Speculators' role in crude-oil prices under examination

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 Newspapers has learned.

The Commodity Futures Trading Commission (CFTC) is expected to issue a long-awaited report before Monday, perhaps as early as today, 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.

But 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 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 tools it needs to gather market information.

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

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 report. The agency's interim report found soaring oil prices earlier this year were due to underlying fundamentals of supply and demand.

Testimony expected

Acting CFTC Chairman Walter Lukken is scheduled to testify this afternoon before the House Agriculture Committee. After the interim report 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.

Sen. Maria Cantwell, D-Wash., a sponsor of an anti-speculation bill, said the Masters report challenges CFTC claims that supply and demand forces — and not excessive speculation — has driven up oil prices.

"This analysis illustrates that when oil speculators poured large amounts of speculative money into oil markets, prices skyrocketed just as they were hoping. ... And when the speculative money got pulled out, prices tumbled," she said.

Speculators blamed

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 indexes, and oil prices, pushing a barrel to a record $145.29 July 3 on the New York Mercantile Exchange. Oil then began its descent to fall 26 percent to $109.71 Sept. 2.

Oil fell 68 cents Wednesday to settle at $102.58 a barrel on the New York Mercantile Exchange.

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

"Clearly what affects prices is money. Money came in and money went out," Masters told reporters, saying that prices moved 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.

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.

Swap dealers

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 banned 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.

Positions exceeded

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 ultrawealthy and big institutional investors into high risk-high return investments. Amaranth cornered the natural-gas market, driving up prices for U.S. consumers before its crash resulted in $6 billion in energy losses.

Once regulators began to fear 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, 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 think 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, believed by regulators to be 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.

Information from Bloomberg News and The Associated Press is included

in this report.