Speculation on speculators

WASHINGTON, D.C.-No resounding explanation has presented itself in the last few months for the recent spikes in the prices of oil and food. Many in the commodities market-and many Republicans-attribute it to normal swings of supply and demand.

But Democrats, led by Sen. Byron Dorgan of North Dakota, who is chairman of the Senate Subcommittee on Energy, are calling foul on speculators in the commodities markets. Hedge fund guru Michael Masters said in a newly released report that these "index speculators" were directly responsible for the massive rise of the price of oil, and equally responsible for its rapid decline.

Crude oil prices rose from $95 a barrel in January to $145 in July. This week, oil is back in the $95-a-barrel range. The spike in between, however, led to a massive increase in food prices around the world.

"This is really a social justice issue," said Adam White, a hedge fund manager and co-author of the report on speculation with Masters. When speculators pushed up oil prices, he believes, the fallout hit the developing world hard by driving up other commodities, such as food.

Masters argues that index speculators flooded the market with purchases, driving up prices precipitously, and then pulled out quickly when Congress began investigating speculators' role in the price spike.

Some critics, including Sen. Pete Domenici, R-N.M., questioned the credibility of Masters' analysis and pointed out that his company has significant holdings in transportation.

Speculation in commodities markets is not illegal, but excessive speculation could indicate manipulation of the market by those with significant commodities holdings. But pinpointing what "excessive speculation" means is difficult, demonstrated by the opposite conclusions Masters and the U.S. Commodity Futures Trading Commission (CFTC) reached with the same data.

"Speculation is body fat. We can't live without body fat," said Fadel Gheit, an energy analyst with Oppenheimer & Co., explaining that speculation provides cash flow for companies. "[But] if you over-grease the wheel, you skip all over the place."

The CFTC serves as the referee for the oil futures market. With its recent report, the Commission stood by its earlier reports that the price changes were market-driven, but acknowledged that through new classifications 70 percent of futures contracts belong to speculators.

Sen. Dorgan wasn't buying it, saying the CFTC had performed "a weak regulatory function" and in some cases was "willfully blind" to excessive speculation.

Jeff Harris, chief economist for the CFTC, responded that everyone at the Commission had done their jobs, and had pursued unprecedented amounts of data on swap-deals, or off-market speculation.

Data on oil speculators is often unavailable because many of the firms with the largest holdings in the market are private. Only last month, David Cho of The Washington Postreported on the CFTC finding that one Swiss firm, Vitol, held 11 percent of all oil contracts on the New York Mercantile Exchange.

"This is like the plot of a Robert Ludlum novel," said Robert McCullough, managing partner of McCullough Research, which researches the energy industry. "As an economist, you're very concerned about oligopoly. An oligopolist can change prices with his decision."

Wall Street bigwigs testifying to the Senate Subcommittee on Energy couldn't agree on whether an oligopoly caused the oil spike. Lawrence Eagles, representing JP Morgan Chase, said their firm saw no evidence of market manipulation. Republican Sen. Lisa Murkowski from Alaska agreed, saying that factors like a spike in demand from China and India brought on the price spike. But she acknowledged, "Speculation does play a role."

Gheit was more emphatic.

"The global supply is controlled by cartel," said Gheit. "We'd like to think it's free market, but it's not."

The issue will rear its head next week when the Senate discusses energy legislation, and whether to impose stricter regulations on speculators.