Are Pension Funds Fueling High Oil?

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Speculative activity in commodity markets has grown dramatically over the last several years. In the past decade, the share of long interests—positions that benefit when prices rise—held by financial speculators has grown from one-quarter to two-thirds of the commodity market. In only five years, from 2003 to 2008, investment in index funds tied to commodities has grown twentyfold, from $13 billion to $260 billion.

Some analysts say that as commodities markets have been deluged with investment bank money, supply and demand has been rendered less relevant, to the detriment of consumers and producers and marketers. In a May 9 research note, Lehman Brothers (LEH) economists argued that oil's recent rise has been fueled by "non-supply-demand factors and by potential inventory misperceptions." In other words, the dollar weakening and "investors' desire to be exposed to real assets" has spurred increased inflows from investors biased toward long positions. Additionally, hedge fund director Masters points to data showing that over a five-year period, China's demand for oil has increased by 920 million barrels, while over the same period, index speculators' demand has increased by 848 million barrels.

Time to 'Muscle Up'?

Pressure on Congress is increasing not only from consumers but also from industry groups. The New England Fuel Institute (NEFI) and the Petroleum Marketers Association of America (PMAA), whose members are marketers and retailers of petroleum products, have called on Congress for more oversight of speculation in energy markets. A trucker-consumer coalition called Truckers & Citizens United has also called for greater market transparency amid "crippling" energy prices.

At the Tuesday hearing, Senator Claire McCaskill (D-Mo.) grilled CFTC chief economist Jeffrey Harris on why his agency is not more concerned with the impact of speculation on commodity prices. "The people of America are about to pick up pitchforks," she said. "If you were Popeye, I'd give you a can of spinach. It's time to muscle up here." Harris said the agency monitors markets daily, and has "an active engagement in the Agriculture and Energy Depts. The CFTC does not need further legislation to perform its duty of overseeing commodities markets, and that government intervention could distort the market, he added. "Markets are most healthy when there is no limit on who can participate in them," Harris said. "When investors are limited, they will transfer funds to other [less regulated] markets and diminish the effectiveness of hedging."

For their part, pension fund managers say they're not to blame for commodity price surges. The California Public Employees Retirement System (CalPERS), the largest U.S. pension fund, has invested about $1.1 billion in commodities swaps contracts through investment banks like Goldman Sachs. CalPERS spokesman Clark McKinley says the fund started considering commodities investing in 2006 as an inflation hedge and because many economists predict rising energy costs for several decades. However, that represents a fraction of the fund's $242 billion in assets, he says, and ultimately has only a minimal effect on commodity prices. "We understand that there is of course some effect of investors on [commodity] prices. But it's a relatively small impact," McKinley said in a telephone interview.

Senator Joe Lieberman (I-Conn.), the committee chairman, concluded the hearing by agreeing that institutional investors are having a disproportionate impact on commodity prices. He says he will convene another panel of witnesses to examine how to close the "swaps loophole," among other ideas for reform, some of which are included in the Consumer First Energy Act of 2008 proposed on May 7 by a group of Senate Democrats. "At times it is in the public interest to limit the opportunity people have to maximize profits," Lieberman said. "A lot of the rest of us are paying through the nose as a result, including a lot of us who can't afford to pay through the nose."

Herbst is a reporter for BusinessWeek in New York.