Two federal regulatory agencies are moving too timidly in response to record crude oil prices, Sen. Maria Cantwell (D-Wash.) said during a Senate committee hearing on energy market manipulation and federal regulatory regimes.
Consequently, she intends to continue pressing both the Federal Trade Commission and the Commodity Futures Trading Commission to regulate oil and commodity markets more aggressively, Cantwell said following the June 3 Senate Commerce, Science and Transportation Committee hearing which she chaired.
Specifically, she told OGJ following the hearing, she plans to press the FTC to issue an interim rule under the oil market investigation and regulation authority it received under the 2007 Energy Independence and Security Act while it completes its formal regulatory rulemaking process.
She also intends to continue pressuring the CFTC to revoke "no action" letters issued by its staff which allow electronic exchanges operating outside US borders to continue trading West Texas Intermediate crude oil and related commodities without being directly regulated, Cantwell said.
"It is abundantly clear to me that the CFTC is not doing everything it can to protect American families and businesses from possible oil price manipulations. Americans may be surprised to learn that our oil futures markets were substantially deregulated by CFTC staff decisions that were made behind closed doors," she said in her opening statement.
London, Dubai loopholes
These decisions created loopholes for exchanges based in Britain and Dubai to continue operating in the US, Cantwell said. "This is no different than when U.S. businesses take out a post office box in the Cayman Islands to avoid U.S. business laws. Two weeks ago I sent a letter to the CFTC, along with 21 of my colleagues, insisting that they reverse their 'no-action' policy and start policing all US oil markets," she said.
Cantwell said that 21 other senators joined her in writing the CFTC on May 23 demanding that it revoke the no-action letters. The commission's apparent response on May 29, when it disclosed that it has been investigating oil markets since December and announced that Britain's Financial Service Authority intends to supply it with more information about trades under its jurisdiction, was unsatisfactory for four reasons, she maintained.
"First, there are still no large speculation limits that are critical to preventing fraud, manipulation and excessive speculation. Second, the CFTC will not collect the same kind of information that it would collect from other fully regulated exchanges. The information will be unaudited and unverifiable. Third, unlike fully regulated US exchanges like [the New York Mercantile Exchange], there are no enforcement mechanisms. And fourth, the CFTC approach is partly just an agreement to agree – there are no firm commitments – so all of these measures may not even be put in place," Cantwell said.
Other Democrats on the committee agreed that more aggressive oil market and futures regulation is needed because speculation has become rampant. Crude oil prices jumped at approximately the same time hedge funds and institutional investors moved into commodity markets, said Byron L. Dorgan (N.D.). Many trades occur in unregulated, or "dark," markets where it's time for the federal government to shine a bright light, he declared.
Increased trading overseas and in unregulated energy markets has been one factor in the recent fuel price spike, according to Amy Klobuchar (Minn.) "Middle class families are feeling the squeeze in their pocketbooks while oil companies are raking in record profits and energy markets have turned into gambling halls. You can write all the laws you want, but if we don't have aggressive enforcement, we're not going to get the results our consumers and businesses need," she said.
'Clearly a tipping point'
Committee Republicans also called for more aggressive oversight. "This clearly represents a tipping point for the economy and for many Americans. Many people in Maine face the prospect of a $5,000 heating bill next winter. I'm concerned about the timidity of the agencies in not pursuing this issue more aggressively," said Olympia J. Snowe (Me.), who also signed the May 23 letter to the CFTC.
"It's essential that all regulatory agencies understand what's happening and stop any manipulation that's taking place. We also must make certain that agencies have the right regulatory authority. If we want our exchanges to be world leaders, they have to be transparent," said John E. Sununu (N.H.).
"I do believe it is important that we investigate the price impact of speculators driving up the price of our energy over the natural flow of supply and demand. Each and every Louisianan is concerned about the rising price at the pump as well as their utility bills, so I am looking for solutions that work in accordance with basic healthy economics but rein in and enforce any potential abuse from artificial price escalation in the speculation market," added David Vitter (La.).
Witnesses' assessments of the impacts of speculators on crude oil prices were varied. George Soros, chairman of Soros Fund Management LLC in New York, said that speculators are a factor but added that declining production from maturing oilfields and growing demand in China, India and other expanding economies are bigger influences. "I find commodity index buying eerily reminiscent of a similar craze for portfolio insurance which led to the stock market crash of 1987. In both cases, the institutions are piling in on one side of the market and they have sufficient weight to unbalance it. If the trend were reversed and the institutions as a group headed for the exit as they did in 1987, there would be a crash," he said.
An oil market crash is not imminent, Soros quickly added. "The danger currently comes from the other direction. The rise in oil prices aggravates the prospects for a recession. Only when a recession is well and truly in place is a decline in consumption in the developed world likely to outweigh other factors I have listed. That makes it desirable to discourage commodity index trading while it is still inflating the bubble," he said.
Unintended consequences
The case for taking regulatory action is less clear cut because regulations may have adverse, unintended consequences such as pushing investors further into unregulated markets which are less transparent and offer less protection, he continued. "Raising margin requirements would have no effect on the commodity index buying strategy of financial institutions because they use cash. Nevertheless, it would be justified in the current circumstances because it would discourage speculation and speculation can distort prices," Soros said.
But other witnesses said that more aggressive regulation clearly is needed. "The CFTC has abdicated its responsibility to regulate 30% of the total US crude oil futures traded to regulatory authorities in Dubai and the United Kingdome. I find that inexcusable," said Michael Greenberger, a professor at the University of Maryland School of Law who directed the CFTC's trading and markets division in the late 1990s.
"The FTC should be encouraged to move in and aggressively regulate oil futures markets as aggressively as the Federal Energy Regulatory Commission which moved in and began to regulate natural gas and electricity markets. All the questions the FTC has asked have been answered by FERC. It can use FERC's template. As it is, we can't expect regulations before sometime this fall," he added.
A FERC staff member, while emphasizing that she could not address how the FTC might prevent manipulation in oil markets because they are outside FERC's jurisdiction, said that FERC's experience implementing authority it received under the 2005 Energy Policy Act to prevent manipulation in wholesale electricity and natural gas markets might prove helpful. It used the prohibited activity in Section 10(b) of the Securities Exchange Act as a model to provide guidance and certainty to electricity and gas market participants operating under the Federal Power Act and Natural Gas Act, said Lee Ann Watson, deputy director of the investigations division in FERC's enforcement office.
Gerry Ramm, president of Inland Oil Co. in Ephrata, Wash., who testified on behalf of the Petroleum Marketers Association of America, said that Congress should push the CFTC to revoke the no-action letters which were issued for foreign exchanges, raise margin requirements for non-commercial entities in energy commodity markets and require them to have the ability to take physical delivery of at least some of the product, and significantly increase funding for the CFTC which has had to cut its staff as commodity trading has grown.
"We must take back the authority we have given to foreign exchanges and stop abandoning authority to private actors. Large traders should be required to register and report their entire positions in those commodities across all markets. Without comprehensive reporting, there will always be room for mischief that is out of sight of the regulator. Registration and reporting should trigger scrutiny to ensure the good character, integrity and competence of traders. Failure to comply should result in mandatory jail terms. Fines are not enough to dissuade abuse in these commodity markets because there is just too much money to be made," said Mark Cooper, research director at the Consumer Federation of America.
Contact Nick Snow at [email protected]
