U.S./UK oil trade rules may signal more to come

NEW YORK (Reuters) - A transatlantic deal in the works to cap speculation in London oil futures trading is a baby step toward wider market oversight and should not initially slow the flood of money into commodities.

For hedge funds and other investors, energy and agriculture markets have been one of the hot plays of the year. Even as regulators move to counter the ripple effect of runaway commodity prices, tougher steps may still be needed to restrict speculation and alleviate global worries about inflation and food supply.

"I don't think this particular activity is going to have a big effect, but I think eventually the government's continued nibbling will have a big effect," said a commodities trader at a Connecticut-based hedge fund. "It's a sign of what's to come."

A U.S. congressional source told Reuters on Thursday that the U.S. Commodity Futures Trading Commission and Britain's Financial Services Authority are working on a deal to impose position limits for the first time on U.S. crude oil contracts traded on the ICE futures Europe exchange.

If the U.S.-UK regulatory plan comes together, it would test the theory that the commodities boom which saw crude oil prices strike record highs last week is driven more by economic fundamentals than speculators betting that prices in oil, grains and metals will keep going higher.

Even a slightly tighter regulatory environment and greater government scrutiny could temper the binge. If it does not, it would bolster the argument of investors who say 'don't blame us,' pointing to demand from China and a refining and production infrastructure which has not expanded in line with the world's growing need for oil.

"Psychologically, it has some impact, but the bottom line is that it doesn't really change the fundamentals of the market. At the end of the day, it will probably be of only passing interest," said Jim Ritterbusch, president of Ritterbusch & Associates in Galena, Illinois.

"The intent, I guess, is to dislodge some speculative longs from the market, and to some extent that may happen, but the longs that are currently involved have some pretty deep pockets," he said.

Meanwhile, a bipartisan bill introduced by two U.S. lawmakers on Thursday would give the U.S. futures markets regulator more authority to regulate overseas trading of crude oil contracts on a U.S.-based electronic exchange. IntercontinentalExchange (ICE.N), the parent of ICE Futures Europe, is based in Atlanta.

Electronic trading of WTI contracts on a London exchange operated by ICE is exempt from most CFTC oversight, even though such contracts are linked to the New York Mercantile Exchange's NMX.N contract, which has a delivery option in Cushing, Oklahoma.

The Capitol Hill source said regulators were concerned that the London exchange does not have position limits comparable to the New York Mercantile Exchange, which has a 75 percent market share in the WTI oil contract, the world benchmark. ICE has the other 25 percent share.

But there is less to the deal than meets the eye, analysts said. Only the front month WTI futures would be subject to restrictions on how many contracts an investor could hold.

"Any restriction solely in the front month is meaningless political grandstanding. What's to prevent people from investing in the second month or third month?" asked Tom Knight, an energy trader at Truman Arnold in Texarkana, Texas.

"Who's to say there are too many investors in oil markets? Oil is the investment du jour. Next week it may be gold, next month it may be copper."

Politicians and regulators have had to respond to a global outcry against rising energy and food prices.

Many see excessive speculation behind this year's 40 percent rise in crude oil prices, which almost hit $140 a barrel for the first time last week.

The easiest scapegoats are funds who poured billions of dollars into commodities in recent years, to diversify portfolios as stocks and bonds languished and speculate that commodities had entered a prolonged up cycle after years of underperformance.

The volatility caused by these new participants in the market has made it far more expensive for traditional hedgers like oil refiners and grain elevator operators, who use commodity exchanges to lock in prices, to manage their risk.

"The CFTC is under extreme political pressure to help ease oil prices. What makes this story important, more than position limits, is what are we going to see going forward?" said Rob Kurzatkowski, futures analyst at OPTIONSXPRESS in Chicago.

"There's probably a feeling among the hedge fund and index fund community that there is a big target on their backs."

(Reporting by Alden Bentley; editing by Jim Marshall)