Here's a bit of juicy news. According to the Wall Street Journal (subscription required), The Federal Trade Commission (FTC) plans to crack down on market manipulators. They have decided to levy fines up to $1 million dollars per violation a day. The rule covers both physicals and futures.

The crackdown involves mainly the oil traders. Specifically, the language reads as follows: It bans oil market players from issuing "false public announcements of planned pricing or output decisions, false statistical or data reporting, and wash sales intended to disguise the actual liquidity of a market or the price of a particular product." The rules would also prohibit "material omissions from a statement that, although true, is misleading under the circumstances."

Who is going to crackdown on the speculators? The agency responsible for supervision of the commodities markets is the Commodity Futures Trading Commission (CFTC.)

If you remember, last year the spike in oil prices to $147.00 per barrel was done through speculation in oil futures contracts. A futures contract gives the trader to right to bet on the prices of various commodities, on whether they will go up or down. Contracts usually last for three months, at which time the longs and the shorts are paired down to zero, leaving the speculators out of the final trading. However, the speculators simply move their positions to another forward contract, keeping their positions in place.

The rub has been on the concept of "position limits." In most commodities the CFTC imposes a limit on the number of contracts that a single person or firm can hold. The real bone of contention is that the CFTC does not impose limits on oil or oil products contracts. That has been left up to the various exchanges.

Who is in charge of regulating the wheat futures market? That agency is the Commodity Futures Trading Commission (CFTC) which oversees trading in the futures markets. One area of regulation is the number of open contracts any one person can have at any given time. The limit is 6,500 contracts.

So then what caused the price of wheat to go wild last year? It seems that the CFTC was complicit in that they gave exemptions for traders to go beyond the 6,500 limit. One trader was allowed to hold 53,000 contracts. Then to make matters worse, six traders ganged up and held 130,000 contracts. According to Bill Tomson, the value of these investments jumped "from an estimated $15 billion dollars in 2003 to around $200 billion by mid 2008.

Will derivatives be eventually regulated? At the moment, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are drafting legal language to submit to Congress on the details of regulating the derivatives markets. Just which agency will take the lead in overseeing these markets is not clear at this writing. The SEC is the older of the two agencies.

There had been some talk about merging the two agencies, but political pressure has all but ruled this out. It now looks like they will share the oversight responsibilities.

BBC News reports that another hedge fund has closed down thanks to its failure to bail out of the oil speculation trade that boosted oil to a peak of $147 in July. This is yet another piece of evidence that people like Hank Paulson, who insisted that record oil prices were due to supply and demand, were either being less than honest -- particularly since his former employer Goldman Sachs Group (NYSE: GS) was a big beneficiary of this speculation -- or ignorant of reality.

The hedge fund in question this time is Ospraie Fund, which invested in commodities like oil and gold. It "has lost 38% of its value since the start of the year." Gold is down 22% to $800 from its $1,030.80 an ounce high in March. Oil has tumbled 25% to $109 since peaking in July, according to BBC News. But 1440 Wall Street suggests that the biggest commodity culprit in Ospraie's demise was copper's tumble. The lesson here is that if a sufficient number of big money speculators get together and decide to, say, short the dollar and go long commodities, there will seem to them to have safety in numbers.

But when the government started investigating the cause of spiking oil prices, the trade got very unprofitable very fast. As I posted, the Commodities Futures Trading Commission (CFTC) recently found that 81% of oil trading volume was driven by speculation. Then we witnessed the failure of SemGroup and the indictment of Optiver Holding for manipulating energy prices -- those funds who were too slow to reverse their positions and got creamed.

Upset about paying $3.80 a gallon for gasoline? Hank Paulson, former Goldman Sachs Group (NYSE: GS) CEO, argued that it was all supply and demand so quit your bellyaching. I thought speculation was playing a big part -- traders who bought oil and sold the dollar to drive up the price. Indeed, a few months agao I found a source who thinks 60% of the volume was from speculators.

Seems even that was too low an estimate. The Washington Post reported Wednesday that the Commodities Futures Trading Commission (CFTC) has analyzed the books of oil traders and calculated that 81% of oil trading volume was conducted by speculators.

Guess who broke open the opportunity for oil speculators to trade oil in a loosely regulated fashion? Goldman. The Post reports that In 1991, its J. Aron unit argued that "it should be granted the same exemption given to commercial traders because its business of buying commodities on behalf of investors was similar to the middlemen who broker commodity transactions for commercial firms."

With oil prices at $130 a barrel, The Washington Post has finally picked up the story about how a regulatory loophole allows hedge funds and other institutional investors to control unlimited quantities of oil contracts. Over the last few weeks, I've posted about this topic here and here. Nobody seems to know how much of the oil trading these speculators control, but I came across one source that put the figure at 60%.

The so-called swaps loophole is promulgated by the Commodity Futures Trading Commission (CFTC) which has exempted investment banks from rules that limit speculative buying, a prerogative traditionally reserved for airlines and trucking companies that need to lock in future fuel costs. The CFTC also waived regulations limiting trading in overseas markets.

The CFTC is complaining that it needs more resources. It claims that commodities trading has exploded in complexity and popularity growing six-fold in trading volume since 2000. But the CFTC's staff has dropped to its lowest levels in its 33-year history. According to CFTC acting Chairman Walter Lukken, "We could hire an extra 100 people and put them to work tomorrow given the inflow of trading volume."

I think the CFTC should close the loophole and get the people it needs to do its job. If the speculators can't find a way around the closed loophole, their share of oil trading volume will drop. Then we'll see what happens to the price of oil.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

Hedge funds and speculators reduced positions in oil by 80% as prices rose to records and as U.S. regulators started investigating trading, Bloomberg News reported Monday, citing government data.

Net long positions decline to 25,867 contracts on the New York Mercantile Exchange in the week ended May 27, 2008 from a record 127,491 contracts on July 31, 2008 according to a U.S. Commodity Futures Trading Commission report.

Last week, the CFTC, under pressure from Congress, announced that it had expanded an investigation of oil's price rise and oil futures contracts. Oil has increased about 100% in the past 12 months, and about 480% since 2002. Oil rose $1.50 to $128.50 per barrel in mid-day Monday trading.

Politicians this week have come up with a brilliant plan. Oh, let's blame the recent oil price hike on speculators, why don't we? This way, we can continue not doing anything about energy prices and oil's scarcity and still keep our jobs. Let's just deflect attention from us and our inaction and blame it all on those commodity traders.

Okay, of course, anyone who manipulates oil prices, inflating them artificially and causing us to pay $4 a gallon at the pump as a result while making a nice juicy profit on our backs, should pay. No doubt. But here's a thought: what if these speculators are doing us a service?

I'll use a line from Syriana: "It's running out." We all know it. At some point there will be no more oil, or it will become so scarce that $4 a gallon will sound like a joke, like my grandma telling me about those five-cent movie tickets (I still think she was pulling my leg!). And barring any alternative energy found to heat our homes, fuel our cars and power our factories, it is not difficult to envision doomsday scenarios.

So perhaps, instead of reaching that crucial stage and having to start scrambling for solutions then, perhaps the recent oil price hikes have done us more good than harm. It put the problem of oil and energy in the forefront; it made the problem too big to be ignored, brushed aside. Indeed, there has never been this much news and these many resources diverted to alternative energy as there has been in the past year (at least it feels that way).

The high price of oil has repercussions throughout the economy; it trickles down to the smallest of items and we've only been experiencing the beginning. The effect on prices is lagging. Still, only Wednesday Dow Chemical (NYSE: DOW) announced a price increase of up to 20% to offset these higher costs. Dow's CEO blamed Washington for not listening to industrialists when they demanded action for years.

The Associated Press reports that the Commodities Futures Trading Commission (CFTC) is investigating possible market manipulation by oil traders. The purpose is to shut down big trading bets that drive up the price of oil -- rather than follow the price discovery that results from the interaction of supply and demand. Since one source said that 60% of oil trading comes from speculators, the flow of capital into oil could fall as speculators stop their abuse. And the price of oil could drop.

The investigation went public yesterday and the CFTC appears to be examining whether investment banks are trading more than their share of contracts. As I posted, The Goldman Sachs Group (NYSE: GS) is among the investment banks taking advantage of a swaps loophole that classifies them as a commercial market participant -- like an airline -- instead of a trader. This loophole allows these banks to avoid disclosure of their bets that oil will rise.

This excess capital flowing into oil -- and against the dollar -- has driven up the price of oil. If the price of oil was set solely on supply and demand, it would surely drop. The numbers I posted here suggest that demand in the U.S. is down 300,000 barrels per day thanks to the slowdown in driving due to $4 a gallon gas.

Now if we could get Goldman and its peers to start betting heavily on a drop in oil prices and a rise in the dollar, we'd really be getting somewhere. What's good for Goldman is good for America -- or at least the top 0.1% of Americans.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in Goldman Sachs securities.

Discussion in financial and public policy circles appears to building regarding increased monitoring of energy markets, as well as, at minimum, inquiries into whether oil prices have been manipulated.

One group, closetheenronloophole.com - - a coalition of oil dealers (the people who deliver heating oil in trucks, etc.) and other groups - - argues that certain unregulated energy trading platforms provide an environment for what the group calls "excessive speculation and energy price manipulation."

Capitol Hill

In Washington, several lawmakers have requested inquiries of the energy markets. Among them are U.S. Senators Maria Cantwell (D-Washingotn), Dianne Feinstein (D-California), and Ron Wyden (D-Oregon), who sent a letter to the chairmen of the Commodity Futures Trading Commission (CFTC) and the Federal Energy Regulatory Commission (FERC) giving them 45 days "to develop a plan to deliver effective oversight for energy markets and implement anti- manipulation provisions."

There are roughly 10,000 hedge funds managing $2.7 trillion. And not one of them is required to disclose its holdings to regulators. That's why we can expect the unexpected every day for the foreseeable future until every single hedge fund that's lost money for investors dribbles out its bad news -- in the form of a leaked letter to clients.

This comes to mind for those seeking an explanation for today's nasty market action. According to this letter to clients from Sentinel Management Group, a $1.5 billion hedge fund that appears to provide a short-term parking place for the cash of commodities traders, there's a run on the bank going on at Sentinel. That's because for some reason, its clients want to get all their money out RIGHT NOW!

And Sentinel has asked the Commodities Futures Trading Commission (CFTC) to keep its cash hungry investors at bay. But the CFTC has declined. This situation raises so many questions: Why would Sentinel's investors lack confidence in what is supposed to be a money market fund? If Sentinel invested in assets other than money market funds, is that consistent with its charter? What kinds of risks was Sentinel taking? Why are its investors clamoring for the exits?

And most importantly to the market, does anyone know how many more such hedge fund implosions we can expect before we get to the bottom of this mess?

Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter.