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Speculators' Influence 'Clear' in Oil Markets, Say Rice Economists

The size and influence of speculative traders in the oil markets has more than doubled in the past decade, and "enhanced regulations" should be implemented for noncommercial traders, energy economists at Rice University's Baker Institute for Public Policy said Thursday.

Citing data from the Commodity Futures Trading Commission (CFTC), coauthors Kenneth Medlock and Amy Myers Jaffe said the influence of noncommercial trading in the oil futures market is "clear" since regulations were eased by the Commodities Futures Modernization Act of 2000 (CFMA). Noncommercial traders now make up about 50%, of those holding outstanding positions in the U.S. oil futures market, versus 20% before 2002, they said.

The correlation between oil and the dollar also has strengthened "significantly" in the past few years, said Medlock, an energy fellow at the Baker Institute and adjunct professor of economics. Jaffe is a fellow in energy studies at the Baker Institute and associate director of the Rice Energy Program.

The CFTC's claims that speculation wasn't influencing oil futures markets were based on an "inappropriate analysis," they said.

Although the reasons for the sharp swings in oil prices since 2005 are "complex" and require "further and deeper study," the economists said "there are inescapable facts that need to be part of the debate about regulating the activities of institutions betting on movements in oil price purely for financial gain."

Hedgers, said the economists, are typically producers and consumers of physical commodities who use futures markets to offset price risks. However, speculators, designated by CFTC as reportable traders not using futures contracts to hedge have increased their footprint in the marketplace" dramatically" from 10 years ago.

"To protect the U.S. economy and American consumers, there needs to be greater market oversight," Medlock said. "The tremendous increase in the market presence of speculators by fifteen-fold speaks for itself."

According to a 2007 Government Accountability Office report, the CFMA made it easier for financial players to obviate speculative limits and more difficult for CFTC to regulate oil futures markets, the authors noted. "Changes at the London International Petroleum Exchange, which is now the Intercontinental Commodities Exchange, regarding U.S. delivery-based contracts also created problems with monitoring and limiting speculative activity because these contracts were outside the jurisdiction of the CFTC."

There were "short windows" before 2001 when oil prices and the value of the dollar were closely correlated, but "a dramatic sustained period of high correlation emerged during the 2000s," said Medlock and Jaffe. This close correlation threatens U.S. economic health and national security because "the dollar risks getting caught in a vicious cycle where continually rising oil prices feed the U.S. trade deficit, leading to increased U.S. indebtedness and thereby an even weaker dollar, which further drives oil prices higher."

"We need to reevaluate our policies for how we utilize strategic oil stocks in light of the oil-dollar linkages," said Jaffe. "Clearly, our government needs to fashion a better response."

The 18-page study is available at www.bakerinstitute.org/oil-futures-speculation.

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