The speculative trading that has helped drive oil prices over $135 a barrel continues largely unchecked despite much talk and repeated attempts by Congress and regulators to rein it in this year, top analysts say.
As much as 99 percent of the market for U.S. premium crude oil is dominated by big financial firms, hedge, pension and index funds seeking short-term profits from oil’s rise. The speculative free-for-all is enabled by a regulatory exemption called the “Enron loophole,” after the now-defunct Houston energy trading firm that successfully lobbied for its enactment in 2000.
Charles Biderman, chief executive officer of TrimTabs Investment Research, which tracks the flow of money into oil investments, said the more than $2 billion a month flooding into commodity index funds and other oil investments has the potential to create a financial disaster.
“At current oil prices, the U.S. is going broke, and the rest of the world is sure to follow,” he said. “At $135 per barrel, the U.S. will spend $1 trillion per year on oil, which is equal to 15 percent of the $6.8 trillion in take-home pay of everyone who pays taxes.”
Mr. Biderman said regulators need to take aggressive action to burst the speculative bubble, but have not done so despite much talk at the Commodity Futures Trading Commission about investigating and pursuing illegal manipulation in the oil market.
“Oil prices would collapse if regulators increased” the cash requirement for oil futures contracts to 25 percent from the current 7.5 percent, he said. Other analysts suggest raising the cash requirement as high as 50 percent and imposing an overall limit on participation by financial players in oil trading on the New York Mercantile Exchange.
The commodity commission imposes minimal standards on speculators in New York and allows as much as 30 percent of oil trading to escape U.S. regulation altogether by exempting trades routed through overseas electronic exchanges. The commission has given control over those transactions to regulators in London and Dubai who have been granted jurisdiction over the leading U.S. oil contract for West Texas Intermediate crude.
The foreign exchanges gained control over oil trading through the Enron loophole, which granted an exemption from regulation to electronic energy trading, which was a small part of the market in 2000. But since that time, electronic trading has burgeoned to the point that even the New York exchange last year sought to join those escaping regulation by teaming up with the Dubai Mercantile Exchange.
“I’m sure that American consumers will take little comfort that they are being protected from manipulation and excessive speculation driving up gas prices - not by U.S. regulators but by the Dubai government,” said Michael Greenberger, a University of Maryland law professor and former head of the commodity commission’s division of trading.
Congress sought to close the “dark markets” created by the Enron loophole in a provision of the farm bill that was enacted over President Bush’s veto this month.
Rather than remove the exemption entirely, Mr. Greenberger said, the new law creates a lengthy bureaucratic process involving case-by-case review of energy contracts, which he said is unlikely to result in re-establishing regulatory control over most electronic trading.
Mr. Greenberger estimates that the electronic “dark markets” constitute nearly 30 percent of oil trading today. When combined with the estimated 70 percent of oil trading on the New York exchange that is dominated by major financial firms and speculators such as Goldman Sachs and Morgan Stanley, speculators control an estimated 99 percent of the oil market.
“By any objective assessment, the crude oil market is now overwhelmingly dominated by speculation,” Mr. Greenberger said. “One can easily see how Goldman Sachs, a huge trader in these markets, could confidently predict that oil will soon reach $200 a barrel.” The Wall Street firm’s prediction in May, not surprisingly, caused an immediate updraft in prices.
Enron benefited greatly from the exemption before the firm imploded in 2002. Federal investigators later charged the high-flying energy firm with illegally manipulating the market and driving up California energy prices by as much as 300 percent.
Enron’s lucrative energy trading business was taken over in bankruptcy by UBS, a giant Swiss bank, and energy trading has largely been dominated by banks and Wall Street firms ever since.
Many political pundits blame the enactment of the Enron loophole on former Senate Banking Committee Chairman Phil Gramm, a Texas Republican who is now vice chairman of UBS as well as co-chairman of Sen. John McCain’s presidential campaign.
Mr. Gramm shepherded the bill through Congress at Enron’s request, but the bill passed by lopsided margins and was signed into law by President Clinton.
Mr. Gramm’s post at UBS, a major player in energy trading and the mortgage and derivatives markets governed by the Enron bill and other legislation Mr. Gramm championed, shows how he was able to cash in on his financial connections after leaving Congress in 2002.
Mr. Gramm’s wife, Wendy, was chairwoman of the commodity commission from 1988 to 1993 and afterward served on Enron’s board of directors. She remains a fierce advocate of unregulated energy markets at George Mason University’s Mercatus Center, a free-market think tank.
Sen. Barack Obama, the presumptive Democratic presidential candidate, on Sunday highlighted the connection between Mr. Gramm and Mr. McCain in declaring that he intends to close the Enron loophole and crack down on oil speculation should he win the presidency.
Mr. McCain has not advocated controls on energy speculation but rather attributes high prices to foreign energy cartels. To bring down prices, he proposes a mixture of increased offshore drilling and ratcheting up the energy efficiency of automobiles.
Major business groups - including the airline industry, farming organizations and even the oil industry - have called for closing the Enron loophole, even though oil firms generally have profited from high prices.
Major oil firms have testified that they think speculation has as much as doubled the price of oil beyond what is justified by normal market factors such as supply and demand.
Mike Corley, an oil official who has worked to close the “dark markets” created by the Enron exemption, said he is worried that “oil fever” among investors - who regard oil as a good hedge against inflation and the falling dollar - might have accelerated too much to be stopped.
“We need to recognize that there has been a significant integration of the energy markets into the global financial markets,” which now regard oil as just another “asset class” like stocks or bonds, he said.
Calpers, the largest U.S. pension fund, for example, has announced that it will invest $5 billion in commodity funds in the next two years in an attempt to increase its returns and diversify its portfolio - with about 38 percent of that likely going into oil contracts, he noted.
“And Calpers is not alone,” he said, noting that investors have poured at least $100 billion into energy funds this year. He estimated that speculation has driven the size of the oil market to between $5 trillion and $6 trillion.
“The markets that our industry often considers our own are no longer ours,” he said. “If the U.S. decides to increase regulations on energy trading, you can be sure that a number of foreign exchanges will be more than happy to introduce products that are similar to the benchmark” U.S. crude, heating oil and gasoline contracts.
Commodities investor Jim Rogers, founder of the Quantum Fund, is among those leading the craze on Wall Street. He has created a new stock index tied to energy and other commodity industries worldwide that he expects to benefit from booming growth generated by rapidly developing Third World countries.
“We think the bull market in commodities still has a long way to go, especially when you look at growth rates in China, India, the Middle East, North Africa and throughout most of the developing world, where demand for just about every commodity is rising at unprecedented rates,” he said.