Congress needs to take steps to regulate all natural gas markets equally, impose a limit on traders' positions, enforce the statutory prohibition against excessive speculation and give the Commodity Futures Trading Commission (CFTC) a bigger budget to prevent a replay of the Amaranth hedge fund collapse last year, which took a major toll on consumers, said the chairman of the Senate Permanent Subcommittee on Investigations Monday.
"The first step is [for Congress] to close that Enron loophole, which never should have been opened," said Chairman Carl Levin (D-MI) during a hearing into excessive speculation in natural gas markets less than a year after the collapse of Greenwich, CT- based Amaranth Advisors LLC last fall, which experienced an estimated $4 billion in gas trading losses (see Daily GPI, Sept. 19, 2006).
The closing of the loophole would make the New York Mercantile Exchange (Nymex), which currently is regulated by the CFTC, and the nonregulated electronic exchange IntercontinentalExchange (ICE) subject to the same oversight by the CFTC, he said.
Levin said the CFTC's latest proposal to require traders in regulated markets to disclose their holdings on unregulated exchanges was a "step in the right direction," but Congress still needs to close the Enron exemption loophole (see Daily GPI, June 25).
Levin said Congress also should give the CFTC the authority to collect user fees from the markets it regulates to conduct better oversight of the energy industry. Levin noted that currently the CFTC has an annual budget of $98 million to oversee commodity trades that are in the billions of dollars. "The CFTC suffers from antiquated technology, shrinking staff and inadequate oversight resources," he said.
"We need to get the regulatory cop back on the beat," he noted. "It's one thing if gamblers gamble with their own money, if speculators gamble with their investors' money, but it's a totally different thing when the U.S. energy markets are turned into a casino."
A 130-page report on speculation in the natural gas markets was released in advance of the hearing. It was the result of a nine-month investigation by the Senate subcommittee that reviewed millions of trading records from Nymex and ICE. It found that Amaranth's 2006 positions in the natural gas market constituted "excessive speculation" that ultimately influenced the price that consumers paid for gas last winter.
"Amaranth's actions in causing significant price movements in the natural gas market demonstrate that excessive speculation distorts prices, increases volatility and increases costs and risks for natural gas consumers, such as utilities, who ultimately pass on inflated costs to their customers," the Senate subcommittee said.
Arthur Corbin, president and CEO of Municipal Gas Authority of Georgia, which has 76 member municipalities, estimated that Amaranth's domination of the gas market cost its members an additional $18 million during 2006, which was passed through to their customers.
Paul N. Cicio, president of Industrial Energy Consumers of America, said gas prices prior to Amaranth's collapse were $6.81/Mcf, and then fell to $4.20/Mcf post-collapse. Despite the drop in price, many buyers were already locked into higher prices for last winter. Cicio estimated that if only $1 of the inflated price was due to Amaranth's speculation, U.S. energy consumers paid an additional $9 billion in 2006.
Cicio noted that there was ample gas supply in 2006. Prices were higher than they should have been based on the laws of supply and demand, he told the Senate subcommittee.
Purchasers of natural gas during the summer of 2006 for delivery last winter paid inflated prices due to the speculative trading of Amaranth, the Senate subcommittee report concluded. Amaranth "used massive trades to bet the store," and forced a lot of consumers to make that bet, Levin noted.
The Senate report revealed that, from early 2006 until its September 2006 collapse, Amaranth dominated trading in the U.S. natural gas market, buying thousands of contracts for future delivery of gas on a daily basis. At some points in 2006, Amaranth held 100,000 natural gas contracts in a single month, and held 40% or more of the outstanding contracts on Nymex for 2006.
When a hedge fund holds that many contracts, an increase of one cent/Mcf for natural gas could translate into $10 billion of additional costs for consumers nationwide, Levin said.
In August 2006, Nymex became concerned about the large number of contracts that Amaranth held on the exchange and ordered it to reduce its position. Amaranth complied, but it shifted the contracts to the unregulated ICE. This drew the concern of both Levin and Sen. Norm Coleman of Minnesota, the ranking Republican on the subcommittee.
It's similar to a cop on one side of the street stopping the sale of alcohol to a minor, only to see a bar on the other side of the street serve the minor, Levin said. He questioned whether the current law was sufficient to stop excessive speculation on all exchanges -- Nymex, ICE and over-the-counter (OTC) exchanges -- and possibly bilateral trades.
Surprisingly, Shane Lee, a former gas trader with Amaranth, said he believed that Nymex and ICE should be regulated in the same fashion. If that had been the case, "we would not have been allowed" to switch contracts from Nymex to ICE.
Lee also dismissed concerns that traders would resort to unregulated bilateral trades if the electronic exchanges are regulated, and he did not believe there would be a "flight" of traders to foreign markets.
Lee, who worked for Brian Hunter, the head of Amaranth's natural gas trading desk, said there was "no question that the volume of Amaranth's trading was very large," but he would not say whether it was excessive.
"Amaranth's [large] positions were known to the market," said Vince Kaminski, a professor at Rice University's Jesse H. Jones Graduate School of Management in Houston. Watching Amaranth's collapse in 2006 was "like watching a train wreck in slow motion," he said. Kaminski supported the subcommittee's call for the removal of the Enron loophole. The CFTC should be given "more fire power," he said.
Michael Greenberger, a professor at the University of Maryland School of Law in Baltimore, said he believes part of the problem lies with the CFTC. He contends that the agency is controlled by the big banks -- Morgan Stanley, Goldman Sachs and Bank of America. With several vacancies at the agency, he said the opportunity was ripe for the Senate to approve someone to the CFTC who actually represents the interests of the consumer.
News surrounding Amaranth's meltdown last year focused on the lack of regulation of hedge funds and over the counter markets. Robert McCullough, manager of McCullough Research, said last September that he believed Amaranth's Hunter -- who had amassed the significant natural gas position -- quite possibly attempted to corner the natural gas market and that the "lack of federal oversight" of energy markets and hedge funds by the Federal Energy Regulatory Commission, the Securities and Exchange Commission and the CFTC helped him almost accomplish his goal (see Daily GPI, Sept. 27, 2006).
Sen. Dianne Feinstein (D-CA) joined a chorus of critics last year, blaming the CFTC for a failure to properly perform its oversight responsibility for energy trading markets. Feinstein also renewed her call for passage of legislation she has sponsored to increase transparency and accountability in energy trading markets for oil and natural gas (see Daily GPI, Sept. 28, 2006).
ICE took issue with the Senate subcommittee's report on Monday. "With great respect for the work of the staff, we believe that the report does not fully reflect the level of oversight that now exists in the natural gas markets today," said ICE CEO Jeffrey C. Sprecher. "We...have already implemented, since the end of 2006, a large trader reporting system related to Henry Hub natural gas markets. The report itself describes the CFTC's large trader reporting system as the agency's primary tool for identifying suspect conduct and the 'backbone' of its market surveillance program...We will continue to work with the CFTC to provide it with this information to ensure the integrity of price discovery."
ICE also said that to ensure the aims of the committee are met, it agrees with the minority staff's view that regulation should not create incentives for traders to shift from venues into which the CFTC has visibility into the large, unregulated off-exchange markets, where no reporting or record-keeping obligations exist. The exchange noted that while it offers the most transparent and auditable portion of the OTC market through electronic trading and digital record-keeping of each transaction conducted in its marketplace, ICE represents only a small part of a substantially larger OTC market.
"Tremendous strides have been made with respect to the transparency and soundness of the energy markets in the last five years as the result of market-driven solutions," ICE said. "In addition, due to ICE's development of OTC clearing, the market has been able to quickly and efficiently absorb the transfer of positions after an event like Amaranth in a manner that did not present systemic risk to the broader market, largely as the result of the margining system that effectively prevented risks from spreading."
Commenting on the Senate's report, one New York-based energy broker said it will be interesting to see what comes from it.
"While the Amaranth collapse was probably the exception and not the rule, it shows what you can do with a lot of money," the broker said. "You can go from a regulated to an unregulated exchange. Is that a good or bad thing? I think that is what the Senate is going to have to determine.
"It will be interesting to see what the Senate does, or doesn't do in an election year," the broker added. "I really think the CFTC needs to ask the Senate for something because what they ask for they will likely get. What we have seen so far with regards to the CFTC is that they have never asked for anything. They have said that they don't want to regulate those guys like Amaranth. Now, with all of the publicity, they might say they can now regulate, but they need 'X' amount of dollars as a budget."
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