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CFTC Commissioner: Belief that Speculators Drove Up Futures Prices 'Defies Logic'

The widely held belief that speculators in the futures market were behind the sharp run-up in natural gas prices over the past year has no basis in fact, said Commissioner Sharon Brown-Hruska of the Commodity Futures Trading Commission (CFTC) last Tuesday.

"The idea that a group of speculators can simply enter the market, buy up futures positions and sustain a long-term manipulation of the market defies logic," she told energy executives and regulators at the Natural Gas Roundtable in Washington, DC.

"For one, futures contracts have a finite life. So whatever long or short position is established, it must be unwound prior to the expiration of the contract. In this case, prices are governed by the law of gravity -- what goes up must come down. Secondly, when speculators enter into futures contracts all they have is a price play. They do not actually have a position in the underlying commodity, so they are not able to tie up inventories, thereby making [them] unavailable to the market. Thus, their trading does not create shortages that could serve as a mechanism to drive up prices. This can only be accomplished in the physical markets," Brown-Hruska said.

"As further evidence that speculators in the natural gas markets are likely having little effect on raising natural gas prices, we can look at the activity of managed money traders or hedge funds, the largest group of speculators in the market. This group of traders has often been identified as a group that is responsible for pushing up prices. While those charges may make for good headlines, the facts do not support them," she noted.

"Managed money trading may involve large individual outright positions, [but] on a whole their position is opposite of what would be expected if they were exerting upward pressure on prices, and overall it represents a small part of the market."

The CFTC monitors activity in the futures markets to protect against price manipulation. "There are two ways that we do this. First, we review the terms of contracts listed on the exchanges to make sure that the contracts themselves are not susceptible to manipulation...The second way that the Commission monitors the market is through its market surveillance program," Brown-Hruska said.

She noted there are proposals in Congress that would require the CFTC to apply a similar surveillance program to the broader natural gas market, including contracts for physical delivery and the over-the-counter (OTC) derivatives markets.

"While the efforts behind these proposals may be well intentioned, attempting to construct such a surveillance program that would be effective in identifying and preventing market manipulation would be extremely costly and not likely to produce much benefit," Brown-Hruska said. "The problem with attempting to monitor the natural gas markets generally for manipulation is that you are dealing with a myriad of transactions that are not easily aggregated, and in terms of pricing may be difficult to compare from one transaction to another."

She noted that her chief concern with lawmakers' proposals seeking surveillance of the physical and OTC natural gas markets "is that they may represent more of a political response to high energy prices than...a practical attempt to identify manipulative behavior in the markets." But this "is not to say that we shouldn't be vigilant with respect to market manipulation or that we cannot today identify market abuses and go after it...The Commission will continue to monitor the natural gas markets and it will pursue wrongdoing where we have the authority to do so."

For example, when natural gas prices hit $15/Mcf at the end of 2005, she said "we were scrutinizing every large player" in the market.

Despite beliefs to the contrary, Brown-Hruska said that in a lot of the OTC markets, the CFTC has "significant authority over what we call the exempt commercial market." As the players have become more significant, the agency has approved rulemakings that require players in that market to provide more routine information to the CFTC, she noted.

Moreover, Brown-Hruska said the CFTC has brought a number of actions against traders in the OTC market, collecting about $250 million in fines. The agency believes that it currently has adequate authority over the OTC markets and exempt commercial market, and doesn't need further legislation to bolster its oversight capability, she noted.

Brown-Hruska said both the CFTC and the Federal Energy Regulatory Commission "[have] come a long way" in the last couple of years in enhancing their oversight and enforcement authorities in the energy markets. "The cops are on the beat. We have all the tools that we need to go forward [and] deter abusive behavior" in the gas market.

While a "bad actor" will surface from time to time, "I believe the market's bigger, smarter and stronger than those people," she said. "I think the markets are very transparent."

Like FERC, Brown-Hruska also said she found fault with some of the findings of a recent report that was commissioned by the attorneys general of four midwestern states, which claimed natural gas customers in their states had been overcharged $5 billion a month. Steven Harvey of FERC's Office of Market Oversight and Investigations last month said he detected "fairly serious errors in the report," noting that the $5 billion/month estimate was based on faulty assumptions (see NGI, March 20).

"The part that...I thought that they were way off [on] or they misinterpreted the fundamental economics was suggesting that demand had not increased" measurably over the past couple of years, Brown-Hruska told NGI.

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