Soaring Oil Prices Put Focus on Speculators

Are Speculators to Blame?

Examine the evidence on whether a new bubble is behind soaring oil and food prices.

Crude oil prices rose again Monday, despite Saudi Arabia's promise over the weekend to modestly increase oil production.

Costly crude oil has pushed gasoline prices over $4 per gallon in most parts of the country. And that has politicians eager to show their concern.

There have been a lot of explanations offered for the doubling of crude oil prices over the last year: a weak dollar, strong demand overseas, greedy oil companies, a stubborn OPEC. The latest culprit singled out on Capitol Hill and the campaign trail is oil speculators.

"We all know that some people on Wall Street are not above gaming the system," said Republican presidential candidate John McCain last week in Houston. "When you have enough speculators betting on the rising price of oil, that itself can cause oil prices to keep on rising."

McCain's Democratic rival took aim at speculators as well.

"Big investors or purchasers or buyers can artificially jack up the price of oil in order to secure short-term profits," Illinois Sen. Barack Obama told reporters, traveling in his campaign plane.

Both presidential candidates have called for more government oversight of oil speculators. And Congress has been busy holding hearings on the subject.

The House Subcommittee on Oversight and Investigations reported Monday that speculators are responsible for about 70 percent of the oil traded on the New York Mercantile Exchange — up from less than 40 percent at the beginning of the decade.

Unlike traditional players in the oil market, who buy and sell futures contracts as a way to lock in prices, financial speculators have no use for the oil itself. They're simply placing a bet that the price of oil, and in some cases other commodities, will rise.

This speculative money "has nothing to do with the real world supply or demand for crude oil," said Michael Masters, portfolio manager of Masters Capital Management.

In other words, consumers might not be putting any more gasoline in their tanks, but their pension funds are loading up on oil futures. That growing demand from institutional investors is driving up the price.

One witness likened it to the run-up in real estate prices when rich retirees move into a small town. "The increase in the size of the funds that these people have is so enormous, there can be no doubt that this increase in the demand for paper barrels has bid up the price of paper barrels," said Edward Krapels, director of Energy Security Analysis.

Not everyone is convinced that speculators are to blame for rising oil prices. The Bush administration has downplayed their role. And Severin Borenstein, who heads the University of California Energy Institute, argues that speculators are chasing high prices, not causing them.

"There is no evidence that the current price of oil is being driven by speculators or hedge fund activity, or by anything else that's going on on the financial side," Borenstein said. "Every day, real supply and real demand are meeting in the physical oil market and trading at prices of $130 a barrel. It's hard to see how financial traders could be causing that to happen."

Still, Congress is looking for ways to rein in speculators, or at least get a clearer picture of what they're up to.

Some lawmakers worry that the problem goes beyond speculation to manipulation — especially since much of the oil trading happens out of sight, or on lightly regulated markets.

"Here's one economic principle that I know: Bad things happen in the dark," said Rep. Jay Inslee (D-WA). "That's where these markets are now: in the dark. And it's time to shed a little light on them."

Inslee recalled what happened in the West Coast electricity market at the beginning of the decade, when traders deliberately withheld power and used other schemes to artificially drive up the price.

The federal agency that oversees the oil market has already taken some steps to increase transparency. Lawmakers will be considering ways to go further, including rules making it harder for speculators to buy up large quantities of oil and limiting financial speculation in the oil market altogether.

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