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Senators Delve Into Speculators' Control of Commodity Assets

Members of a panel testifying at a hearing of a Senate Banking, Housing and Urban Affairs subcommittee last week warned that allowing global conglomerates to own multiple pieces of the production and marketing chain for any commodity, including oil and natural gas, while simultaneously also speculating on the price of those commodities, opens the door to potential manipulation of prices.

Should institutions be allowed to own oil tankers and also speculate on oil prices, for example, members of the Subcommittee on Financial Institutions and Consumer Protection asked Saule Omarova, associate professor of law at the University of North Carolina.

"Is that an issue, that not only can they set the price, or affect the price in the financial market, but can also influence the price of the physical oil if they own the fleet of tankers, or contractually have access to the physical barrels of oil? I think it's a far more important issue than the traditional anti-trust DOJ [Department of Justice] concerns with market share, calculated based on some definition of the market, for example," Omarova said.

Allowing too much of the product chain to be controlled by a single entity creates the potential for price manipulation, and "may or may not hurt the individual consumer, but it raises an issue of market integrity in the financial market and also the underlying commodities market," Omarova said. "It also interferes with the traditional supply and demand dynamics that typically forge prices in a lot of markets."

Goldman Sachs, Morgan Stanley and JPMorgan Chase "have emerged as major merchants of physical commodities and energy, notwithstanding the legal wall designed to keep them out of any non-financial business," she said. The three financial holding companies "currently own and operate what appear to be significant businesses trading in crude oil, gas, refined petroleum products, electric power, metals and other physical commodities. In conducting these activities, they function as traditional commodity merchants rather than purely financial intermediaries." But there is "no meaningful public disclosure" of their assets and activities related to physical commodities and energy, she said.

Joshua Rosner, managing director of Graham Fisher & Co., an independent research firm for institutional investors, said "an unprecedented mixing of banking and commerce" allowed by the government and Federal Reserve over the past decade has "gone better for the banks than it has for consumers.

"Electricity users appear to pay more because of Wall Street involvement, aluminum for airplanes and soda cans costs more, and some say gasoline at the pump costs more, without any measurable benefit to anyone but the banks...the Federal Reserve Board should not allow banks to be in businesses that don't directly support the resilience of the payments system of the stability of FDIC insured deposits."

The hearing was convened to examine whether banks should be allowed to control power plants, commodities warehouses and oil refineries. The Commodity Futures Trading Commission has opened an investigation into aluminum warehouse operations controlled by Goldman Sachs and others, and has told those firms to retain internal documents related to those businesses, according to a report in the New York Times.

Tim Weiner, global risk manager of commodities and metals for MillerCoors, said aluminum is his company's single largest price risk and, because of "an economic anomaly in the aluminum and other base metal markets," he wants legislators and regulators to strengthen oversight of bank holding company activities. In the past few years, the market for base metals "has drastically changed," and manufacturers "can no longer plan to buy the aluminum we need directly from aluminum producers." U.S. bank holding companies have gained effective control of the London Metal Exchange (LME) "and they have created a bottleneck which limits the supply of aluminum," he said.

"What's most concerning is that all the key elements of the LME (ownership, warehousing, policy control) for aluminum and other base metals worldwide are controlled by the same entities: bank holding companies."

But, according to Randall Guynn, head of the financial institutions group of the law firm Davis, Polk & Wardwell, financial holding companies are held accountable, having to show that "physical commodities activities are complementary to permissible financial activities, such as entering into futures, forwards or other commodities contracts before being permitted to engage in such physical commodities activities."

Last week the Federal Reserve appeared to question whether banks should even be allowed to trade in physical commodity markets. The Federal Reserve is reviewing a landmark 2003 decision that allowed Citigroup's Phibro unit to trade oil, a move that at the time set a precedent other banks followed. Soon after, numerous banks had established their own commodity trading businesses, and these quickly became major profit centers.

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