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Testifying to the House Energy and Commerce Committee, Michael Masters of Masters Capital Management said that the price of oil would quickly drop closer to its marginal cost of around $65 to $75 a barrel, about half the current $135.

Fadel Gheit of Oppenheimer & Co., Edward Krapels of Energy Security Analysis and Roger Diwan of PFC Energy Consultants agreed with Masters’ assessment at a hearing on proposed legislation to limit speculation in futures markets.

Krapels said that it wouldn’t even take 30 days to drive prices lower, as fund managers quickly liquidated their positions in futures markets.

“Record oil prices are inflated by speculation and not justified by market fundamentals,” according to Gheit. “Based on supply and demand fundamentals, crude-oil prices should not be above $60 per barrel.”

Futures trading in London has not been a major factor in rising oil prices, testified Sir Bob Reid, chairman of the Chairman of London-based ICE Futures Europe. Rising prices are largely a function of fundamental supply and demand, not manipulation or speculation, he said.

“Energy speculation has become a growth industry and it is time for the government to intervene,” said Rep. John Dingell, D-Mich., chairman of the full committee. “We need to consider a full range of options to counter this rapacious speculation.” It was Dingell’s strongest statement yet on the role of speculators.

Dingell introduced a bill on June 11 that would ask the Energy Department to gather the facts on energy prices, including the role played by speculators.

There are two kinds of speculators in the futures markets, Masters said. Traditional speculators are those who need to hedge because they actually take physical possession of the commodities. Index speculators, on the other hand, are merely allocating a portion of their portfolio to commodity futures.
Index speculation damages price-discovery mechanisms provided by futures markets, Masters added
The committee will likely consider legislation that would rein in index speculation by imposing higher-margin requirements; setting position limits for speculators; requiring more disclosure of positions; and preventing pension funds and investment banks from owning commodities.

Both major presidential candidates have supported closing loopholes that encourage speculation in the energy markets. Read more on Election Blog.

However, other witnesses said that pure speculators have had little impact on energy prices, which have doubled in the past year to about $135 per barrel. Both Treasury Secretary Henry Paulson and Energy Secretary Samuel Bodman have dismissed the impact of speculators on prices paid by consumers.

Speculators now account for about 70% of all benchmark crude trading on the New York Mercantile Exchange, up from 37% in 2000, said Rep. Bart Stupak, D-Mich., chairman of the investigations subcommittee. Stupak introduced a bill on Friday that would limit index speculation.

There has been much discussion recently about how big a role speculators have been playing in the sharp rise in energy prices, though no consensus has emerged on this point.

Congress, however, has grown increasingly concerned over speculative investors’ role in the energy market in comparison with those buying futures contracts to hedge against risk from price changes. Lawmakers are expected to consider legislation to set strict limits — or in some cases, an outright ban — on speculative trading in energy futures in some markets.

Dingell is looking into any legal loopholes that may have contributed to speculation in energy markets. In 1991, according to documents provided by the Commodity Futures Trading Commission to the committee’s investigators, the agency authorized the first exemption from position limits for swap dealers with no physical commodity exposure. This began what Dingell said was “a process that has enabled investment banks to accumulate enormous positions in commodity markets.”

Is Congress barking up the wrong tree?

Neal Ryan, manager at Ryan Oil & Gas Partners, said that if Congress develops regulations to cut back speculative trading, speculation will just find a new home.

“Speculation is the root of capitalism,” he said. “If the speculation is forced out of the U.S. exchanges, it’ll simply show up on other exchanges that are OTC like the ICE, or new exchanges will pop up to allow for the spec trades to continue functioning.”

Ryan said he does see a reason for Congress to look at eliminating aspects such as allowing West Texas intermediate crude oil futures to trade on foreign markets and the “Enron loophole,” but “these exchanges are currently functioning as they are supposed to in a free marketplace.”