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Closing the Enron Loophole: Feds May Limit Speculative Trading of Oil, and Calm Prices

The crazy behavior of oil prices in 2008 has been blamed on excessive speculation in the futures markets from pension funds and endowments. In keeping with the new appetite for tighter financial regulation, the Commodity Futures Trading Commission (CFTC) is looking into limiting energy futures trading volumes, to bring them more into line with the real-world supply and demand. Sounds bureaucratic, I know, but the step could stabilize the cost of a gallon of gasoline, and reduce disruption to the real economy.

The futures markets for grains, metals and energy were created to give the people who produce or consume commodities a way to buy or sell their wares at fixed prices in the future. They've operated in the U.S. since the 1860s, and some of the players in the market have always been speculators -- those not involved directly in growing or manufacturing, just investors trying to make a buck on the price swings.

The futures markets for grains and metals have always had limits on the extent of non-physical, speculative positions. Not so with energy futures: Wikipedia informs us that The Commodity Futures Modernization Act of 2000, signed by President Clinton, created the so-called "Enron Loophole" which exempts energy commodities from federal regulation. (It also reminds us that Wendy Gramm, wife of Senator Phil Gramm, was a former chairman of the CFTC, and took a seat on Enron's board of directors after leaving the Commission.)

Therefore in June 2007, the equivalent of 3 billion barrels of oil traded daily in paper markets, versus just 67 million barrels a day traded in the physical oil markets, according to OPEC Secretary General Abdullah al-Badri, speaking at a recent Reuters Global Energy Summit.

These are the results, said energy trader Michael Masters, in his June 2009 testimony to Congress, calling for regulation of speculation:

When speculators become dominant in the market for derivatives on consumable commodities, the supply- and demand-based trading of physical commodity producers takes a back seat to the high stakes trading of speculators as they attempt to out trade each other.
So even though oil demand was falling in 2008 ... well, you know the story:

And in 2009, oil prices are double what they were in March, even though inventories are their highest in many years:

President Obama called for repeal of the Enron Loophole while campaigning in 2008, and the new head of the CFTC, Gary Gensler, has moved toward making good on the promise. It's a big reversal from the hands-off policy of several administrations. His announcement of a policy review doesn't refer to oil prices directly -- that not his agency's job -- but he does set goals to:

eliminate, diminish or prevent the undue burdens on interstate commerce that may result from excessive speculation
By "undue burden" I figure he's referring to gasoline at $4 a gallon during an economic downturn.

With luck, the CFTC can plug the Enron Loophole, and we'll get more realistic oil prices that won't choke off the recovery. But what will we writers do without those price-at-the-pump stories?