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Hedge Fund Impact on Energy Trading


Regulators hope to shed light on the issue.

Editor's Note: This article was written by Darrell Delamaide of, which offers free information and analysis on energy and commodities. Sheikh focuses on fossil fuels, alternative energy, metal, oil prices, and geopolitics.

Do hedge funds have an impact on energy trading?

While the answer might seem intuitive, the debate as to whether they actually do has come to resemble the medieval theological dispute about how many angels can dance on the head of the pin.

Because, like angels, many trades in energy futures are invisible, and it's often not possible to pinpoint where they take place.

And yet, for most of us, including lawmakers on Capitol Hill, it seems obvious that when hedge funds buy and sell billions of dollars worth of oil and gas futures, it must be having an impact on energy prices. While hedge funds and other speculative traders would never dream of taking delivery of a barrel of oil, their trading activity affects the prices for actual consumers of oil and gas and their downstream customers -- or so it would seem.

When Gary Gensler, a former Goldman Sachs banker and Treasury Department official, was nominated last year as chairman of the Commodity Futures and Trading Commission -- the chief regulator for energy futures trading -- he reversed the CFTC party line that speculators don't have an impact on energy trading.

"I believe that excessive speculation in commodity futures can cause sudden or unreasonable fluctuations or unwarranted changes in commodity prices," Gensler said in a written response to lawmakers' questions ahead of his nomination hearing.

Gensler went on to pledge that if confirmed, he would have the CFTC guard against such speculation.

While he stopped short of saying that excessive speculation had taken place in the run-up of energy prices in 2008, he did express the opinion that the rapid growth of commodity index funds and increased hedge fund allocation to commodity assets contributed to the "bubble in commodities prices that peaked in mid-2008."

He noted that non-commercial investors sometimes account for up to 90% of open interest in a contract. (Open interest is a calculation of the number of active trades for a particular market, and is used as an indicator whether trading is becoming more or less active.)

Gensler's answer, enshrined in draft legislation currently before Congress, is to make trades more visible by requiring all over-the-counter derivatives to trade through an approved clearing house. While the thrust of new legislation is to get a better handle on financial derivatives such as credit default swaps, it will give regulators a better picture of all derivatives trading, including energy contracts.
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