reining in speculative trading. "We're not talking about [an oil price] bubble; we're talking about a tumor," said Michael Masters, managing member of Masters Capital Management, a Virgin Islands-based hedge fund. "It grows and grows, and it's hurtful as it expands. But now we have discovered the tumor and we should take it out immediately. The time to act is now."

At times, the tone of the daylong hearing by the U.S. House Committee on Energy & Commerce was as scorching as the oil market itself. Elected officials are scrambling to get ahead of what's turning out to be a political hurricane. Oil prices have more than doubled since last June and sent the cost of gasoline, air travel, and other basic consumer goods and services soaring. Republicans including President George W. Bush have called for more access to U.S. lands for drilling (BusinessWeek.com, 6/20/08), while Democrats, including independent Connecticut Senator Joe Lieberman, and some Republicans say tighter regulation of oil trades will take the speculative air out of prices.

U.S. officials have also called on OPEC to increase production to ease prices. But a June 22 pledge by Saudi Arabia to increase production by 200,000 barrels a day (BusinessWeek.com, 6/22/08) had little impact on oil prices, which rose $1.38, to settle at $136.74 per barrel on the New York Mercantile Exchange on June 23. Gas prices, meanwhile, remained at a nationwide average of $4.07, a cent short of the all-time high reached June 16.

To $70 a Barrel in 30 Days?

With large short-term changes in a tight supply-and-demand equation, attention has turned to the way oil is traded. The June 23 hearing included four panels of witnesses, such as Fadel Gheit, senior energy analyst at Oppenheimer (OPY); transportation industry executives including Doug Steenland, president and CEO of Northwest Airlines (NWA); Walter Lukken, acting chairman and commissioner of the U.S. Commodity Futures Trading Commission; and futures exchange representatives such as James Newsome, CEO and president of Nymex (NYMEX).

Masters, who said his own firm does not trade oil futures contracts, suggested several measures to further regulate oil futures trading. He said that could cut oil prices to about $70 a barrel within 30 days. He proposed requiring that trades of West Texas Intermediate crude be overseen by the CFTC and not by foreign boards of trade. He also recommended raising margin requirements on oil trades and reclassifying investment banks as speculators so they are subject to position limits on exchanges. Members of Congress, including Senator Lieberman, Representative Bart Stupak (D-Mich.), and Senator Maria Cantwell (D-Wash.), have introduced bills to tighten oil trading regulations.

Several witnesses focused on investment banks' ability to trade oil futures for clients such as pension funds and university endowments without limit. The Commodity Futures Modernization Act of 2000 allowed for investment banks like Goldman Sachs (GS) and Morgan Stanley (MS) to be classified not as speculators subject to position limits but as "commercial" traders with no restrictions. Analysts say the influx of these funds into the market has been a primary cause of price increases. "Large investment banks are fanning the flames and exaggerating prices because of the government's unwillingness to hold them accountable," said Gheit.

CFTC Chief Grilled

Stupak then asked Gheit if there is an "actual or apparent conflict" when investment banks' commodities research arms project prices to rise to $150 or $200 while at the same time the firms are investing their own money in the market. "Unequivocably and absolutely yes," said Gheit. "It's a self-fulfilling prophecy. The largest trader predicts the price of a commodity will go up, guess what will happen? It goes up."

At the hearing, CFTC Acting Chairman Lukken faced intense grilling. Representative John Dingell (D-Mich.) asked Lukken: "How is it that the market situation isn't working to the benefit of the consuming public, while it's benefiting the good-hearted folk in New York working on this wonderful speculative enterprise? Who gets ahead and who gets skinned?"

Lukken said the CFTC has introduced a number of measures to gather more information on large trades (BusinessWeek.com, 6/8/08), but Dingell was not satisfied with that response. "Don't tell me you're doing studies," he said. "Tell me what you've done. …You've spent more than a year sitting idly by" while oil prices have surged.

Herbst is a reporter for BusinessWeek.com in New York.