Oil Boom and Gloom

LCT Magazine
Posted on June 23, 2008


The American Lawyer * June 19, 2008

NEW YORK CITY -- With crude oil prices hovering near $140 a barrel and gasoline selling for $4 a gallon, there's growing pressure from American consumers and businesses on lawmakers to end what is seen as
excessive speculation in the commodities markets.

Regulators at the Commodity Futures Trading Commission have been scrambling to react. On Tuesday, the CFTC announced an agreement with London-based electronic exchange ICE Futures Europe to extend limits
on oil contracts traded in the U.K., as The Wall Street Journal reported Wednesday. And as Reuters reports, lawmakers would like to limit the volume of commodities trading taking place in so-called dark pools, beyond the reach of U.S. regulators.

The Am Law Daily called Philip McBride Johnson, a former CFTC chairman under President Reagan, for some answers. Johnson now heads Skadden, Arps, Slate, Meagher & Flom's exchange-traded derivatives practice; he's the guy to call if you don't want trouble from the feds over your oil trades (or if you're setting up a foreign exchange and you don't want trouble with your U.S. counterparts).

Q. What do you make of the huge increase in oil prices and the rising concern over speculation in the commodities markets these days?

The CFTC's economists are saying that supply and demand seem to be driving this. But we have clients in the business that have experienced these markets for many, many years, and what I'm hearing from them is that they don't see any change in the fundamentals of supply and demand.

Q. Is it a matter of institutional investors seeking shelter from the subprime crisis and the credit crunch?

I don't know. But I do know that speculators as a class do not agree on anything, and yet there is almost unanimity of opinion these days and the money to make the opinions matter. The fact that prices have been relentlessly trending up suggests a new type of market participant [with] a mentality that is traditionally more in line with investing in securities than trading in commodities. If enough of these wealthy people, or funds, or other entities with a lot of capital decide to flip out of securities for a little while and go into commodities, and they're all looking for something that is going up, and you get enough billions of dollars thinking that way, then their wish comes true.

Q. What role might the Commodity Futures Trading Commission (CFTC) play in controlling the markets?

In 2000 Congress decided that there were certain kinds of high-end investors that were big enough and smart enough that they shouldn't be constrained to do all their business on the exchanges. The situation now is that the CFTC is sitting there looking at one screen, one piece of the picture, which is whatever is happening on the exchanges. Meanwhile, an increasing volume in dollars is taking place in the form of over-the-counter activity where no one can see it.

The CFTC very recently gained some authority over exempt commercial markets like ICE that are designed to put those markets on the same screen as the futures markets. That is a positive development. But there is still a blind spot with respect to the true over-the-counter activity that is going on, which represents billions and billions of dollars. So I think Congress is quite keen on making sure there is someone, preferably the CFTC, who has better information on what is going on out there.

Q. You're saying that a third or more of all trades are basically invisible to the government?

Except to the degree that they are able to buy, borrow or steal information. They don't call them "dark pools" for nothing.

Q. What's the benefit to the traders or speculators of staying off the exchanges?

Some would say they remain invisible. Also, the CFTC rules are complicated and they are fairly intrusive, and if you're doing stuff on an exchange, then you've got to hire somebody. You need Phil Johnson.

Q. Will prices eventually come back down?

I think the markets will eventually settle down. The commodity markets have always had a reputation for being volatile, but this is ridiculous. It would be wonderful if we had confidence of knowing that there was somebody there who has a complete picture of everything that's going on in the purchase and sale of crude oil, or natural gas, or wheat or corn. That would be a wonderful outcome.

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