Oil Traders Face New Regulation

Under pressure from Congress—and runaway oil prices—U.S. regulators are moving to exert far greater oversight

By Moira Herbst

The dramatic surge in oil prices—including a $16-per-barrel jump in just two days last week—has left Washington regulators scrambling to exert new oversight on futures trading in oil and other commodities. The U.S. regulatory agency's abrupt shift toward more rigorous oversight in the past two weeks also represents a stark example of how the pinch from high gasoline prices has changed the political landscape and made energy traders prime suspects in congressional inquiries.

As recently as May 20, the U.S. commodities regulator, the Commodity Futures Trading Commission (CFTC), insisted at a Senate hearing that speculation was not causing the rapid spike in energy prices. The CFTC's chief economist, Jeffrey Harris, testified that the agency found that speculation and manipulation are not causing energy prices to surge. He said that instead prices are being driven "by powerful economic fundamental forces and the laws of supply and demand." Nine days later, after further pressure from Congress, the agency announced steps aimed at more oversight of energy futures trading.

Among the measures (BusinessWeek.com, 5/30/08):

• A new information-sharing agreement with Britain's commodities regulator, the Financial Services Authority (FSA), to gather information on large positions of the benchmark West Texas Intermediate (WTI) contract.

• A proposal to consider reclassifying investment banks such as Goldman Sachs (GS) and Morgan Stanley (MS) as speculators, which would subject them to trading limits from which they're currently exempt.

• An investigation of the crude oil trading market dating to December, 2007. On May 30, The Wall Street Journal (NWS) reported that the CFTC has also expanded an investigation into allegations of short-term manipulation of crude oil prices through a price-reporting system overseen by Platts, the energy data unit of The McGraw-Hill Companies (MHP), which also owns BusinessWeek. The CFTC won't confirm such a probe, and Platts has declined to comment.

The agency's pronouncements come as oil prices spike to new record highs. On June 6, oil prices jumped to a record settlement of $138.54, after touching an intraday record of $139.12. The 13.3% rise—$16.24 per barrel—on June 5-6 marked the biggest two-day gain for oil in trading history. Meanwhile, gas prices reached a new record national average of $4.005 a gallon on June 8.

Critics say such changes are long overdue. "The CFTC has been deregulating itself out of existence," says Michael Greenberger, a law professor at the University of Maryland and former head of the CFTC's Div. of Trading & Markets. "The only way to permanently deflate the [commodities] market is to ensure more aggressive oversight." If the CFTC took the next step of requiring all U.S. crude trades to be subject to CFTC regulation and trading limits, oil prices would drop by 25% "overnight," says Greenberger.

The CFTC declined to comment for this article, but on a June 3 conference call with reporters Acting Chairman Walter Lukken explained the recent actions: "In a free-market society we want to encourage access to markets. However we want to make sure that the funds coming into the markets aren't distorting them." To be sure, the CFTC has not yet made any regulatory changes. But its recent steps indicate a more serious public engagement with the issue of speculation, which could ultimately lead to more regulation.

More Regulation Needed?

Several changes over the past decade have relaxed the agency's oversight of commodities markets. The Commodity Futures Modernization Act of 2000 (CFMA) allowed energy commodities for the first time to be traded on deregulated "exempt commercial markets," meaning exchanges exempt from CFTC or any other U.S. government oversight. This law was a departure from the Commodity Exchange Act of 1936, which had confined commodities trading to CFTC-regulated exchanges.