LONDON (Dow Jones)--The shadow of U.S. oil futures regulators is looming large on the other side of the Atlantic.
In the wake of the Commodity Futures Trading Commission's move towards deeper oil market scrutiny, traders in Europe are concerned that a high profile probe could have a destabilizing effect - lowering oil prices and crimping liquidity as cautious investors retreat from the market in a bid to avoid unwanted attention.
Of particular concern is the reaction of investment funds who allocate their investments based on indexes of energy futures, and from whom the CFTC says it will seek more information.
"Any change of regulation on index trading will likely not materialize overnight, but it exposes the long term passive investors (such as pension funds) to a new risk; basically that the rules change by the time they want out, or force them out of positions," said Olivier Jakob, managing director of Swiss consultancy Petromatrix.
Should a fund departure emerge it could have a knock-on effect, some warned.
"If one or two of the big boys start getting out, it could be interesting...it's a herd mentality," said an independent oil trader based in the U.K. Any recovery in other financial markets could make a flight from crude more appealing, he added, offering investors an alternative destination for their cash.
On Thursday, the CFTC said it had reached an agreement with the IntercontinentalExchange (ICE) and Britain's Financial Services Authority to extend international surveillance information for crude oil trading, specifically on the ICE's WTI crude contract.
While ICE oil futures are traded electronically on computer terminals across the U.S. and have prices tied to the light, sweet oil futures contracts offered by rival New York Mercantile Exchange, owned by Nymex Holdings Inc., they haven't been subject to the same CFTC reporting requirements as Nymex trading.
The CFTC's move comes as worldwide protests over the high cost of fuel ratchets up pressure on politicians to act. While politicians are eager to be seen responding to record oil prices - crude oil prices hit record highs above $135 a barrel last week, double the levels of a year ago - concrete restrictions either limiting speculative interest or hindering investment in crude markets have failed to emerge - the CFTC intiative included.
"There's obviously a lot of political attention being paid particularly in the U.S. now but also around the world...in Europe, in Asia," said Michael Wittner, global head of oil market research at Societe Generale in London. "The pace of the (price) increase has made it a political issue."
Eye On Speculation
Some traders said they were already seeing the early impact of the Commission's initiative Friday.
"One of the effects we've seen already in my opinion is the recent selloff with traders and banks liquidating positions," an oil products trader based in Europe said Friday.
To be sure, there are many in the energy markets who believe the CFTC is acting more to prove it is aggressively regulating markets amid soaring oil prices. Market participants note that the regulator is not imposing position or margin requirements on traders.
At the heart of the CFTC's move is an attempt to discern whether record crude oil prices owe more to investor activity than fundamental forces. Some commentators believe that the regulator is likely to find that oil's record price-setting rally is attributable to a combination of the two things.
"No doubt speculation is boosting the oil price, and perhaps oil markets are also being manipulated," said David Strahan, a trustee for the Oil Depletion Analysis Centre, a U.K.-based charity. "But the reason the oil price continues to soar, and why investors apparently see crude as a one-way bet, is a growing physical shortage of supply."
"Even if the CFTC investigation does uncover market manipulation it is unlikely to moderate the oil price, since the fundamental cause is geological constraint and the approaching global oil production peak," Strahan said.
Should an initial shakeout occur, investors are likely to return to energy markets on the long-term view that supplies will continue to tighten in the future and emerging economy demand growth remains robust.
"Fundamentally we are in long-term supply crisis. I don't think that the real long term investors, i.e. pension funds, will bail easily," the gasoline trader said. "But that will depend how much of a down correction we get, how much pain can they take. And that is difficult to quantify," he added.
Source: Lananh Nguyen, Dow Jones Newswires; +44 (0)20-7842-9479;lananh.nguyen@dowjones.com, (Ian Talley, Ann Davis and Gregory Meyer contributed to this report)