August 31, 2009
Ken Silverstein
EnergyBiz Insider
Editor-in-Chief
The Enron saga still lives. Elements of the so-called "Enron loophole" remain intact -- provisions that that some say distort markets and drive up commodity prices.
The uncertainty in oil and natural gas markets, along with the country's financial morass, has prompted legislative changes. But the Obama administration wants those commodities that are bought and sold through trading platforms to be subject to even stricter oversight. The administration's Commodity Futures Trading Commission is considering regulations that would diminish the power of those exchanges and set limits on the number of energy positions that traders take.
The commission has said it will propose new rules by fall. As it proceeds, its goal will be to attract participants and thus maintain the liquidity that those platforms require while at the same time to promote investor confidence in markets. It's a task that has been exacerbated by charges that traders have manipulated futures markets -- a matter that has led to a rash of new congressional bills to "correct" the problem.
"I believe that the size of the markets and the effects that they have on the day-to-day lives of the American public make it that much more important that we aggressively fulfill our mandate," says Gary Gensler, head of the commission, at a Congressional hearing. "Position limits should enhance liquidity by promoting more market participants rather than having one party that has so much concentration so as to decrease liquidity."
Created in 2000, the Enron loophole had exempted from government regulations most over-the-counter energy trades and trading on electronic commodity indices. The thinking was that all commodities could be packaged and sold over online trading forums. Unfettered markets would then bring down prices for everyone.
But such free market finesse has been blamed for not just excessive price volatility but also fraud and manipulation. In the intervening years, Congress introduced legislation that went nowhere. However, last year one such bill passed both chambers and was sent to President Bush for his signature. And while he vetoed it, Congress was able to override that rejection in June 2008.
One of those accused of price manipulation was hedge fund Amaranth that managed $9 billion in assets. On a practical matter, the feds are still dealing with the fallout resulting from its failure in 2006. The Federal Energy Regulatory Commission recently approved an agreement that settles the case against the fund -- one that concluded its large natural positions created unstable markets and forced average people to pay much higher prices. The settlement requires the Amaranth parties to pay $7.5 million to the U.S. Treasury.
Task Ahead
Amaranth had dominated trading in U.S. natural gas markets just before its collapse, holding about 40 percent of all outstanding natural gas contracts on the New York Mercantile Exchange. At times, it held 100,000 natural gas contracts in a month.
Critics maintain that such large positions have been the driving force behind higher natural gas prices. They add that speculators generally have become the dominant force in the futures markets, distorting the basic economic laws of supply and demand.
In testimony before Congress this month, the Industrial Energy Consumers of America said that from January 2008 to August 2008, the price of natural gas more than doubled because of too much speculation. During the same time period, U.S. production of natural gas actually rose about 8 percent while national inventories were well within the five-year average and demand was essentially unchanged from the same period of the previous year. As a result of that excessive risk taking, consumers paid more than $40 billion in higher natural gas costs, it concludes.
A report by the Government Accountability Office in 2007 tends to agree with that overall assertion. It said that speculation among futures traders could cause prices to escalate. But it went on to add that the lack of transparency, not just among the opaque hedge funds but also within the commodities commission itself, makes it difficult to give a precise answer.
Others, however, caution against over-regulation. Many trading organizations say that the added involvement in the energy sector creates more liquidity and transparencies that would otherwise be lacking. Investment banks and hedge funds are the catalysts. And while they try to profit from price volatility, they are responsible for product innovation and the formation of a robust market. That, in turn, creates efficiencies and prices are eventually a truer reflection of supply and demand.
The trading forums agree, with the NYMEX pointing out hedge funds typically account for a modest share of futures markets and therefore those sophisticated investment funds are generally unable to cause large movements in price. Specifically, such holdings comprise a modest amount of the natural gas futures trading volume -- levels that the exchange says add liquidity and vibrancy without distorting markets.
"We believe that eliminating or limiting swap dealer hedge exemptions not only will not address the 'swap loophole' but actually will have several negative consequences," adds Donald Casturo, managing director of Goldman Sachs Group, during testimony before the commodities commission hearings on the matter.
The Obama administration must walk a fine line between promoting participation in futures markets and preventing market manipulation. The White House understands the task ahead but says that it must forge ahead with new rules. Natural gas, in fact, is the lifeblood of many aspects of the American economy and it is therefore the responsibility of government to ensure that the associated trading markets remain healthy.
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