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House Urged to Proceed with Caution to Constrain Speculation

July 14, 2008
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House Agriculture Committee Chairman Collin Peterson (D-MN) urged caution last week as a number of Democratic lawmakers appeared before his committee seeking swift congressional action to eliminate what they believe is excessive speculation in the energy commodity markets.

"Any legislative remedy that seeks to remove speculative interests from futures markets could result in more volatile markets," he said at the start of three days of hearings into various bills that seek to close energy commodity market loopholes. Democrats believe these loopholes have allowed traders to skirt the full jurisdiction of the Commodity Futures Trading Commission (CFTC) and drive up energy prices.

While many are quick to believe that a "flood of speculation money" is behind the run-up in crude oil prices and that "speculation has been the bogeyman for commodity markets," Peterson said he wasn't so sure.

Testifying before the committee last Thursday, Craig Pirrong, director of the Global Energy Management Institute at the University of Houston, also urged lawmakers to proceed in a "prudent" manner, given what he believes is a lack of evidence to suggest excessive speculation or manipulation exist in the energy futures markets.

"If excessive speculation or manipulation is distorting prices, that will become manifest in what goes on in the physical market. You will see distortion in the amount of inventory or you will see distortion in the flows of oil in the interstate and the international market. To date nobody, to my mind, has brought up any credible evidence that these distortions exist. And given such absence of evidence, there's really no firm basis to believe that there is anything in the order of excessive speculation or manipulation that is causing oil prices to be $140 or $130 or $135," he said.

"I think that the key thing is, going forward, we just shouldn't look at prices. We should look at the real market for oil. We should look at the physical market as well as the derivatives markets. [We need to] understand the linkages between these two markets and proceed in a prudent and considered manner because intemperate or ill-thought-out actions to constrain speculation could have very adverse effects on [the] operations of both the physical and financial markets."

Rep. Bob Goodlatte of Virginia, the ranking minority member, was the sole Republican at the House agriculture hearing. "We have no reason to believe that there has been any nefarious activity in [the] commodity markets or on the part of speculators," he said.

In order to bring down energy prices, "we need to increase domestic energy production in this country" by opening the Arctic National Wildlife Refuge (ANWR) to drilling, giving producers greater access in the Rockies and lifting the moratorium on drilling in much of the federal Outer Continental Shelf (OCS), he told the committee.

"I urge caution in blaming only speculators. Speculators add liquidity to the markets," Goodlatte said.

Acting CFTC Chairman Walter Lukken, appearing before a House Appropriations subcommittee last week, echoed the sentiment of Pirrong and Goodlatte, saying that the agency so has has not uncovered any evidence of excessive speculation by traders or the hoarding of supplies.

Nevertheless, House Speaker Nancy Pelosi (D-CA) said last Thursday that the chamber plans to offer legislation addressing speculation in energy markets before Congress departs for its August recess.

Rep. Rosa L. DeLauro (D-CT) countered that she has "come to believe that such [speculative] activity is responsible for a big part of the commodity price increases." Consequently, "we need to hold the CFTC's feet to the fire to do its job." She noted that inflated energy prices have become a "suffocating tax on our entire economy."

With crude oil at $147/bbl Friday and the national price of regular gasoline at $4.10/gallon, Rep. Bart Stupak (D-MI) said energy has been transferred into a "financial asset" in the market rather than a commodity.

DeLauro and Stupak were among six House Democrats who appeared before the agriculture panel last Wednesday. Each of the lawmakers has either individually or jointly sponsored legislation to amend the Commodity Exchange Act (CEA) and close market loopholes.

While "I do not believe that excessive speculation is the sole cause or even the major cause of the recent surge in energy prices," a growing force of congressional testimony and market commentary has concluded that the run-up in crude oil prices cannot be explained by supply and demand fundamentals alone, said Rep. Chris Van Hollen (D-MD).

Van Hollen and DeLauro have sponsored legislation that would add energy commodities to the definition of exempt commodities under the CEA. They contend that the measure would close the door "even more firmly" on the so-called Enron loophole; bring swaps under the CFTC's jurisdiction; and eliminate the foreign boards of trade loophole.

"There's a legitimate role for speculation, particularly in the futures market," said Rep. Jim Matheson (D-UT). "Our goal as a Congress should be to make sure that the regulator, the CFTC, has the ability to ensure undue manipulation isn't taking place in the market."

Charles Vice, CEO of Atlanta-based IntercontinentalExchange (ICE), disputed claims that ICE's exchanges in the United States and United Kingdom have contributed to the run-up in oil prices. He noted that ICE's over-the-counter (OTC) markets have no bearing on the price of crude oil and do not set the price for major benchmark products. Trading volumes in ICE's OTC markets are almost solely related to contracts for natural gas and power, he told the House agriculture panel.

Moreover, Vice said that trading in the West Texas Intermediate (WTI) crude oil futures contract on ICE Futures Europe exchange comprises only 15% of the open positions in the global WTI market, while the New York Mercantile Exchange (Nymex) has 85% of the open positions. He noted that ICE's share of the WTI market has been steadily declining since prices began to rise in 2007. "This fact is counter to assertions that investors have been 'flooding into overseas markets' in search of an imagined regulatory loophole."

Under amended agreements with the CFTC and the UK's Financial Services Authority, he said the ICE WTI contract is subject to the same U.S. regulatory provisions of the Nymex WTI contract, including position reporting and position accountability and limits.

While the focus of the hearing was on oil prices, a municipal utility executive testifying on behalf of the American Public Gas Association warned that natural gas consumers are going to cringe when they receive their gas heating bills this coming winter.

"This December when natural gas customers open their heating bills, the commodity cost is expected to have doubled from last December," said Michael Comstock, acting director of the City of Mesa's Arizona Gas System. Given that natural gas is used as an input fuel to generate electricity, electricity heating bills also are expected to be high.

"We, along with other consumer groups, have watched with alarm over the last several years certain pricing anomalies in the market for natural gas. More recently we have noticed record run-ups in the price of natural gas." The August futures prices for natural gas was $12.30 at the close of Thursday.

"If gasoline prices increased at the same rate of natural gas prices have increased over the last 10 years, drivers would now be paying more than $6.50 per gallon," Comstock said.

"To bring natural gas prices back to a long-term affordable level, we ultimately need to increase the supply of natural gas," he said. But that isn't likely to happen given the House Democrat leadership's opposition to lifting the moratorium on leasing in the federal OCS and/or opening the ANWR to exploration and production.

"However, equally critical, is [the need] to restore public confidence in the pricing of natural gas. This requires a level of transparency in natural gas markets, which assures consumers that market prices are the result of fundamental supply and demand forces, and not the result of manipulation [or] excessive speculative trading," Comstock said.

He noted that passage by Congress of the farm bill in May, which closed the Enron trading loophole, was a good first step, but he said that more action was needed (see NGI, May 19). "For example, the over-the-counter market currently remains opaque to regulatory scrutiny." Comstock said more transparency was needed in the OTC market to enable the CFTC to assemble a full picture of trader positions and thus understand large traders' potential impact on the market.

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