Friday, May 30, 2008

Federal regulators disclosed yesterday that they are six months into a wide-ranging investigation to determine whether illegal manipulation of the oil market by Wall Street speculators, hedge funds and investment banks is driving up fuel prices.

The disclosure contributed to a big drop in the price of premium crude, which landed at $126.62 a barrel in New York trading - nearly $9 below the $135.09 record high set a week ago. While fuel prices typically decline after Memorial Day, the price of regular gas continued to creep up yesterday to within a nickel of the $4 a gallon barrier, according to

Concern has been growing from Main Street to Capitol Hill that a speculative frenzy since the end of last year has helped to drive oil and food prices to unprecedented and unwarranted levels, creating hardships for consumers worldwide. Key lawmakers have called for action by regulators, with some threatening to severely limit trading in the oil and commodity futures markets by financial speculators who are using the markets to make quick profits.

The public outcry has not prevented Wall Street banks from continuing to bid up the price of oil, however, with some predicting price spikes as high as $200 a barrel by the end of the year. The Wall Street firms and hedge funds making such predictions typically cite soaring world demand for oil and tight supplies, but most of them also have large positions in the oil futures markets and stand to profit greatly if their widely reported predictions come true.

The Commodity Futures Trading Commission’s announcement yesterday appears designed to put those speculators on notice and address concerns raised by Congress, saying that the investigation begun in December was prompted by “unprecedented market conditions” and is aimed at “ensuring that the markets are properly policed for manipulation and abusive practices.”

Commissioners issued a joint statement pledging to “deter, detect, and punish futures market manipulation.”

Sen. Pete V. Domenici, New Mexico Republican, hailed the commission’s action and said the investigation will help determine whether legislative remedies are needed.

“While it is clear that fundamental supply and demand issues are mostly to blame for the current high price of gasoline, it is certainly worth examining whether speculators are also having an impact,” he said.

Senate Energy and Natural Resources Committee Chairman Jeff Bingaman, New Mexico Democrat, applauded greater disclosures the commission said it will require from financial firms involved in index trading - which has introduced a flood of new investors to the oil markets recently - as well as an information-sharing agreement the commission announced with European authorities that supervise trading in U.S. oil contracts.

Mr. Bingaman informed the commission earlier this week that he is concerned that Wall Street players are escaping scrutiny and sidestepping market safeguards by placing trades through anonymous off-exchange “dark pools” and by exploiting regulatory loopholes for “swap dealers.”

Many lawmakers and economists are worried that the oil and commodities markets might be afflicted with the same kind of speculative fever that fed hyperbolic increases in technology stock prices in the late 1990s and unsustainable increases in home prices earlier this decade. Those earlier investment “bubbles” ended badly with busts that were destructive to small investors, consumers and the economy in general.

Commodities investment has been increasing but appeared to take off at the end of last year just as the housing and credit markets were crashing, suggesting to some analysts that the Wall Street herd had simply switched to a new venue.

Like the earlier investment bubbles, the commodities boom has been fed by dramatically lower interest rates engineered by the Federal Reserve since August. Wall Street firms and hedge funds use loans to leverage their investments in oil and commodity futures contracts many times over.

Unlike refineries, farmers and other commodity businesses that trade in the futures markets, the financial firms are not interested in using, hedging or taking delivery of the commodities they purchase. They just buy and sell contracts short term to make quick profits.

Oil prices have increased sixfold since 2002, making it a popular investment for small and large investors alike, particularly those who seek a hedge against rising inflation and the falling dollar. Oil and most other commodities are priced in dollars and tend to go up when the dollar goes down.

The Commodity Futures Trading Commission is responsible for regulating trading on the New York Mercantile Exchange, where oil futures are traded. It could impose civil fines on market manipulators or, as an alternative to enforcement action, raise the amount of cash that financial firms must put into contracts to prevent them from taking large, highly leveraged positions.

Because oil futures are traded worldwide, Wall Street firms have warned that any enforcement actions in the U.S. might only drive speculators into the London market or elsewhere. The steps the commission announced to coordinate with London yesterday appeared aimed at avoiding that problem.

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