Gambling on black gold

Our view: Commodities markets need to be more tightly regulated to curb oil speculation

August 26, 2008

If you are shocked to learn that speculators have been profiting from soaring oil prices this summer as ordinary Americans have suffered at the pump, there is a bridge in New York you may be interested in buying.

Prodded by Congress, the Commodities Futures Trading Commission has released data showing that a handful of trading companies controlled a significant fraction of oil futures contracts on the New York Mercantile Exchange. That's as oil climbed to a record level exceeding $147 a barrel in July. At one point that month, one firm held 11 percent of all the oil contracts on the NYME.

You don't need to be an A student in economics to realize that when a single player has that much of the market tied up, there is enormous potential for price spikes, gouging and manipulation. And that suggests the regulators need to be on a tighter leash.

Congress should quickly order a comprehensive review of the CFTC's apparent failure to effectively regulate those markets when it returns to Washington in September. There need to be tougher controls on commodities trading, including limits on borrowing to buy futures contracts. The so-called swap dealers that bought and sold oil this summer have been trading for commercial firms, hedge funds and other investors. They had no intention of taking possession of most of the oil they contracted to buy. With the stock market lagging, these money managers have seen more potential for profit from putting cash in commodities - an estimated $260 billion now, up from $13 billion in 2003.

This gambling on commodity prices used to be against the trading rules. Before 1991, unlimited purchases of commodities were restricted to companies that were going to actually use them or their agents. But that prudent guard against speculation has been significantly weakened since then by the CFTC and Congress. When a handful of firms control a large share of a scarce commodity, the opportunities for market manipulation are obvious and dangerous.

While it may be satisfying to discover some predictable oil villains, Americans should remember a painful truth: With or without speculation, the era of cheap oil is over. Limited supplies and growing global demand ensure that the race to find energy alternatives remains an urgent priority.

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