Were speculators behind last year's oil-price spike?

The top regulator for US commodity markets says oil prices have spun out of control – and that it's time to consider putting a cap on speculative trading activity.

That message, given in a Tuesday regulatory hearing, comes at a time of renewed debate over whether last year's spike in oil prices was a bubble built mainly on speculative frenzy. Soaring oil prices took a harsh toll on consumers worldwide at a time when the economy was already reeling from a bust in housing and credit markets.

Blaming it on speculators remains controversial. And even if last year's petroleum run-up was a needless bubble, there's also controversy over how policymakers should respond.

But commodity markets have entered a new phase in recent years, with many investors flooding in who have little close knowledge of oil or wheat. Commodities have become an increasingly popular "asset class" alongside stocks and bonds. New financial products have aided the process by making it easier to invest in oil futures than to get an oil change.

The US Commodity Futures Trading Commission is weighing how to best promote healthy markets for commodity contracts.

"Speculators who do not necessarily grow the wheat or store the oil provide necessary liquidity by being on the other side of the trade with the farmer and the oil producer," Gary Gensler, the CFTC's chairman, said in an opening statement Tuesday. But "Congress long ago recognized that there may be burdens to the economy when the market becomes too concentrated."

"We must seriously consider setting strict position limits in the energy markets," Mr. Gensler said, citing similar curbs that now exist for traders in some other commodity markets.

The Wall Street Journal reported Tuesday that the CFTC has concluded that speculative investors played a big role in the oil-price surge that took oil prices to a peak last July of about $145 per barrel. The agency's report is expected to be released next month, and will counter another report -- issued under a different CFTC Chairman -- that reached the opposite conclusion last year.

Commodity markets are complex beasts, and some economists warn that it won't be easy to improve the functioning of markets by trying to impose caps on speculation.

"It's an unfortunate idea," says Gary Shilling, who heads an economic research firm in Springfield, N.J. For one thing, he says, investors often find ways to get around regulations when there's a financial opportunity at stake. He also says speculators can't force prices to diverge from fundamental forces forever. "Yeah, you can say markets stray from reality occasionally … but not for long and not to huge extents."

Last year looks like a case in point.

Mr. Shilling was among those who correctly predicted that oil run-up was a bubble that would burst.

Many people at the time believed that the oil spike had solid foundations, however. They said demand from nations like China would keep rising despite America's economic slowdown. By July, as the financial crisis deepened, the bullish view on oil prices was overtaken by the reality of a deep global slump.

Mr. Gensler at the CFTC doesn't differ with the widely held view that speculators play a vital role in commodity markets. But he's worried that some commodity markets aren't functioning properly.

In recent testimony, he pointed to the example of wheat. In recent years, a widely traded type of wheat contract has failed to converge toward the cash price of wheat, as it normally should when a futures contract expires. The gap exceeded $1 a bushel last year.

One reason, he said, may be the sheer scale of financial activity surrounding this particular "soft red winter wheat." This type of wheat is a tiny fraction of US production, but it's the most popular with commodity investors.

To some extent, oil and other commodities may be affected by a rising level of financial trading. That's because of the popularity of commodity investing with pension funds and hedge funds. Products such as exchange-traded funds have made it easy for the small investor to buy commodity futures.

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