Murky oil dealings to stay beyond regulators' reach

By Jane Merriman - Analysis

LONDON (Reuters) - Record oil prices have prompted calls to tighten regulation of oil futures exchanges, where politicians have blamed speculators for driving up prices.

But the multi-trillion dollar unregulated over-the-counter markets in physical oil and related derivatives potentially pose a bigger challenge.

"I believe there is a loophole here because no one looks at it," said Chris Cook, an energy market consultant. "And there is no transparency in the market."

Regulators are being asked to grapple with the OTC market in oil, but face a difficult task.

Its size is hard to estimate as there are no detailed statistics.

The Bank for International Settlements estimated the OTC market in commodity derivatives at $9 trillion at the end of 2007, up by nearly a fifth from the end of June 2007.

The BIS data does not give any breakdown for oil.

One senior executive at a UK investment bank estimated that the OTC market is 10 to 15 times bigger than futures markets.

Others in the industry say it is hard to make a precise assessment.

"If you take the view that firms that do stuff on the OTC/physical markets and hedge on the futures markets, you would think there would be at least an equivalent OTC market to the futures markets, plus any proprietary and speculative interest," said one senior executive at a U.S. investment bank.

"So you would have to say the OTC would be bigger."

The OTC markets are closely linked to futures.

"What is often overlooked is that a lot of the risks in the OTC markets are offset in futures markets," said Lawrence Eagles, of the International Energy Agency.

"Much of the trading that goes on is related to risk management in different derivatives, so you cannot look at a single part or a single exchange, you have to look at the whole to give a clear picture of what is going on."

OTC markets, which also include physical oil trading, encompass a range of energy-related products used for risk management, proprietary trading or investment.