Costly oil could mean recession - Soros

Investor tells lawmakers that economy is at risk as housing bubble deflates and rising oil prices rise. Senate panel probes whether speculators are manipulating prices.

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By David Goldman, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- High oil prices, driven by decreasing crude supplies and increasing demand could drive the U.S. economy into a recession, George Soros, the fund manager and commodities investor, told lawmakers Tuesday.

The Senate Commerce Committee held a hearing on Capitol Hill in an attempt to find out if oil prices are being manipulated by speculators, what can be done to regulate commodities trading, and what effect high oil prices have on the economy.

Soros told the committee that speculation, while not the only contributor to the recent runup in crude, "reinforces the upward pressure on prices." He said speculation is "distinctly harmful" to the economy.

"The rise in oil prices aggravates the prospects for a recession," Soros added.

Speculation boosts oil prices

Recent investor interest in commodities is an issue of intense debate. Though some analysts say market fundamentals are playing a large role in the doubling of oil prices in a one-year span - driven by strong global demand and a shrinking supply - others believe that commodities investors have boosted the price of crude with speculative trading, treating oil as a hedge against inflation due to the weakened dollar.

"We have what I think is a speculative bubble, and the laws of bubbles is that all bubbles burst," said Sen. Byron Dorgan, D-N.D. "The problem is, this bubble is causing a dramatic amount of damage to our economy and to individuals."

Nearly all of the witnesses agreed that speculation has artificially boosted the price of oil.

"Excessive speculation on energy trading facilities is the fuel that is driving this runaway train in crude oil prices today," said Gerry Ramm, president of Inland Oil Company.

Others tried to quantify the scope that speculation has had on crude costs.

"We're paying, some believe, as high as a 50% premium to the pockets of speculators that are operating in markets that are completely unpoliced," said Michael Greenburger, a University of Maryland professor and former CFTC official. "At least 70% of the US crude oil market is driven by speculators and not people with commercial interests."

Mark Cooper, director of research at consumer rights organization Consumer Federation of America, said $40 of oil's current price is "baloney" and can be chalked up to speculation, though Soros called that an exaggeration.

Soros said the increasing cost of discovering new oil reserves, diminished supply, foreign subsidies on petroleum product prices, and speculation have all contributed to higher prices - a "bubble" that may not burst until prices become so high that they drag the economy into a recession.

"Only when a recession is well and truly in place is a decline in consumption likely to outweigh the other factors."

Solution: Close the Enron loophole

Some suggested closing the "Enron loophole" as a possible solution to the speculation problem. The loophole, which was codified in the Commodity Futures Modernization Act of 2000, allows oil futures to be traded electronically in unregulated markets outside of the jurisdiction of the Commodities Futures Trading Commission.

"Americans may be surprised to learn that the oil futures markets were substantially deregulated by the CFTC staff decisions that were made behind closed doors," said Sen. Maria Cantwell, D-Wash. "Now this London and Dubai loophole is keeping important U.S. energy trading in the dark and without proper light ... it can give manipulators free rein in energy markets."

As part of the recently-passed Farm Bill, Congress attempted to close that loophole, but Greenburger said language did not go far enough. He said the Farm Bill placed the burden on the public to prove a trade needs regulation rather than placing the onus on the trader to prove it does not need regulation. Greenburger said Congress should return the language of the original bill "this afternoon," saying that overnight it would bring the price of crude oil by 25%.

Greenburger also suggested that Congress impose increased margins for oil traders and regulate hedge fund owners' public speculation on oil prices.

"I find it highly ironic that when you control the price of oil, you can speculate it will go up to $150," he said.

Goldman Sachs and Morgan Stanley hedge funds own large amounts of oil futures, and have both recently said the price oil could go up to $150 or even $200 this year.

CFTC investigation

Last Thursday, the CFTC announced it had launched a wide-ranging probe into oil price manipulation six months ago, saying it would gather more information about the effect investors are having on the market.

The commission's public acknowledgment of a normally secret probe has sparked talk that it has evidence oil companies are withholding oil from the market in an attempt to manipulate prices.

Regarding speculators, CFTC has previously said that it had not found any evidence that traders were artificially inflating prices.

On the day the CFTC announced its investigation, crude oil futures dropped $4.41 - the third-biggest one-day slide since 1991 - and prices have hovered around that $127-a-barrel level since.

But some lawmakers were critical of CFTC's investigation.

"If we want our exchanges to be world leaders, they need to have transparency, and speed and integrity," said Sen. John Sununu, R-N.H.

Cantwell said the CFTC investigation will not go far enough and doesn't have any enforcement mechanism. As a result, she called it a "ruse to deflect criticisms" and an "abdication of oversight responsibility."

"It is clear to me that the CFTC is not doing everything that it can to protect consumers from oil price manipulation," said Cantwell. "CFTC's response is a toothless tiger."  To top of page

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