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Cause of 2008's crude oil price surge remains elusive, CFTC says

Nick Snow
OGJ Washington Editor

WASHINGTON, DC, Apr. 9 -- Nine months after crude oil prices reached record levels, experts agreed at the US Energy Information Administration's 2009 annual conference on Apr. 7 that speculators shouldn't be blamed. They also could not say definitively what pushed prices upward during 2008's first half.

The US Commodity Futures Trading Commission's large trade reporting system gives it a powerful tool to determine what's moving markets, according to Jeffrey Harris, the CFTC's chief economist. An effort is continuing to determine why crude prices surged and then plunged in 2008, he continued.

"The answers haven't been palatable to politicians or to us. We haven't been able to point at one particular type of trader and hold them responsible for running oil prices up to $140/bbl last summer. We have not been able to find the smoking gun," Harris said.

The CFTC is the single government agency which identifies hedge funds in commodity markets, but it has found that index fund traders could not be found as easily, he said. "Index funds can come to the market through commodity pools or banks. Many come through swap dealers," he said.

Examinations of reported trades on regulated exchanges showed that the average index fund decreased its crude oil commodity position as prices rose, suggesting that adjustments were designed to maintain the positions as percentages of total commitments, Harris said. "We've since updated our reports with numbers for September and the end of 2008 and haven't found a widespread abandonment of the market," he said.

Incomplete data
But Robert F. McCullough Jr., managing partner at McCullough Research in Portland, Ore., said the CFTC's investigation is not complete because it doesn't include unregulated over-the-counter trades. "We have no data. We don't survey spot oil transactions as we do for other commodities. This is Congress's fault," he said.

He agreed it was politically convenient to blame speculators when crude oil prices climbed amid growing inventories. But he said underlying fundamentals, including supply and demand, could not provide a reason for soaring prices either. "We were flat out of interesting events. Almost every answer the pundits gave us was wrong," he said.

McCullough said the CFTC uses outmoded classifications that do not reflect the current makeup of commodities markets and concentrate on the largest traders using regulated exchanges. Harris said the commission actually has begun to receive fairly good data from over-the-counter markets, especially about index funds, to supplement its own findings.

Other panelists warned against trying to assign blame too quickly for soaring and plunging crude oil prices last year. "We have it in our heads that speculation is fraud. It's not," said Adam E. Sieminski, Deutsche Bank's chief energy economist.

Several factors could have set the stage for crude oil prices to soar in early 2008, he continued. Emerging market economies had an average annual growth in gross domestic product of 7% from 2000 to 2005. Crude oil prices did not rise enough to justify heavy exploration, reducing the Organization of Petroleum Exporting Countries' spare production capacity considerably. Refining capacity also didn't grow, and the value of the US dollar declined, he said.

Then there's stupidity
Finally, said Sieminski, "stupidity can drive decisions. That's the best explanation for somebody buying a crude oil contract at $147/bbl and expect the price to go up. Governments can't regulate against this."

The conventional wisdom that heavy commodities trading causes volatile prices is driven more by intuition than facts or systematic analysis, according to Robert J. Weiner, an international business professor at George Washington University. "Over a time period where trading increased significantly, aggregate statistics did not show a corresponding increase in volatility," he said.

Weiner said traders adopting a herd mentality, where they made decisions by copying other market participants instead of examining fundamental influences, is a likelier force. "If lots of people try to get into or out of a position at the same time, volatility can result," he said.

Investigations have not found evidence of parallel trading among commercial market participants or financial speculators, although there were some apparent cases of what Weiner termed "flocking."

He said that scarcity of data and lack of market transparency serve traders and the public poorly. "We need to examine fundamentals to understand why oil markets change," he said.

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