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CFTC Chairman: No Evidence of Excess Speculation in Oil Market

June 23, 2008
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Commodity Futures Trading Commission (CFTC) Acting Chairman Walter Lukken told a joint Senate committee hearing last Tuesday that the agency has uncovered no evidence of excessive speculation in the crude oil market, but he could not rule out the possibility of manipulation.

"We have not seen evidence from our data" of speculation driving oil prices, he said during the hearing before the Senate Agriculture Committee and the Senate Subcommittee on Financial Services and General Government. "We have not [found] a smoking gun." Lukken said that "hopefully soon" the CFTC will release the results of its six-month investigation into the crude oil markets (see NGI, June 2).

"I can't" assure the Senate panels that there is no manipulation in the energy markets, he told Subcommittee Chairman Richard Durbin (D-IL). "But we are looking for it and are policing" the markets aggressively, he said. Lukken noted that the CFTC plans to report to Congress by Sept. 15 on the scope of commodities index trading in the futures markets and make recommendations for improved practices and controls, should they be required.

Lukken said he was unable to estimate what portion of the trading market the CFTC was overseeing, which subsequently triggered an exchange with Sen. Byron Dorgan (D-ND). "If you don't have the foggiest idea of what percentage of the contracts that you are seeing or regulating, how would you have a conclusion about whether there is excess speculation [in] these markets?" Dorgan asked.

"Well we certainly see all of the contracts that are discovering prices...Our main focus [is] those contracts that people are referencing every day," including those on the New York Mercantile Exchange (Nymex) and the IntercontinentalExchange (ICE) markets in the United States and London, Lukken said. "We're [also] reaching into swap markets in an unprecedented way."

Dorgan countered that Lukken's prior statements to Congress and the public -- that the run-up in crude oil prices was the result of market fundamentals -- was at odds with his claim that the agency has been acting aggressively.

"I would look at the actions that the CFTC has taken over the past year. I think [they're] pretty powerful," Lukken shot back.

Recent actions taken by the agency will bring "greater transparency" to the oil market, but "I'm not sure that short-term relief will be the result of some of these measures," he said.

The recent actions included last Tuesday's announcement by the CFTC that it will condition ICE Futures Europe's access to U.S. customers on the exchange's adoption of equivalent U.S. position limits and accountability; and the CFTC's creation of an interagency working group to study investor practices, fundamental supply and demand factors and the role of speculators and index traders in commodity markets (see related story).

In addition to the CFTC's initiatives, Congress has passed a farm spending bill that closes the so-called "Enron loophole," which had allowed large electronic trading platforms to circumvent the full oversight of the CFTC for years (see NGI, May 19). The bill also increases the CFTC's penalty authority for manipulation.

To carry out new authorities approved by Congress, Lukken said the CFTC was requesting an additional $27 million for a total $157 million and 596 full time employees in fiscal year 2009. "It is imperative that the CFTC receive additional resources," Lukken said, adding that the agency would be "unable to sustain" its current level of activity without an additional 100 staff members.

While the CFTC carries out its oil price investigation and seeks to implement new initiatives, industry and consumers are suffering. This year "could turn out to be the worst year in the industry's history," even a "worse shock than 9/11," said James C. May, president of the Air Transport Association of America Inc. "The country's airlines expect to lose in the range of $10 billion this year -- a loss equal to or greater than the worst year in this industry's history," he told the joint committee hearing.

"We will spend more than $60 billion on fuel, at least $20 billion more than last year and slightly more than our combined fuel bill for the first four years of this decade," May said. "More than 14,000 airline jobs have been cut so far this year, and that is just the tip of the iceberg. It is not unrealistic to think that...more than 200 communities could lose all commercial air service by early next year."

The speculative premium associated with oil is more than $40 per barrel or about $1 per gallon, said Mark Cooper, director of research for the Consumer Federation of America in Washington, DC. An equivalent figure for natural gas would be about $2.50/Mcf, he noted.

"Over the past two years this speculative premium has cost the typical American household over $1,500 and the economy over $500 billion," he testified. "Regulation of commodity exchanges is far too lax with low margin and capital reserve requirements, allowing traders to leverage their assets and multiply their trading in 'asset-light' companies who do not have the equity to ensure soundness. The exchanges also set limits on positions that are far too high, allowing single entities to control large quantities of supply," Cooper said.

"Institutional investors and new trading instruments like index funds have poured hundreds of billions of dollars into commodity markets at such a rate that speculation swamps the markets," he said. Hence, the markets fail to properly serve commercial traders who use them to hedge their physical production or consumption.

The recent actions by the CFTC "are too little too late," Cooper said. "Begging foreign exchanges for data and foreign regulators to act responsibly is not only embarrassing, it is absurd when the CFTC has not put its own house in order...The CFTC must be forced to assert regulatory authority over trading within the United States and trading in financial instruments designated in U.S. commodities."

In light of growing concerns about the impact of speculation in energy markets, U.S. senators have offered a flurry of measures that would extend the regulatory arm of the CFTC, as well as immediately increase its funding.

One bill (S. 3130), sponsored by Durbin, expresses the "sense of the Senate" that President Bush should immediately send to Congress a request for emergency appropriations to add at least 100 new full-time positions at the agency and to significantly improve the information technology of the CFTC during the current fiscal year.

With respect to U.S.-based traders trading on foreign boards of trades, exchanges or markets outside of the United States, Durbin's legislation would give the CFTC the authority to enforce its manipulation and attempted manipulation authority; require or direct traders to limit, reduce or liquidate any position to prevent or reduce the threat of price manipulation; and require such traders to comply with certain recordkeeping rules. Prior to taking this action, the bill would require the CFTC to consult with the foreign board of trade, exchange or market and the appropriate regulatory authority.

In effect, the bill would close the so-called "London Loophole" by requiring all traders on oil futures markets to report transactions in a detailed manner to the CFTC, Durbin said. It directs the CFTC to investigate the impact of these trades on the price of oil and other energy commodities as well.

A second measure (S. 3129), sponsored by Sen. Carl Levin (D-MI), also seeks to extend the CFTC's regulatory reach and increase transparency with respect to energy trading on foreign exchanges. Both bills were co-sponsored by Sen. Jeff Bingaman (D-NM), chairman of the Senate Energy and Natural Resources Committee, and a number of other senators.

Sens. Dianne Feinstein (D-CA) and Ted Stevens (R-AK) have introduced legislation to require the CFTC to impose the same position limits on the trades of institutional investors to which other investors are now subject.

While the CFTC currently is required to impose speculation limits on the size of energy trader positions, the agency in practice regularly exempts institutional investors from position limits when their trades are executed through brokers or dealers, Feinstein and Stevens said.

"It is becoming clear that rampant speculation in energy markets by institutional investors may be driving up the price of oil and gas. And yet [the] CFTC exempts these investors from the position limits that are imposed on all other speculators," Feinstein said.

"This gives institutional investors an unfair advantage in the marketplace -- and is contributing to the skyrocketing energy prices. It's time to level the playing field, and require position position limits for all speculators."

The legislation (S. 3131) calls for the CFTC to review the trading practices of institutional investors and their dealers within 30 days to determine whether increased regulation is necessary, and to propose to Congress regulations and measures that are necessary to prevent the run-up in fuel costs in futures markets.

In addition to setting position limits for institutional investors, the measure would require institutional investors to report their energy market positions to the CFTC as other traders must do, even when trades are executed by a third-party broker, and it would force CFTC regulations and reports to begin distinguishing between institutional investors and the "swaps dealers" or "index traders" who broker their own trades.

Moreover, the bill calls for the Office of the CFTC's Inspector General to be removed from the CFTC chairman's office and and to be established independently.

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