Friday, May 23, 2008

Are Pension Funds Fueling High Oil?

Are Pension Funds Fueling High Oil?


If you're wondering why driving to work has gotten so expensive, you might want to peruse your pension fund's investments. That's because speculation by institutional investors pouring money into the commodities market may be largely to blame for spiking oil prices, according to testimony on May 20 before the Senate Committee on Homeland Security & Governmental Affairs. Crude oil, a so-called hard asset, is viewed as a buffer against inflation—a foe of longer-term investment returns. At the hearing, "Financial Speculation in Commodity Markets: Are Institutional Investors and Hedge Funds Contributing to Food and Energy Price Inflation?," senators heard from those defending the role of speculators in oil and commodities markets as well as those who argue that excessive speculation is the root of global price surges.

"[Commodities] are experiencing demand shock from a new category of speculators: institutional investors like corporate and government pension funds, university endowments, and sovereign wealth funds," said Michael Masters, managing member of Masters Capital Management, a Virgin Islands-based hedge fund. "Index speculators are the primary cause of the recent price spikes in commodities."

On May 20, crude oil prices settled at a record $129.07 on the New York Mercantile Exchange (NMX) after touching a new high of $129.60. The national average for a gallon of gasoline hit a record of $3.80 per gallon the same day.

Light CFTC Hand

The explosion in the number of financial players in the energy markets has occurred particularly in the past two years—also a period of soaring energy prices. That's why speculators are now under fire from Congress and the public as potential culprits (BusinessWeek.com, 5/15/08).

But in the hearing, Masters distinguished between traditional speculators and what he calls index speculators, or passive investors who enter the commodities markets as a long-term hedge against inflation. Commodities exchanges limit the number of positions an investor can take in the market, but Masters says the Commodity Futures Trading Commission has allowed unlimited speculation in these markets through a loophole. This so-called swaps loophole exempts investment banks like Goldman Sachs (GS) and Merrill Lynch (MER) from reporting requirements and limits on trading positions that are required of other investors. The loophole allows pension funds to enter into a swap agreement with an investment bank, which can then trade unlimited numbers of the contracts in futures markets.

Some experts fault the CFTC, charged with regulating commodities markets, for allowing such loopholes. "Congress has provided the CFTC the power to control this unlimited [speculation]; the law is very specific about establishing position limits," says Steve Briese, author of The Commitments of Traders Bible and CommitmentsOfTraders.org, a site that focuses on U.S. futures markets. "The problem is they have abdicated this role." The dramatic surge in energy prices has helped to spark inflation across the economy and, as others at the hearing testified, has cut into profits of most in the supply chain. Briese points to Treasury reports that the top five users of swap agreements are investment banks, four of which dominate swap dealing in commodities and commodities futures: Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM), HSBC North America Holdings (HBC), and Wachovia (WB).



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