http://www.chron.com/disp/story.mpl/front/5800462.html
Some wonder if speculators are fueling oil run-up
Debate centers on the rush to cash in on crude
By DAVID IVANOVICH
Copyright 2008 Houston Chronicle Washington Bureau
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WASHINGTON — With American motorists struggling to pay record-high gasoline prices, a debate rages in the halls of Congress and across the Oil Patch over the role speculators may be playing in driving up oil prices.
Crude prices have rocketed nearly $70 a barrel in the past year. Some energy experts suggest speculation could account for $20 to $30 of that run-up.
Desperate to help angry constituents, lawmakers have been scrambling to find solutions. They have voted to close the so-called Enron loophole by regulating electronic trading, and they've given the Federal Trade Commission more authority to guard against market manipulation.
Now some energy and trading experts are calling on lawmakers to focus on the pension funds, endowments and other institutional investors — including the University of Texas and the state's teacher retirement system — that have poured billions of dollars into the commodities futures market in the last few years. The trend has exacerbated the crude price run-up, these analysts say.
Institutional investors' interest in oil "is accelerating and emboldening the price rise," said Mark Lapolla of Sixth Man Research, an Atlanta-based financial research firm. "We just can't quantify it."
Last week, oil futures shot past $133 a barrel, while prices at the gas pump, according to AAA, again reached new heights — nearly $3.88 a gallon on Friday for regular.
Oil is just the most visible of a slew of commodities — corn, soybeans, wheat, rice — to see dramatic price rises this year.
Federal regulators admit commodity futures markets have seen "robust growth," but they point to market forces to explain the rise in prices.
"We really don't think the case has been made that speculation is driving prices," John Fenton, director of market surveillance for the Commodity Futures Trading Commission, told a House panel.
Shell Oil Co. President John Hofmeister seconds that argument, noting that neither he, nor his company's trading experts, see any evidence that speculators are a key factor. "I don't believe it," he said.
To be sure, the oil markets give plenty of reason for concern, irrespective of any trading factors. Despite a moribund U.S. economy, world oil demand continues to rise, and fears are growing about whether production can keep up with the global thirst for crude.
No shocking influences
Oil markets can be rocked by any number of disruptions, whether it be political turmoil in Nigeria or production woes in Mexico. And the Paris-based International Energy Agency is reportedly preparing to give the world some worrisome news about future oil supplies.
If oil prices really were so much higher than supply and demand forces would suggest, argues John Felmy, chief economist for the American Petroleum Institute, then holders of crude oil would be unable to find buyers, and inventories would build. But that's not happening, Felmy said.
Still, the world oil markets have not experienced any dramatic shock that many would have thought necessary to cause oil prices to double in a year.
Disruptions in world oil supplies are nothing new. And with the U.S. economy weak, the International Energy Agency recently lowered its projections for demand growth this year.
"We're right back in the soup again — market prices bearing no resemblance to supply and demand," said Urban "Obie" Obrien, director of government affairs for Houston-based Apache Corp., an oil and gas producer.
Getting the reins ready
Lawmakers have zeroed in on an assessment by Exxon Mobil Corp. Senior Vice President J. Stephen Simon that current inventory levels around the world historically would have suggested a crude price of around $50 to $55 a barrel.
But since 2005, Simon said, a weak U.S. dollar, geopolitical risks and speculation have created a "disconnect" between historical norms and current prices.
Speculation, trading experts say, is a crucial component of any commodity market. It provides liquidity for the market and helps buyers and sellers understand what direction prices are headed. No one is suggesting that it would be possible or practical to ban speculation.
"This isn't a witch hunt against speculators," researcher Lapolla said.
But with commodity prices spiking, and motorists complaining loudly about the price of gasoline, lawmakers are wondering whether they should step to rein in the speculators.
Officials at the New York Mercantile Exchange, arguing against any such effort, point to government statistics that suggest the role of "non-commercial" players — those not actually in the business of producing or processing a commodity — has declined, even as prices headed skyward.
Looking for a hedge
But critics argue that the government data mask the real impact institutional investors are having on commodity prices.
Institutional investors started adding commodities to their portfolios of stocks, bonds and real estate about five years ago, as a hedge against inflation and a weak U.S. dollar. And what began as a trickle has become a torrent following the sub-prime mortgage crisis, trading experts say.
The Teacher Retirement System of Texas, for instance, began investing in commodity indexes in the fourth quarter of last year. Now those investments have a market value of $4.4 billion, system spokesman Howard Goldman said.
The University of Texas Investment Management Co., which invests money for the University of Texas System, has about $500 million in commodities, and the California Public Employees' Retirement System, the nation's largest public pension plan, has $1 billion invested.
Lehman Brothers' Edward Morse, in a recent report, estimated that assets under management in commodity indexes ballooned from about $70 billion in early 2006 to $235 billion by mid-April. The bulk of that investment has been in oil.
Equal to China's demand
Trying to assess the significance of that stampede, Michael Masters, managing member of Masters Capital Management LLC, noted that while China has increased its annual demand for petroleum by 920 million barrels over the last five years, these institutional investors or "index speculators" as Masters calls them, have upped their demand for petroleum futures contracts by 848 million barrels during the same time.
"The increase in demand from index speculators is almost equal to the increase in demand from China," Masters told the Senate panel.
The problem, critics say, is that the institutional investors have waded in and bought sizable "long" positions, betting that oil prices — no matter how high they may seem now — will continue to rise.
Because of a loophole in federal trading regulations, experts say, the institutional investors can circumvent typical speculative limits. The cumulative effect, critics say, of all of this lopsided betting that prices will rise has been to propel prices skyward.
Closing that loophole, some lawmakers say, may be how Congress steps into this issue.
"It's not like they're evil or malicious," Masters said of the institutional investors. "It's just they're so big, and they all act the same."