Regulators of energy commodities markets would do well to take a page from An Inquiry into the Nature and Causes of the Wealth of Nations in which 18th century economist Adam Smith writes of "the invisible hand" as a beneficial consequence of free markets, a witness told a Senate subcommittee last Wednesday. "It's been often quoted; it's been seldom read," said Robert McCullough of McCullough Research.
"The passage was not simply praise of the market. It was warning against market participants who say that they are performing their trades for the public good. The point is, without understanding the market, without the data to review the market, we don't know that they're telling the truth or not," he said.
The researcher was one of four witnesses testifying before the energy subcommittee of the Senate Energy and Natural Resources Committee on two bills that would mandate that the Energy Information Administration (EIA) collect information on ownership of oil and natural gas inventories and give the Federal Energy Regulatory Commission cease-and-desist authority in gas and electricity markets. They two measures, the Energy Market Transparency Act of 2009 and the Natural Gas and Electricity Review and Enforcement Act, will be incorporated into broader energy legislation, which the full committee will begin marking up Tuesday (March 31).
Much of the hearing testimony focused on the oil market, particularly last year's rapid rise and then decline in prices. Last July oil peaked at nearly $150/bbl only to drop to nearly $30/bbl by the end of the year. McCullough blamed speculators for the run-up and said commodities markets were not intended to be an asset class. Another witness agreed.
"Investors were not looking to actually buy oil futures but to make a fast buck in a paper trade," said Gerry Ramm, an executive with Inland Oil Co. who represented the Petroleum Marketers Association of America at the hearing. "This practice caused oil prices to rise faster and fall harder than could ever be explained by ordinary market forces. Consumers, small businesses and the economy were forced into a roller-coaster ride of greed and fear."
Last year's oil market volatility had never been seen before, McCullough asserted. "At the time we had a variety of explanations," he said. "We were told that it was having to do with the Chinese and the Indians, who apparently are easy to blame for things, exchange rates, surging demand..." While some posited a demand spike from developing markets, a later examination of EIA data revealed that the agency was "spot on" in its oil forecast. "It was, frankly, astonishingly good," McCullough said.
However, EIA's price forecast was "just flat wrong." The culprit was oligopolistic behavior by industry players, McCullough said. "You would tend to hold inventory while prices were increasing, hoping to be able to sell it at a much higher price. It may not be criminal. It could in fact have simply been cagey. But the key is we have almost no data to follow it through," he said.
But collecting the data on positions and inventories won't be enough if it's not in the hands of the appropriate regulator, he said. Recalling busted hedge fund Amaranth Advisors LLC, which collapsed following wrong-way natural gas trades (see NGI, Sept. 25, 2006), McCullough said the firm's activities could not have been detected by FERC because trading data was in Commodity Futures Trading Commission (CFTC) files, "and the CFTC itself didn't react until Amaranth went under. So the manipulations at Amaranth -- they were trying to corner North American natural gas for certain months -- would not have been accessible to the regulators to move on in a timely fashion. We need to get that data out there as well as giving people the power to react to it."
Howard Gruenspecht, EIA acting administrator, said the proposed data collection would involve a "major investment of resources and time." He suggested taking a sample of commodity asset holders and their positions rather than a complete polling and suggested that the time lines proposed for implementation are not realistic and could sidetrack "high-priority" projects at EIA.
Anna Cochrane, acting director of FERC's Office of Enforcement, testified that cease-and-desist authority, if it were granted to FERC, would be used sparingly.
During the hearing Sen. Byron Dorgan (D-ND) expressed exasperation with EIA. Its former Administrator Guy Caruso blamed fundamentals for last year's oil price spike while speculative activity in the oil market had been growing rapidly. He also asserted that the CFTC had blinders on. "The CFTC did in my judgment a shameful job of what they should have done in regulating."
McCullough praised the bills and said he would like them to go further and suggested that FERC should have jurisdiction over oil markets. "Frankly, they've got some of the skills built up in the agency for electric and gas. These are, when all is said and done, Siamese twin commodities. Natural gas prices and oil prices are very highly correlated. Electricity prices and natural gas prices are highly correlated...
"If I had my way, I would go much further than this bill."
The market transparency bill calls on the EIA to develop a plan to collect data on the ownership of commercially held oil and natural gas inventories within 90 days of enactment of the bill, and to implement the plan 30 days later. It would require the EIA administrator to gather company-specific data on the volumes of product under ownership, and storage and transportation capacity (including owned and leased capacity).
The draft legislation also would require the collection of information from persons who hold or control energy futures contracts or energy swaps for commodities to be delivered in the United States, including the quantity of physical stocks owned; the amount of fixed-price purchase commitments open; the quantity of fixed-priced sales commitments open; physical storage capacity owned or leased; and other information deemed necessary.
In addition, the bill would create a Financial Market Analysis Office within the EIA to analyze the financial aspects of energy markets. The director would report to the head of the EIA, which would use the new information when conducting market analyses and forecasting energy prices. It is noteworthy that the legislation would give the primary role of analyzing financial energy markets to EIA, which has never before had a role in financial oversight, rather than the CFTC, which has more Wall Street connections.
It would create a seven-member Working Group on Energy Markets, which would investigate the effect of increased financial investment in energy commodities on energy prices and the nation's energy security; and recommend to President Obama and Congress laws that may be needed to prevent excessive speculation in energy commodity markets.
Members of the working group would be the secretary of the Department of Energy (DOE), secretary of the Department of Treasury, chairman of the Federal Trade Commission, chairman of FERC, chairman of the Securities and Exchange Commission, chairman of the CFTC and EIA administrator.
The working group also would be charged with conducting a study to identify the factors that affect the pricing of crude oil and refined petroleum products; review the roles, missions and structures of "relevant" federal agencies; and assess the gaps that need to be filled for the federal government to effectively oversee and regulate energy markets, according to the draft bill.
It requires the DOE secretary to submit quarterly reports to the Senate energy panel and House Energy and Commerce Committee during the course of the study, and to file a final report within a year after enactment of the bill.
In an effort to protect natural gas and electricity customers from "significant harm," the energy enforcement bill would give FERC the authority to issue a temporary order requiring a company to cease and desist from violations or threatened violations of the Natural Gas Act, Natural Gas Policy Act or the Federal Power Act. Cease-and desist orders are generally to be issued only after a hearing, but the proposal does allow FERC to serve a temporary order without a hearing.
And "in the case of an emergency to ensure continued reliability of service to electric consumers or to protect electric consumers from potential abuse of market power or market manipulation in wholesale markets regulated by the Commission," the proposed bill would give FERC emergency authority to change or suspend temporarily the rates, terms or conditions of service of a company on file with the Commission.
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