Investors' Growing Appetite for Oil Evades Market Limits

By David Cho
Washington Post Staff Writer
Friday, June 6, 2008

Hedge funds and big Wall Street banks are taking advantage of loopholes in federal trading limits to buy massive amounts of oil contracts, according to a growing number of lawmakers and prominent investors, who blame the practice for helping to push oil prices to record highs.

The federal agency that oversees oil trading, the Commodity Futures Trading Commission, has exempted these firms from rules that limit speculative buying, a prerogative traditionally reserved for airlines and trucking companies that need to lock in future fuel costs.

The CFTC has also waived regulations over the past decade on U.S. investors who trade commodities on some overseas markets, freeing those investors to accumulate large quantities of the future oil supply by making purchases on lightly regulated foreign exchanges.

Over the past five years, investors have become such a force on commodity markets that their appetite for oil contracts has been equal to China's increase in demand over the same period, said Michael Masters, a hedge fund manager who testified before Congress on the subject last month. The commodity markets, he added, were never intended for such large financial players.

"I've never said that financial speculation is behind all of the recent price increase here, but even if it's some of the reason, it's something society needs to look very hard at," he said.

Commodities have become especially enticing to investors as the credit crisis has roiled other investment opportunities such as stocks and debt-related securities. The recent flood of investment money has transformed the markets for oil, as well as uranium, wheat, cotton and other goods, into a volatile realm that some insiders call the Wild West of Wall Street.

Even as record oil prices translate into staggering increases at the pump, some regulators, including Treasury Secretary Henry M. Paulson Jr., say investors are not to blame. These officials cite supply and demand as a far bigger factor.

Since last year, this was also the position of the CFTC. But agency officials have recently signaled greater concern, saying they want to collect more data to determine whether speculation might be a significant factor. That information can be difficult to obtain because commodity trading often occurs through private, unregulated transactions and on overseas exchanges.

Walter Lukken, the acting chairman of the CFTC, acknowledged in an interview that his agency has had a hard time keeping up with the sector it oversees. Commodity trading has exploded in complexity and popularity, he said, growing six-fold in trading volume since 2000. That was the year a handful of giant energy companies, including Enron, successfully lobbied Congress to ease the regulation of energy markets.

Meanwhile, the CFTC's staffing has dropped to its lowest levels in the agency's 33-year history.

"We could hire an extra 100 people and put them to work tomorrow given the inflow of trading volume," Lukken said. "We are doing the best we can in difficult circumstances. . . . This is something that we are obviously concerned with -- the potential for manipulation."

CFTC officials said in interviews that they planned to re-examine the exemptions granted by agency staff to Wall Street firms. These date to 1991, when complex derivatives used to bet on futures contracts emerged and their significance was little understood. These officials said they would also reconsider the waivers given to overseas trades.

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