While the major commodity exchanges were divided over the effectiveness of broad-based position limits, the head of the Commodity Futures Trading Commission (CFTC) Tuesday indicated that the agency was clearly headed in this direction for trading in the energy futures markets.
Energy users believe there is no time to lose. “Rome is burning,” they said, urging fast action on across-the-board hard position limits before the energy markets, particularly crude oil, take off again.
“It is clear that the CFTC has significant statutory authority to set strict position limits in energy markets” to prevent excessive speculation, said CFTC Chairman Gary Gensler during the agency’s first hearing on whether to restrict the amount of trading in energy futures.
The CFTC can establish position limits on energy traders, even if an exchange already has established its own position limits, said CFTC General Counsel Dan Berkovitz. And he agreed that the CFTC can take this action even if there is no finding of excessive speculation. “The Commission has been able to set position limits without such a finding.”
Jeff Sprecher, CEO of Atlanta-based IntercontinentalExchange, agreed that the CFTC should lead the way. “We think that any aggregate position limits, accountability levels and hedge exemptions should be set and administered by…the CFTC and not by the exchanges,” he said.
While supporting increased CFTC regulation of energy futures, Sprecher said, “we…have not seen a quantitative study that shows speculation in the futures market was the cause of the increased energy commodity prices that we’ve seen over the last year.”
Craig Donohue, CEO of CME Group, told CFTC commissioners that “efforts to control price volatility by position limits is generally a failed strategy.” But in response to concerns over energy prices, he said CME plans to adopt a “hard limit regime for those [energy] products, including single-month and all-months combined limits, in addition to current limits that apply during the final three days of trading. Donohue argued for leaving much of the business of setting position limits with the exchanges, getting into a brief debate with Sprecher over the issue.
“This modified regime will include the administration of tailored hedge exemptions for swap dealers and index funds, and as a whole should alleviate the external concerns that positions held by these investors and hedgers will increase price volatility or artificially inflate or deflate prices,” he said.
Currently the major exchanges set energy position limits only in the last three days of trading to address manipulation and congestion, according to the CFTC. The exchanges, however, are not required by statute to set and enforce position limits to prevent excessive speculation in energy futures markets.
The exchanges also set position accountability levels and issue early warning to traders when they are near or have exceeded that level. But CFTC Commissioner Bart Chilton said accountability levels were about as effective as “speed limits on a dark desert highway.”
Nearly 70 traders in four New York Mercantile Exchange (Nymex) single-month energy contracts (crude oil, natural gas, gasoline and heating oil) exceeded the accountability level during the last 12 months, Gensler noted. For the Nymex natural gas contract, 40 traders exceeded the single-month accountability level of 6,000 contracts for an average of 84 days. Three-quarters of the time traders were issued a simple notice for the overage. “So it wasn’t a stop sign or a yield sign. It was sort of honk if you go past this?” Gensler asked Donohue.
“Yes. That’s as it is intended and designed to be,” Donohue responded.
From a legal standpoint, “the Commission’s authority to establish position limits only goes to designated contracts, designated derivative transaction and executive facilities or where there’s a significant price discovery contract [in] exempt commercial markets,” Chilton said. “So we do not have statutory authority to post position limits in the over-the-counter [OTC] markets or other markets.”
Several at the hearing expressed concern that restrictive position limits could force traders into the unregulated OTC markets. To prevent this, Gensler said, “the CFTC must be able to set aggregate limits on all persons trading OTC derivatives that perform or affect a significant price discovery function with respect to regulated markets that the CFTC oversee.”
This would “ensure that traders are not able to avoid position limits in a market by moving to a related exchange or market, including international markets.”
Another key issue is “whether or not we should grant exemptions from position limits to persons using the futures markets to manage purely financial risks rather than risks arising from the actual use of a commodity,” Gensler said. “Although our statute directs the Commission to set position limits as necessary to prevent undue burdens on commerce, Congress [has] made it clear that position limits would not apply to bona fide hedgers.”
Toward this goal, Gensler said the CFTC will take a close look at whether to eliminate the hedge exemptions for certain swap dealers and possibly create a new risk management exemption.
Sen. Bernie Sanders (I-VT), who had blocked Gensler’s confirmation for months, blasted the CFTC for granting bona fide hedging exemptions to Wall Street firms, such as Goldman Sachs, to “do as much oil and gas trading as they want.”
If the CFTC fails to take aggressive action, the country will be back to “where bubble economics and speculation were the rule of the game,” he said.
Rep. Bart Stupak (D-MI) said he looked forward to seeing a “revised analysis” of a CFTC report issued last September dismissing the role of excessive speculation in driving up crude oil prices in 2008 (see Daily GPI, Sept. 12, 2008). Gensler said reports that CFTC plans to reverse its 2008 position on excessive speculation in the oil market was “premature and inaccurate.”
Petroleum marketers, representatives of the airlines and municipal members of the American Public Gas Association (APGA) were unanimous in calling for unified hard position limits across all markets. This would include bilateral non cleared OTC contracts and economically linked contracts, Laura Campbell with Memphis Light, Gas and Water testified.
All months should come under regulation, as is done in the agricultural markets, said Sean Cota of Cota & Cota fuel oil dealers, representing the Petroleum Marketers Association. He noted that Amaranth, which crashed and burned on a huge hedge position, did a lot of trading in the outer months as well as the front month. Passive hedgers need to have much smaller limits, and noncommercial traders should hold no more than 30-40% of the market. Limits on a single company’s trading should include all of a company’s funds, subsidiaries and other appendages, Cota said.
Exemptions to the limits should be available only to those who produce, process or consume a commodity, said a Delta Airlines witness, testifying on behalf of the Air Transport Association. Fuel is the airlines’ largest single expense, Delta’s Ben Hirst said. He noted the spike in market speculation for jet fuel, which went from a $15 billion market in 2003 to $200 billion in 2008. He estimated that Delta lost $1.7 billion over the last year from excessive speculation. Questioned by Gensler as to how to go about setting position limit levels, Hirst suggested the Commission look back at trading patterns before the “speculative explosion,” which started in 2007.
While the Commission dithers over exactly what markets it should get into and how far position limits should go, “Rome is burning,” both Cota and Hirst said, urging the CFTC to “act now before we see a repeat of last year’s oil bubble.” Under its current authority the agency can make rules and revise them whenever it needs to, the commercials advised. This is not like legislative action, which is set in cement. “You can always make mid-course corrections,” Cota said. It may take legislation, however, for the CFTC to get into the OTC markets, although there could be ways to pursue their authority even there.
Cota said that where the cost of fuel oil hedging for residential customers used to be about six cents/gal, that has gone as high as $1/gal and is in the range of 60 to 70 cents now. Those costs are passed on to the consumers.
The energy users called for a lot more detailed information or transparency in the Commitment of Traders (COT) reports. “We want to see who is a physical trader and who is not,” Cota said. Responding to a question from Gensler about his reference to a “bona fide speculator,” Cota said he meant the kind of trader “who used to be in the pits at Nymex” compared to “a lot of big, dumb money” from index funds.
Campbell agreed there should be more refinement as to who the market participants are and more information on the OTC market. For instance, who are swaps dealers working for?
Gensler said the CFTC is working on more transparency, for instance the possibility of having four categories of traders in the COT report, having the swaps dealers report quarterly and then eventually monthly, having a thorough index investor report, including having gross longs and gross shorts instead of just nets. These, however, are just in the discussion stage and have not been circulated to the other CFTC commissioners.
Todd E. Petzel, chief investment officer of Offit Capital Advisors in New York and a member of two futures industry groups, warned against interfering in the futures markets, advising that would-be hedgers always will find other ways to their goals, such as going to foreign markets. Petzel said a lot of recent activity in the energy commodity markets is aimed at hedging the U.S. dollar. “Over the last 10 years in particular, there has been an increasing awareness of the role commodities can play in a portfolio,” he said, acknowledging that commodities can be considered a general inflation hedge.
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