Hearing provides early look at Cantwell's energy commodity reforms

A US Senate Energy and Natural Resources subcommittee hearing on Mar. 25 showed the steps one congressional energy commodity reform advocate would like the federal government to take.

"We are here today to examine two pieces of proposed legislation that will help prevent future energy price bubbles and market manipulation," said Sen. Maria Cantwell (D-Wash.), who chairs the Energy Subcommittee.

The first, S. 672, which she introduced on Mar. 24, would give the Federal Energy Regulatory Commission authority to issue cease-and-desist orders to stop manipulative schemes which are in progress. The US Securities and Exchange Commission and Commodity Futures Trading Commission already have this authority, she noted in her opening statement.

She said that the bill also would make FERC able to freeze the assets of any entity suspected of market manipulation. It would give the commission authority to temporarily change or suspend power rates for up to 30 days during an energy emergency caused by market manipulation. And it would have any potential natural gas refund accrue from the time FERC brought a case (an approach currently used in electricity markets, according to Cantwell) instead of when it actually proves it.

"It will allow FERC to act more like a cop catching a robbery in progress instead of trying to piece together what happened at a crime scene after the fact," she said.

Authority under EPACT

The 2005 Energy Policy Act gave the utility regulatory commission its initial authority to investigate and prosecute energy market manipulation, and FERC has used this authority to conduct 135 investigations resulting in 27 settlements totaling $65 million in civil penalties, she said.

Cantwell said that FERC's enforcement actions against Amaranth Advisors LLC for allegedly manipulating markets under this authority resulted in $291 million in civil penalties. "However, I understand that in the case of Amaranth, this hedge fund liquidated its assets before FERC could complete its enforcement action, leaving little left for FERC to collect: only the $291 million in penalties it originally sought. That falls quite short of the estimated $9 billion Amaranth's shenanigans cost natural gas consumers," she said.

FERC would welcome this additional authority, according to one of the hearing's witnesses, Anna Cochrane, acting director of the commission's enforcement office. "Congressional action to give the commission cease-and-desist authority for violations of the [Federal Power Act] and {Natural Gas Act] and the ability to freeze assets of entities that violate the market manipulation rules would give the commission the same enforcement tools that both the SEC and CFTC have long possessed. In addition, authority to temporarily suspend market rules on file under the FPA when necessary to protect against potential abuse of market power could be useful," she said in her written statement.

Cantwell said that while S. 672 would give FERC necessarily new tools for fighting energy market manipulation, other steps need to be taken. "We need to make the line of what is and what isn't acceptable market behavior brighter. This will ensure markets function more efficiently and effectively," she said.

She pointed out that when the subcommittee held a related hearing on energy markets in September, the price of gasoline was around $3.85/gal. "Now, just six months later, the price has dropped almost exactly in half to a national average of $1.96/gal. In these challenging economic times, every American is thankful that energy prices are closer to historical levels. But they still wonder: What happened?" Cantwell said.

Close correlation

She said that another of the witnesses at the hearing, Robert F. McCullough Jr., managing partner at McCullough Research in Portland, Ore., detected a close correlation between financial and physical oil markets last year, in contrast to the US Energy Information Administration which based its conclusions on factors influencing supply and demand.

"Thanks to his work, and several hearings this committee has held in previous years, we have learned that we don't have the necessary data collection or focus to understand what really drives oil market prices. All we really know now is that supply and demand is only part of the equation," she said.

Cantwell said that the second legislation which the hearing would examine would establish an office within EIA to collect and analyze information from both the physical and paper oil markets. This would improve EIA's ability to predict future energy prices and help regulators police markets more effectively, she said.

In his written testimony, McCullough said that no federal agency has been assigned the task of investigated and explaining last year's extraordinary crude oil price changes despite oil's arguably being the US economy's most important commodity.

"The inability of the federal government to fully investigate oil price behavior in 2008 is fundamentally a data problem. Perhaps it is not a coincidence that oil is the most opaque of our nation's energy supplies. The transparency legislation that you are discussing today is a step in the right direction because it will expand EIA's ability to track oil inventories within the US by owner," he said.

Difficult and expensive

Howard K. Gruenspecht, EIA's acting administrator, testified that efforts are under way already to develop new data about short-term price impacts beyond supply and demand. He also warned that adopting procedures outlined in the market transparency bill could prove to be both difficult and expensive.

He said that earlier in March, EIA held a workshop on the relationship between futures and financial market activity and the underlying physical market for crude oil with staff members from the CFTC, Federal Reserve Board, Government Accountability Office and International Monetary Fund. Presentations and discussions highlighted several points, including the need for better and more accessible data on trader activity, the need to examine alternative theories of trader behavior, and the need to continue examining the role of fundamentals with better and more accurate data.

"Looking ahead based on our current understanding, EIA staff believe that effective analysis of the effects of trading on resulting prices will require not only better data, but a much stronger theoretical approach as well. Analysts within and outside EIA continue to grapple with understanding the gap between very short-term and longer-term price formation. A comprehensive theory of how trader behavior affects longer-term prices is simply not well developed. Without a well-developed theory, analysts are reduced to data mining and testing unformed hypotheses," Gruenspecht said.

Limited availability of aggregate data which can be used to track trader strategy and behavior compounds the challenge, he continued. "In the most obvious example, the position information that the CFTC publishes is separated into categories of commercial and non-commercial traders, categories that do not map cleanly to hedgers and speculators. Without a way of identifying trades and positions taken for speculative purposes, direct analysis of the effects of speculation on price formation is not really possible," he said.

Intended uses

Gruenspecht said that while EIA's initial assessment that the data collection efforts proposed in the bill "could be both difficult and expensive," that does not necessarily mean they would be inappropriate, but does suggest a need to consider whether other, more readily obtainable might provide comparable or better insights. "In part, the answer may depend on an even more basic question: the intended uses of the data, which are not described in the draft legislation," he said.

In addition to being difficult and costly, the proposed new data collection efforts would have to be handled by existing EIA employees, unless additional staff and resources were funded, the EIA official continued. These employees would need to be pulled from previously planned activities, which could lead to delays in current high-priority projects such as integrating ethanol into EIA's weekly petroleum data program, collecting custody-based petroleum data at individual terminals instead of across an entire Petroleum Administration for Defense District, and addressing other existing data quality issues, he said.

Finally, instead of having a new financial markets analysis office created, EIA would prefer the latitude to restructure itself as necessary, he said. "Expertise in energy markets is located across several EIA offices, the staff of which work together across office lines to produce forecasts and analyses. Cross-office teams are created as needed, including for work on financial markets," he said.

A fourth witness, Gerry Ramm, senior executive with Inland Oil Co. in Ephrata, Wash., testified on behalf of the Petroleum Marketers Association of America. He said that commodity markets reform legislation should be expedited because it has become clear that speculators who are not interested in taking physical delivery have played such a strong role. Collection of additional data as outlined in the proposed bill would need to occur frequently, and reporting requirements would have to be based on a minimum on the amount of commercially held oil, he said.

Further steps

Beyond Cantwell's bill, he continued, Congress should be ready to impose aggregate position limits on non-commercial traders across all venues, including over-the-counter markets; distinguish between legitimate hedgers and speculators; require foreign exchanges with energy contracts for US delivery or that allow US access to their platforms follow US rules and regulations; remove the position limits exemption for index speculators, and increase staff and other resources at the CFTC. "Reliable futures markets are crucial to the entire petroleum industry and the American economy. Let's make sure that these markets are competitively driven by supply and demand and not pure the speculative whims and greed of Wall Street," Ramm said.

Witnesses did not include anyone from the CFTC, which moved to close a significant energy commodities loophole on Mar. 24 by creating a new regulatory category, exempt commercial markets (ECMs) with significant price discovery contracts, and subjected these electronic trading facilities to additional regulatory and reporting requirements effective Apr. 22.

ECMs were created under the 2000 Commodity Futures Modernization Act as electronic markets to trade exempt commodities on a principal-to-principal basis between qualified commercial entities. By 2007, they had grown to a point that critics said showed speculators used them to circumvent regulated exchanges and manipulate crude oil and other commodity prices. The CFTC began an investigation which continued through 2008 and which eventually concluded that some traders should be regulated because their contracts perform price discovery roles.

But the commission's careful and deliberate inquiry was not enough for many congressional critics. One of them, Sen. Byron L. Dorgan (D-ND), said at the Mar. 25 hearing that stronger reforms were needed. "I hope we can find a way to make the market transparent, develop appropriate regulations and install regulators who will do the job," he said.

Contact Nick Snow at nicks@pennwell.com