Legislators taking hard look at oil trading Oil prices fall, but concern in Washington over market manipulation lingers

NEW YORK - NOVEMBER 20: Traders work minutes before the closing bell in the crude oil options pit at the New York Mercantile Exchange November 20, 2008 in New York City. Crude oil prices fell below $50 a barrel, the lowest since level since May 2005, in another ominous sign for the economy. (Photo by Mario Tama/Getty Images) less NEW YORK - NOVEMBER 20: Traders work minutes before the closing bell in the crude oil options pit at the New York Mercantile Exchange November 20, 2008 in New York City. Crude oil prices fell below $50 a ... more Photo: Mario Tama, Getty Images Photo: Mario Tama, Getty Images Image 1 of / 3 Caption Close Legislators taking hard look at oil trading 1 / 3 Back to Gallery

For a few months this summer, the oil market speculator was one of Washington's favorite whipping boys.

This ilk helped push oil prices steadily higher, shattering records that had lasted for decades. As oil topped $145 per barrel, Congress started looking for ways to rein the speculators in.

Then oil prices plunged, and interest in the issue fizzled.

But that may soon change.

Democrats, who led the charge for increased oil market regulation, will return to Washington in the new year with solid majorities in Congress, a friendly White House and the determination to tighten regulation across America's financial markets. They will likely take another look at oil.

"This will remain an issue," said Sen. Byron Dorgan, D-N.D., who introduced oil market legislation this year. "Because when the price of oil has gone from $50 to $147 and back, it's clear to me and everyone else that this has nothing to do with supply and demand. It has to do with speculation."

In addition, the investment banks that have opposed oil market regulations in the past have far less clout than before.

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"The banks are in a much weaker position right now, and they were the ones really fighting this," said Tyson Slocum, director of the energy program at the Public Citizen watchdog group.

President-elect Barack Obama even made cracking down on oil speculation part of his energy platform during the campaign. But he offered few specifics and gave the issue far less attention than he gave to renewable power and alternative fuels.

Among possible changes, Congress may try to assert more authority over unregulated oil swaps that don't take place on any formal market. Limits on the number of oil contracts a speculator can hold could be extended to cover those swaps as well as trading on electronic exchanges and overseas markets.

There's still disagreement over how much speculators influence oil's price.

The Commodity Futures Trading Commission, a federal agency that regulates much of the American oil market, tends to downplay the role of speculators. A commission task force concluded that the tight worldwide balance between petroleum supply and demand caused the price spike, not speculators.

Plenty of oil analysts disagree. Many factors helped shove prices higher, including the growth of China's economy and the decline of the American dollar. But oil kept rising even as gasoline sales fell in the United States, the world's largest oil consumer. That wouldn't have happened if supply and demand really were driving the market, many analysts say.

"The entire move from $70 (per barrel) to $147 was people fleeing the dollar and looking at oil as an asset class," said Amy Myers Jaffe, an energy research fellow at Rice University's Baker Institute. "It was speculators, so when they exited the market, we went right back to $70."

Speculators are investors who trade in oil or other commodities strictly as a financial investment - just as they would trade stocks and bonds. They have no intention of taking delivery of a tanker-truck full of oil or gasoline. They include hedge funds and investment banks as well as retirement funds.

Speculators focus on oil futures, contracts that allow the holder to buy oil at a particular price at a specific time in the future. And the market where U.S. oil futures are traded - the New York Mercantile Exchange, or Nymex - has become a very busy, crowded place. Since 2004, the number of outstanding contracts on the oil market has more than tripled, while the number of traders almost doubled, according to the futures trading commission.

But not all oil trading happens on the Nymex. Some takes place on purely electronic exchanges, which used to be exempt from many regulations. And an unknown amount of oil trading happens as over-the-counter swaps, complicated private financial arrangements that don't involve any formal market. The government limits the number of contracts an individual speculator can hold on the Nymex, to prevent anyone from cornering the market, but those rules don't apply to swaps.

That troubles many politicians, who often refer to swaps as a "dark market."

Legislation this summer in both the House of Representatives and the Senate would have increased staffing levels at the futures trading commission and given it the authority to monitor swaps. Under separate legislation introduced in October by Sen. Dianne Feinstein, D-Calif., swaps would have counted toward each speculator's contract limit.

"If we want fair play in the energy markets, we cannot continue to instruct the (futures commission) to swallow its whistle when it sees violations at the swaps' end of (the) court," Feinstein said at the time.

The idea of limiting swaps could resurface under the new administration. So could other proposed market changes, such as raising the margin for trading in oil futures. That step would require traders to put up more of their money as a prerequisite for trading, ensuring they could cover their obligations if their bets went wrong.

Some fixes have already been made, at least in part.

Language tucked into this year's federal farm bill gave the futures trading commission authority over electronic exchanges. Under congressional pressure, the commission also began collecting data on swaps trading and started monitoring overseas trading of American crude oil.

Those steps should be given a chance to work before Congress takes any further action, said Scott DeFife, senior managing director for government affairs with the Securities Industry and Financial Markets Association.

"Actions that the (commission) took have worked to help information reporting and disclosure, which are definitely things that market participants felt should help calm the markets," he said.

Some Democratic lawmakers consider the steps taken this year to be a good start, but not enough to rein in speculators. They don't want to wait for the next price spike before acting.

"We cannot be lulled into a false sense of complacency just because gas is back below $2 in some regions of the country," said Rep. Bart Stupak, D-Mich. "Addressing excessive energy speculation must be a key part of any new energy policy pursued by the new Congress and the Obama administration."