WASHINGTON — After months of pummeling oil industry executives, Congress is zeroing in on a new alleged villain for today's record oil prices: investment banks, the same ones who've been instrumental in the housing meltdown.
During two highly partisan hearings Thursday, Democratic lawmakers alleged that the lack of regulation for complex financial instruments is contributing to the oil price run-up, while Republicans defended the investment banks and their involvement in energy trading as merely reflective of supply and demand in world oil markets.
Who's right? The only way to know for sure whether financial speculation is causing oil prices to soar is to ban or at least limit certain kinds of speculation, but opponents of doing that warn that it could disrupt financial markets and drive investment overseas.
The House Agriculture Committee got deep into the weeds of oil trading, grilling the heads of trade associations that represent the players in opaque oil markets. One building over, a House Appropriations subcommittee roughed up the head of the federal agency that's charged with regulating oil markets.
Rep. Rose DeLauro, D-Conn., angrily wagged a finger at Walter Lukken, the head of the Commodity Futures Trading Commission, which oversees oil markets, and in a raised voice told him: "The taxpayer and the consumer are on their backs and we sit and do nothing."
What Congress really wants to know is whether a massive inflow of money into oil markets — $260 billion in new financial instruments since 2004 — simply reflects investors riding a wave of rising prices or if it's causing them to rise.
Answering that question is difficult, largely because a lot of oil trading in financial markets happens far from the eyes of government regulators.
When the regulation of commodities markets began in earnest in 1936, coming out of the Great Depression, federal law sought to quell "excessive" speculation in the sale of farm products. Commodity markets have since grown to include oil, natural gas and other nonfarm products, yet congressional oversight remains in the agriculture committees.
House Agriculture Committee Chairman Collin Peterson, D-Minn., sought and failed to get a consensus definition of what constitutes "excessive" speculation. Critics consider the recent $260 billion "excessive" since it came from investors who have no intention of taking delivery of the oil. For them it's merely an investment, like a stock, to buy and sell for profit. Critics contend that these investments distort the real market for oil.
Others dispute that.
"To date nobody has brought any credible evidence that these distortions exist," Craig Pirrong, a finance professor at the University of Houston and an expert on market manipulation, told the committee.
Critics warned that the lack of regulatory oversight for most oil trading makes it impossible to say anything with certainty, and meanwhile airlines, truckers and many consumers are struggling to stay afloat amid sky-high energy prices.
"I don't think the burden should be on them (consumers) to prove there's no speculation," said Michael Greenberger, who was the head of the Commodity Futures Trading Commission's trading division during the late 1990s.
The sudden inflow of big money into oil markets has come largely through "index investing." That's when state pension funds, university endowments and other big institutional investors place long-term bets on an index of commodities, expecting prices to rise over time.
Some of these investments take place in regulated markets where the Commodity Futures Trading Commission can determine whether a particular investor or group is cornering the market and pushing up prices.
But a much larger portion of index investment happens through unregulated over-the-counter swaps, which usually are arranged by large investment banks such as Goldman Sachs & Co. or Morgan Stanley.
Swaps are complex deals between two parties, usually an investment bank and a big investor. The investor agrees to plunk down a fixed amount of money on a specified quantity — say $135 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.
Big consumers of oil, such as airlines, complain that the money washing through the swaps market is pushing up the prices of regulated futures contracts. To hedge against the risks they've assumed in private swaps deals, investment banks are deeply involved in the regulated futures market. They also are the dominant players in overseas markets in London and elsewhere, where U.S. oil contracts are traded under weaker supervision.
The market for swaps is estimated to be about 18 times larger than the more transparent and regulated futures market. That means a huge amount of trading in oil-related products is happening away from any sort of regulatory scrutiny. Regulators don't even know who's on the other end of a swap. It could be California's pension fund or it could be Osama bin Laden.
"I really believe a little bit of sunshine has a way of purifying things," said Rep. Bob Etheridge, D-N.C., who's sponsored legislation that would increase the reporting requirements on oil trading.
Chairman Peterson suggested that swaps markets are inherently speculative, noting that their investors "rather than go to Las Vegas, they deal with you guys, apparently." He tried unsuccessfully to have Greg Zerzan, the head of public policy for the International Swaps and Derivatives Association, define what percentage of the swaps market commercial players such as airlines represent. He got no answer.
McClatchy put that same question Tuesday to Lukken, the Commodity Futures Trading Commission's acting chairman. He couldn't say.
It's significant that regulators don't appear to know the answer to this question, and it's why the commission has come under criticism and promises to report on the swaps market and index investment by Sept. 15.
Lukken's testimony: Lukken's testimony
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