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www.fueloilnews.com | FUEL OIL NEWS | JUNE 2014 17 ignorance of the real-world crude market over- looked the fact that nearly 30 years ago the decision was made (ironically enough to reduce manipulation and increase price stability) to base long-term physical oil contracts on "for- mula pricing" linked to a premium/discount benchmark relative to a benchmark futures con- tract such as West Texas Intermediate or Brent (depending upon the region). Similarly, oil's inventory/storage behavior was not seen as being in line with traditional academic speculation models. However, oil is again not a typical commodity and in the western world ramping up oil storage (as might be expected with speculators) is hardly a simple matter given environmental pressures and regulatory hurdles. In the non-western world, storage activities are said to be opaque at best, and there is the ability to store oil by leaving it in the ground by producers. But, why should speculation suddenly be an issue? There was an explanation—the passage of the Commodity Futures Modernization Act of 2000; which was developed during the final days of the Clinton administration. Quite a bit had actually changed in commodity trading in just a few years. CFMA, among other things, effectively created the "Enron Loophole," so named because Enron pushed for it, which allowed the option of trading energy commodities on deregulated exchanges such as the Intercontinental Exchange, a "for- eign" over-the-counter swaps market. An additional result was that Wall Street banks were exempt from speculative position limits when those banks hedged over-the-counter swaps transactions, as the CFTC's classification scheme counts all speculators accessing the futures mar- kets through the Enron Loophole as commercial rather than non-commercial. This resulted in two notable impacts: it distorted the analysis of what is and is not a commercial participant when ana- lyzing the impact of potential speculation on the market, and it allowed for highly-leveraged trad- ing that created a "casino" atmosphere. Chinese demand was increasing, oil produc- tion (at that time) seemed to be plateauing or declining and the dollar was decreasing in value. But the changes in the market seemed beyond what the hard data on supply and demand might suggest for those causes, to the point that traditional analysts like the late Peter Beutel were at a loss to explain it. You could also look at the declining dollar and moving beyond the direct inflationary impact on oil prices and see that major investors were increasingly look- ing at commodities as a hedge. A lot of money was moving into the markets. Michael Masters, managing member and port- folio manager at Masters Capital Management, LLC., noted in testimony before the CFTC on March 25, 2010: "In 1998, the average com- modity market was about 25% speculative as a percentage of open interest. By 2008, specula- tors comprised about 65% of open interest. Bona fide physical hedgers once outnumbered speculators 3 to 1; now speculators outnum- ber hedgers 2 to 1. The positions of bona fide physical hedgers doubled during this ten-year period, while the positions of speculators rose by 1,200%." By Keith Reid Fuels Sean Cota