Two federal regulatory agencies are moving too timidly in response to record crude oil prices, US Sen. Maria Cantwell (D-Wash.) said during a Senate committee hearing on energy market manipulation and federal regulatory regimes.
Cantwell will press both the Federal Trade Commission (FTC) and the Commodity Futures Trading Commission (CFTC) to regulate oil and commodity markets more aggressively, Cantwell said following the June 3 Commerce, Science, and Transportation Committee hearing, which she chaired.
She wants 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 CFTC to revoke “no action” letters issued by its staff that allow electronic exchanges operating outside US borders to continue trading West Texas Intermediate crude oil and related commodities without being directly regulated, Cantwell said. “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
Such decisions created loopholes for exchanges based in Britain and Dubai to continue operating in the US, Cantwell said. “This is no different than when US businesses take out a post office box in the Cayman Islands to avoid US business laws...,” she said.
Cantwell and 21 other senators wrote CFTC on May 23 demanding that it revoke the no-action letters and start policing all US oil markets. The commission responded on May 29 that it has been investigating oil markets since December and that Britain’s Financial Service Authority intends to supply it with more information about trades under its jurisdiction.
That response was unsatisfactory, she said: “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 committee Democrats agreed that speculation has become rampant. Crude oil prices jumped at about the same time hedge funds and institutional investors moved into commodity markets, said Byron L. Dorgan (ND). Many trades occur in unregulated, or “dark,” markets, he said.
Republican support
Committee Republicans also supported more-aggressive oversight. “It’s essential that all regulatory agencies understand what’s happening and stop any manipulation that’s taking place, said John E. Sununu (NH). “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.”
David Vitter (La.) added, “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.”
Witnesses held varied assessments of the impact of speculators on crude oil prices: George Soros, chairman of Soros Fund Management LLC in New York, said speculators are a factor but declining production from maturing oil fields 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, Soros 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 aggressive regulation 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 Kingdom,” said Michael Greenberger, a University of Maryland School of Law professor who directed CFTC’s trading and markets division in the late 1990s.
Greenberger said FTC could use the Federal Energy Regulatory Commission’s template to regulate oil futures markets as aggressively as FERC regulates natural gas and electricity markets. “All the questions FTC has asked have been answered by FERC.” He said, “As it is, we can’t expect regulations before sometime this fall.”
Lee Ann Watson, deputy director of the investigations division in FERC’s enforcement office, agreed, saying 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. FERC 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, she said.
Gerry Ramm, president of Inland Oil Co. in Ephrata, Wash., testifying on behalf of the Petroleum Marketers Association of America, said Congress should push CFTC to revoke the no-action letters, raise margin requirements for noncommercial entities in energy commodity markets and require them to have the ability to take physical delivery of at least some of the product, and greatly increase CFTC funding, which has had to cut staff as commodity trading has grown.
Mark Cooper, research director at the Consumer Federation of America, said, “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,” Cooper said. “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,” he added.
