Did speculators use unregulated markets to drive up oil prices?

McClatchy NewspapersSeptember 11, 2008 

WASHINGTON — Federal regulators have uncovered evidence that oil speculators operating in unregulated "dark markets" may have helped drive the price of crude oil to record highs this year, McClatchy has learned.

The Commodity Futures Trading Commission is expected to issue a long-awaited report before Monday, perhaps as early as Thursday, on what role oil speculators played in the 50 percent rise in oil prices earlier this year. The report isn't expected to declare that speculators are the main cause of the price rise, a conclusion the agency rejected in an interim report in July.

One CFTC commissioner, Michael Dunn, signaled in a speech last Friday in Switzerland that the pending report would be inconclusive, noting, "I doubt it is possible to come up with a definitive answer one way or another at this time" about the role of speculators.

However, unregulated markets account for about two-thirds of oil trading on financial markets, and they could be used to manipulate oil prices on the regulated exchanges that account for the remaining oil trading.

The finding that some speculators exceeded positions allowed in regulated markets is sure to spark debate about how much the CFTC knows about the markets it regulates, whether more stringent reporting requirements are needed and whether the government should require more disclosure from speculators and investment banks.

In a recent interview, CFTC Commissioner Bart Chilton told McClatchy that his agency lacks all the tools it needs to gather market information.

"It's not responsible to reach conclusions about speculators based upon current data," he said.

It's not entirely clear how the CFTC, which is under heavy criticism from Congress, will portray its findings about the large dark-market positions in the much-anticipated report. The agency's interim report said it thought that the soaring oil prices earlier this year were due to underlying fundamentals of supply and demand.

Acting CFTC Chairman Walter Lukken is scheduled to testify Thursday afternoon before the House Agriculture Committee. After the interim report was released in July, he was mocked by Sen. Byron Dorgan, D-N.D., who questioned the report's timing ahead of an expected congressional vote on energy legislation.

On Wednesday, timing again was an issue as Dorgan called a news conference to present a report ahead of the CFTC's. His report came from hedge fund manager Michael Masters, who alleges that oil speculators were almost completely responsible for the run-up in oil prices — and their recent decline.

"We have a brain-dead regulator here . . . content to do nothing," Dorgan said.

The CFTC declined to comment on his attack.

The agency also declined to comment on the report by White Knight Research & Trading that blames index fund investment for this year's huge rise in oil prices. Index investors are large institutional investors who place bets on whether the prices of a range of commodities from cocoa to copper will rise or fall.

The report from Masters and his partner Adam White uses CFTC data to conclude that from January through the end of May, index investors pumped $60 billion into major commodity indices, and oil prices rose $33 a barrel.

Beginning on July 15, a sell-off of these commodities began, resulting in about $39 billion pulled out, and a $29 per barrel drop in oil prices.

"Clearly what effects prices is money. Money came in and money went out," Masters told reporters, saying that prices moved not on supply and demand fundamentals, but by investors' decisions.

That view was challenged by the Smart Energy Policy Coalition, a group that represents the futures industry and commodities dealer trade associations.

"The findings of the new 'report' . . . run counter to the analysis and judgment of the vast majority of economists, as well as Federal Reserve Chairman (Ben) Bernanke, Treasury Secretary (Henry) Paulson, the International Energy Agency and the Commodity Futures Trading Commission," the group said in a statement.

It noted that all those authorities had concluded that rising oil prices were "the result of global economic conditions, the changing strength of the dollar and supply-demand fundamentals, not speculative trading activity."

In late May, the CFTC announced that it was, for the first time, using its so-called special call authority to demand that traders show their positions in a complicated, unregulated parallel market called the over-the-counter (OTC) swaps market.

Specifically, the agency is looking into swap dealers, who enter into complex private contracts for oil sales away from the peering eyes of regulators.

McClatchy has learned that some of the speculators doing business with swap dealers — who generally are large investment banks such as Goldman Sachs and Morgan Stanley — have built positions that would be prohibited in regulated futures markets.

Swap dealers such as Goldman are exempt from position limits because they enter into private contracts in the over-the-counter market, and then hedge the risks from those contracts in the regulated futures market.

Regulators know what swap dealers' positions are in regulated markets, but they have far less information about who's on the other end of a swap deal and what their positions in futures markets might be.

In a swap deal, an investor agrees to plunk down a fixed amount of money on a specified quantity — say $100 for a barrel of oil — over a fixed period. The investor is seeking to limit the risk of being exposed to prices going above that point, and the swap dealer hedges the cumulative bets it's made by taking positions in the regulated futures markets, as well as smaller regulated futures markets abroad.

In some cases, speculators in swap deals apparently had reached position limits in the regulated market, and then exceeded them with investments in the swaps market. There were instances in which some speculators significantly exceeded position limits.

Exceeding position limits in a dark, or unregulated market, doesn't necessarily mean something nefarious was occurring. But there's reason to worry given the spectacular 2006 collapse of Amaranth Advisors.

Amaranth was a hedge fund, which pools money for the ultra wealthy and big institutional investors into high risk-high return investments. Amaranth effectively cornered the natural gas market, driving up prices for U.S. consumers before its spectacular crash resulted in a staggering $6 billion in energy losses.

Once regulators began fearing that Amaranth had concentrated too much investment in trading natural gas contracts, it was ordered to liquidate positions. It did so, but then took similar positions in London on the InterContinental Exchange, or ICE. This market involves electronic trading of similar futures contracts, but until recently it didn't provide real-time, actionable information about trader positions to U.S. regulators.

What Amaranth did was maintain the same overall position, and that allowed its trading to influence the price of natural gas in the U.S. market. Some economists believe that Californians paid as much as 30 percent more to cool their homes in the summer of 2006 because of Amaranth's actions. The fund has since collapsed, and last year the Federal Energy Regulatory Commission fined the company and its managers $291 million.

Shortly after Amaranth's problems, The Wall Street Journal reported that Goldman Sachs & Co., believed by regulators to among the largest swap dealers, snapped up a team of Amaranth traders. Goldman Sachs has been among the most bullish on oil prices, predicting $200-a-barrel oil in the near future.


The CFTC's original announcement of a study: http://www.cftc.gov/newsroom/generalpressreleases/2008/pr5503-08.html

The CFTC's interim report: http://www.cftc.gov/stellent/groups/public/@newsroom/documents/file/itfinterimreportoncrudeoil0708.pdf

More on market manipulation charges against Amaranth: http://www.ferc.gov/news/news-releases/2007/2007-3/07-26-07-ama-fs.pdf


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