Excessive Speculation and
Commodity Markets
Separating Myths from Realities
Gene Guilford, President of the Independent
Connecticut Petroleum Association in Presentation to
the House Democratic Caucus.
May 16, 2012
2002 - ENRON
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In 2000, one of Enron’s subsidiaries did something that was both stupid and
criminal: it created an artificial energy crisis in California. Increasing demand
through phony power-plant shutdowns and rolling blackouts, Enron drove up the
price of electricity and its own profits. But this also focused the attention of
journalists and federal investigators on the parent company, whose stock prices
had never been higher.
In 2001, the Enron scandal came to light, resulting in massive stockholder
defections. In December of that year, the company declared bankruptcy, its
formerly golden stock now worthless. Because of its silent complicity in the Enron
scandal, the Arthur Andersen company was also forced to close its doors.
In the end, 90,000 people lost their jobs; Enron employees, who had been
encouraged to invest their retirement plans in company stock, lost $2 billion into
the bargain. Stockholders lost another $70 billion in the Enron scandal, and the
state of California sued for $6 billion in energy losses.
Why did this happen? Federal regulators that had been blinded by the 2000
Commodity Futures Modernization Act and some complicit regulators at the CFTC
who did not want to see what was going on in the OTC markets.
Gene Guilford - House Democratic
Caucus - May 16, 2012
2
2004 – Congress Requested A GAO Study of
Commodity Markets and Existing Federal
Authorities
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We worked with Congressman Larson and others as the Energy commodity markets appeared
to become more volatile in the previous four years, combined with price changes that tended
to not reflect supply and demand, and south a GAO review of existing federal legal and
regulatory authorities;
The 2007 GAO report back to Congress, GAO found that growth in several key areas, including
the number of noncommercial participants in the futures markets (including hedge funds), the
volume of energy futures contracts traded, and the volume of energy derivatives traded
outside of traditional futures exchanges – as contributing factors in energy commodity price
movements;
While the exempt commercial and OTC markets are subject to the Commodity Exchange Act’s
[CEA’s] anti-manipulation and anti-fraud provisions and CFTC enforcement of those provisions,
some market observers question whether CFTC needs broader authority to oversee these
markets. CFTC is currently examining the effects of trading in the regulated and exempt
energy markets on price discovery and the scope of its authority over these markets—an issue
that will warrant further examination as part of the CFTC reauthorization process. Moreover,
because of changes and innovations in the market, the methods used to categorize these data
can distort the information reported to the public, which may not be completely accurate or
relevant.
The CFTC was largely blinded to being able to see what was occurring in the energy
commodity markets, especially within the Over-The-Counter and electronic trading and offexchange trading.
GAO Recommended that Congress should consider further exploring the scope of the agency’s
authority over energy derivatives trading, in particular for trading in exempt commercial
markets. In addition, GAO recommends that CFTC improve the usefulness of the information
provided to the public, better document its monitoring activities, and develop more outcomeoriented performance measures for its enforcement program. Nothing happened.
Gene Guilford - House Democratic
Caucus - May 16, 2012
3
2006 – Amaranth LLC
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Amaranth Advisors LLC went bankrupt in Oct. 2006. By mid 2007 the Committee of Homeland
Security and Government Affairs released a document containing a detailed investigation of
the Amaranth scandal entitled “Excessive Speculation in the Natural Gas Markets.” Amaranth,
hedge fund, was launched in 2000 as a multi-strategy hedge fund, but had by 2005-2006
generated over 80% of their profits from energy trading.
Amaranth became a high profile entity employing leverage to push prices of a high profile
strategic commodity like natural gas higher. This put Amaranth at odds with the 2 % inflation
“kool-aide” illusion that the Fed and U.S. regulators were [and still are] trying to falsely sell the
American people. In 2008, Ludwig Chincarini CFA, Ph.D, penned a paper chronicling
Amaranth’s collapse titled, Lessons from the Collapse of Amaranth Advisors L.L.C. [and found
at http://pages.pomona.edu/~lbc04747/pubs/pub9.pdf] The report gave details regarding
Amaranth’s management style and risk management practices as well as chronologically
detailing the last days of the hedge fund.
As Amaranth began accumulating positions at the NYMEX that the exchange considered
excessive, the hedge fund switched its trading to the Intercontinental Exchange [ICE], which
was unregulated and beyond the view of domestic market oversight.
The $4 billion collapse of this hedge fund, and its use of excessive leverage to drive natural gas
prices higher with its financial positions, illustrates how one financial market player’s actions
drive up the cost of energy to consumers and did so largely outside of the view of market
regulators.
Gene Guilford - House Democratic
Caucus - May 16, 2012
4
2006 - BP Propane Market Manipulation
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In 2006 BP’s propane division paid $303 million to settle civil charges that it cornered the
propane market eight years ago and inflated heating and cooking costs for about 7 million
mostly rural American households
By the end of February 2004, BP controlled almost 90 percent of all the propane delivered on a
pipeline that stretches from Mont Belvieu, Texas, to consumers as far away as New York,
Pennsylvania and Illinois, investigators said. From the beginning of the month to Feb. 27, the
cost of the liquid that is stripped from natural gas skyrocketed by more than 40 percent to
about 90 cents per gallon — “a price that would not otherwise have been reached under the
normal pressures of supply and demand,” investigators said.
Robert G. Hansen, the associate dean at Dartmouth’s Tuck School of Business, said it appears
that “a corporate management failure occurred at BP” and that, with energy markets facing
such a high level of scrutiny from the public, “management has to have the utmost control of
their trading groups.”
BP traders bragged that if their scheme worked they would “be able to control the market
at will.”
The role of rampart speculation in the oil market was noted in 2006 by the U.S.
Senate Permanent Subcommittee on Investigations in the report "The Role of Market
Speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back on the Block."
At that time the report stated: "Several analysts have estimated that speculative
purchases of oil futures have added as much as $20-$25 per barrel to the current
price of crude oil, thereby pushing up the price of oil from $50 to approximately
$70." That report called for ending the Enron Loophole at that time but nothing was
done.
BP had traditionally performed most of its trades in the UK markets and was only caught
through its US activities.
Gene Guilford - House Democratic
Caucus - May 16, 2012
5
The New Money Machine
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Banks used new academic research to pitch commodities as a safe way to diversify.
In one 2004 presentation, Heather Shemilt, then a managing director and now a
partner at Goldman, called the strategy “the portfolio enhancer.” That same year two
professors, Gary B. Gorton of the Wharton School and K. Geert Rouwen-horst of Yale
University, published a paper, funded in part by American International Group Inc.,
which argued that an investment in a broad commodity index would have brought
about the same return as stocks from 1959 to 2004, and would often rise when
stocks fall.
Under the crystal chandeliers of San Francisco’s Palace Hotel in June 2005, Rouwenhorst
presented his findings to more than 100 investment pros; Shemilt also appeared, alongside
managers from Barclays and AIG. After the talk, many in the audience had the same question:
How do I do this?
Barclays, Goldman, AIG, and other firms had developed ways to help them do it -- several
types of investments based on futures contracts, which had been used for almost 150 years to
arrange the price and delivery of a given commodity at a specified place and date. These
products remained the province of wealthy investors. In 2004, however, Deutsche Bank’s Rich
devised a commodity ETF that opened the door to retail investors when it launched two years
later.
The Commodity Index Fund is born. Today these funds plow in excess of $400 billion into
commodity markets, distorting their values and providing phantom price signals by people who
do not deliver or buy anything – only bet on the paper.
A common myth concerning index funds is that they “provide liquidity” to the market, thereby
fulfilling an important role in providing commercial hedgers with needed counterparties.
However, commodity index funds do not trade on the basis of supply and demand
fundamentals or in response to liquidity demands. Rather, they trade on the basis of
investment inflows and the need to perpetually roll contracts forward as they regularly expire.
Gene Guilford - House Democratic
Caucus - May 16, 2012
6
Growth of Commodity Index Funds
Gene Guilford - House Democratic
Caucus - May 16, 2012
7
NORDEA Abandons Speculation in Agricultural
Commodities
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In reviewing the history of the growth of speculative
investments in agricultural commodities in the previous slide;
On May 10, 2012 NORDEA, a Danish bank, announced that it
was abandoning offering its customers financial instruments
investing in agricultural commodities, citing a number of
international analyses which show a correlation between
increased speculation and volatile (and record high) food
commodity prices.
Gene Guilford - House Democratic
Caucus - May 16, 2012
8
2007/08 – Closing the ENRON Loophole
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The "Enron loophole" exempted most over-the-counter energy trades and
trading on electronic energy commodity markets from government regulation.
The "loophole" was enacted in sections § 2(h) and (g) of the Commodity Futures
Modernization Act of 2000, December 21, 2000. It allowed for the creation, for
U.S. exchanges, of a new kind of derivative security, the single-stock future,
which had been prohibited since 1982 under the Shad-Johnson Accord, a
jurisdictional pact between John S. R. Shad, then chairman of the U.S. Securities
and Exchange Commission, and Phil Johnson, then chairman of the Commodity
Futures Trading Commission.
June 2007, the equivalent of 3 billion barrels of oil traded daily in paper markets,
versus just 67 million barrels a day traded in the physical oil markets, according
to OPEC Secretary General Abdullah al-Badri, speaking at a Reuters Global
Energy Summit.
When speculators become dominant in the market for derivatives on consumable
commodities, the supply- and demand-based trading of physical commodity
producers takes a back seat to the high stakes trading of speculators as they
attempt to out trade each other.
Part of this colossal corporate failure and its cost to consumers came as a result
of federal regulators turning a blind eye to market activities and insisting on
“supply and demand” as their excuse for market behavior.
The “loophole” was not effectively closed in the 2008 Farm Bill, leaving more
work to be done in law.
Gene Guilford - House Democratic
Caucus - May 16, 2012
9
Supply and Demand – China and Index Funds 2008
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Some economists point to China's demand for crude oil as the cause
for the [then] recent rise in energy costs
2008 Department of Energy report stated that annual Chinese demand
for petroleum has increased over the last five years [2003-2008] by
920 million barrels.
Yet, over the same five-year period, index speculators' demand for
petroleum futures has increased by 848 million barrels, thus the
increase in demand from institutional investors is almost equal to the
increase in demand from China.
The October 2007 Government Accountability Office report, Trends in
Energy Derivatives Markets Raise Questions about CFTC's Oversight,
determined that futures market speculation could have an upward
effect on prices; however, it was hard to quantify the exact totals due
to lack of transparency and record keeping by the Commodities
Futures Trading Commission (CFTC).
Once again, lack of transparency, accountability and oversight left the
country with energy markets being impacted by financial industry
speculation and higher energy costs.
Gene Guilford - House Democratic
Caucus - May 16, 2012
10
2008 - Supply and Demand – Fails – WTI Crude
Oil
July, 2008
$147 @ bbl
May, 2008
Goldman Sachs Predicts
$200 @ bbl crude
March, 2008
$70 @ bbl
There is no supply and demand argument for WTI
crude oil that more the doubled its price in 5
months and then the absence of such supply and
demand forced its collapse in the succeeding 5 months
Gene Guilford - House Democratic
Caucus - May 16, 2012
November, 2008
$32 @ bbl
11
America’s Second Great Depression and DoddFrank
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The near collapse of the nation’s financial system between 2007 and 2010, driven
by the housing market bubble and misuse of derivatives in the very dark markets
created by deregulation in 2000, resulted in a loss of some $16 trillion in national
wealth – millions lost their jobs, homes and value of their homes and businesses.
Dodd-Frank, signed into law by President Obama in July of 2010, gave regulators
many of the tools that are needed to bring order to markets through appropriate
and necessary regulation, accountability, transparency and oversight.
The CFTC and SEC have been given new, broad powers to return to a pre-2000
period when federal oversight and regulation of financial markets was more
involved and, with the exception of derivatives regulation, more successful.
With hundreds of rulemakings to be done by agencies, particularly in the area of
regulating the nearly $600 trillion derivatives market, and faced with lawsuits
from the financial services industry challenging the agencies at every turn,
progress is slow.
Today, 9 banks are exposed to derivatives positions exceeding $200 trillion in
notional value. That is almost three times the size of the entire global economy.
Our work is not finished, as agency rulemakings need to be completed. Wall
Street seeks judicial nullification of the laws through lawsuits.
Gene Guilford - House Democratic
Caucus - May 16, 2012
12
2012 - Trust Wall Street?
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JP Morgan shocked everyone on the afternoon of May 10th with a surprise conference call from
Chairman Jamie Dimon. Their 10Q revealed that they face way, way more losses than we
thought. There's about $4.2 billion in legal losses, likely because of a trader named Bruno Iksil,
the so-called “London Whale.”
Possibly a $800 million loss in corporate department after tax.
Possible $2 billion losses on synthetic credit positions.
"It could easily get worse this quarter," Dimon says. It is likely they'll be volatile for the next 2
quarters.
Bank analyst Mike Mayo asks: "Can mistakes be made in other departments?" Dimon
answers—"We're not in the business where we're not going to make mistakes... I can never
promise you no mistakes. This one we'll put in the egregious category."
JPMorgan's surprise trading loss is not only tanking the stock itself (which is down over 6% on
the 10th) it's taking down world financial markets.
JP Morgan Chase has a derivative exposure of $70.151 Trillion dollars – roughly the size of the
entire earth’s economy.
The Volcker Rule, a modern-day semi-replacement of the 1933 Glass-Steagall law separating
commercial from investment banking, comes out this summer with aims at restricting
proprietary trading. Wall Street is already screaming at its purposes, hoping the nation and
policy-makers have amnesia about the last four years.
"In other words, JPMorgan Chase, entirely without any help from the government
has lost, in this one set of transactions, five times the amount they claim financial
regulation is costing them," Rep. Barney Frank, May 11, 2012
Gene Guilford - House Democratic
Caucus - May 16, 2012
13
Drawing the Line from Wall Street to the Gas
Pump
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Financial industry speculators have overtaken commodity markets
10 years ago actual producers and users of energy and agricultural commodities
made up 70-80% of the markets, with only 20-30% speculators;
Now, that has flipped and 70-80% of the commodity markets are controlled by
financial industry speculation and only 20-30% of the markets are the actual
legitimate hedgers of purchases of energy and food;
6 years ago Wall Street brought out commodity index funds, resulting in $200$400 billion of strictly speculative investments in commodity markets and that is
contributing to the rise in food and energy prices. Review how one Wall Street
investment house sells these instruments…
"How do I sell something that I don’t own, or why would I buy
something I don’t need". The answer is simple. When trading futures, you
never actually buy or sell anything tangible; you are just contracting to do so at a
future date. You are merely taking a buying or selling position as a speculator,
expecting to profit from rising or falling prices. You have no intention of making
or taking delivery of the commodity you are trading, your only goal is to buy low
and sell high, or vice-versa. Before the contract expires you will need to relieve
your contractual obligation to take or make delivery by offsetting (also known
as unwind, or liquidate) your initial position. Therefore, if you oiginally entered a
short position, to exit you would buy, and if you had originally entered a long
position, to exit you would sell.
[http://www.altavest.com/education/default.aspx]
Gene Guilford - House Democratic
Caucus - May 16, 2012
14
Mid-December 2011 to March, 2012 – CME/Crude
Oil
Gene Guilford - House Democratic
Caucus - May 16, 2012
15
Mid-December 2011 to March 2012 –
CME/Gasoline
Gene Guilford - House Democratic
Caucus - May 16, 2012
16
Mid-December 2011 to March 2012 –
CME/Heating Oil
Gene Guilford - House Democratic
Caucus - May 16, 2012
17
Wall Street’s Reaction to the Fundamentals Taking
Hold?
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"It was a very overdone trade, and people are getting out of it," said
Amrita Sen, an energy analyst at Barclays
"What you're seeing in the market is some back-pedaling from the
hysteria we saw in February and March," said Sander Cohan, a principal
at ESAI, an energy-consulting firm in Wakefield, Mass.
As futures prices drop, investor sentiment appears to be shifting. Hedge funds,
pension funds and other money managers [non-commercial market participants]
are reducing their bets that gasoline futures will rise. Those bets had jumped
35% between early January and early April.
Demand for gasoline, meanwhile, continues to be underwhelming. US DOE/EIA
data showed there is nearly 3% more gasoline on hand at the moment than
there was a year ago. In fact, domestic gasoline inventories were at the top of
their 5-year averages and the US was a net exporter of refined petroleum
products as well, of more than 250,000 barrels a day of finished gasoline and a
total of over 1 million barrels a day of refined products generally.
Gene Guilford - House Democratic
Caucus - May 16, 2012
18
What Has This Mid-December to March Artificial
Inflation Cost Us?
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US Gasoline Consumption
138,496,176,000 gallons annually
11,541,348,000 gallons monthly
380,000,000 gallons daily
CME/NYMEX Gasoline contract increase of 92c a gallon between midDecember and March 28th would translate into an increased cost of
gasoline to American consumers of $10.6 billion per month in March
versus December.
As the wholesale, physical markets are priced directly off the daily
movements of the CME/NYMEX contract movements, we saw 70c per
gallon increases in wholesale prices through the time of the 92c a
gallon increases in the commodity contract;
The direct impact on American consumers was $266 million a day, or
$8 billion per month, in higher gasoline costs by mid-March over prices
charged in mid-December.
CME/NYMEX gasoline contract values have declined of late from their
high of $3.40 down to $3.02 [5/10/2012], and are still 54c a gallon
higher than last Mid-December.
Gene Guilford - House Democratic
Caucus - May 16, 2012
19
The Need for Transparency, Accountability and
Oversight
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The commodity markets are overseen by the CFTC [Commodity
Futures Trading Commission], who put in place a position limits
regulation after the first of year to restrain strictly financial
speculation in these markets and the financial services industry
sued the CFTC in federal court, saying the rules were not
necessary; ask anyone buying energy or food, given these massive
price increases, whether they think restraining the financial
industry is necessary;
The financial services industry drove America nearly into another
Great Depression in 2008, from which we are only now beginning
to emerge. Congress passed the Dodd-Frank law to regulate the
reckless and irresponsible behavior of Wall Street and that law,
and all the agencies responsible for implementing that law, need to
be strongly supported and the law needs to be allowed to work for
the American people.
Due to the previously mentioned market distortions that resulted
largely from trades in opaque markets, these activities need to be
brought into transparent clearing to avoid systematic risk.
Gene Guilford - House Democratic
Caucus - May 16, 2012
20
Are the Effects of Speculation on Commodity
Markets Clear?
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Yes
There are 98 academic and public institution studies that prove
the negative effects of speculation on commodity markets;
There are another 38 studies that demonstrate the harm to
markets caused by High Frequency Trading;
The issue isn’t whether or not speculation is harmful – it is the
degree to which excessive speculation damages the price
discovery mechanism critical to commodity market success –
and the necessary and appropriate government action needed
to restrain it;
Opaque unregulated, uncleared, leveraged markets,
tend to over shoot on the way up and down, AND send
the wrong market signals to the physical markets for
future investment.
Gene Guilford - House Democratic
Caucus - May 16, 2012
21
The Need for Transparency, Accountability and
Oversight
 20% of the trades in areas mentioned here are
within the scope of view of US regulators;
 80% are within ICE and the OTC market and,
therefore, not yet within the scope of view of
US regulators
Gene Guilford - House Democratic
Caucus - May 16, 2012
22
Our Job Is Not Done
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We would throw all purely financial speculators out of these markets and make all
energy and agricultural commodities 100% deliverable, which is to say if you invest in
these markets you MUST be able to take actual delivery of the commodities you invest
in - NOT simply play the Wall Street casino game of placing bets and bidding up the
price of energy and food and leaving Americans with paying the bill;
Support adequate funding for the CFTC, reject proposals to cut their funding which only
guts the agency’s ability to enforce the laws;
Support the efforts of the House Agriculture Committee to initiate hearings on the role
excessive Wall Street oil speculation is having on gas prices;
Action by the Dept of Justice Task Force on Speculation, started last July, 2011 – must
be undertaken immediately and without delay.
Support Representative Markey’s legislation, the “Halt Index Trading of Energy
Commodities (HITEC) Act’’ (H.R. 5186) which would end speculative trading in
energy commodities.
Support the "Sustainable Funding Act" (H.R. 3665) which would provide the CFTC
with a permanent funding source.
The Volcker rule comes this summer, the modern-day version of the 1933 GlassSteagall law whose intent is the restriction of proprietary trading by investment banks.
Wall Street is already screaming at its intent and impact, as though the nation and
policy makers should have amnesia about what has happened the last four years.
Gene Guilford - House Democratic
Caucus - May 16, 2012
23
Does Fixing Financial Market Speculation Alone Fix
Energy Markets?
No. There are three key areas of concern with energy prices;
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Monetary policy that devalues the dollar and has some inflationary
effect on dollar-denominated commodities traded in world
markets;
Speculation in commodities by those with no intention of delivering
anything tangible to a market nor taking delivery of anything
tangible from a market – but whose billions of investment send
false price signals and inflate commodity values;
Energy Policy, as with every 3% increase in GDP growth there is a
1% increase in energy demand. Energy policy, including energy
conservation and domestic production are critical, but also need to
be delivered into a market that sees fundamentals and real supply
and demand – not the phantom short-term thinking of churning
contracts and short-term profit in the casino that has become the
commodity markets.
Gene Guilford - House Democratic
Caucus - May 16, 2012
24
Wall Street’s Strategy…
1.
2.
3.
4.
Sue. What they couldn’t change in Dodd-Frank ends up as
rulemakings in agencies and the strategy is to litigate everything;
Stall. Flood agencies with comments [15,000 on the CFTC Position
Limits Rule alone] so that most agencies’ rulemakings fall behind and
hope Congress changes so that legislative changes can be enacted;
Bully Regulators. Threatening lawsuits isn’t the only tactic,
threatening agency budgets in Congress is also part of the strategy as
they attempt to undermine an agency’s ability to carry out its
statutorily-directed functions and as that gets elongated – complain
about regulatory uncertainty harming the economy;
Beg for Loopholes. As agencies make progress formulating and
enacting rules, and as that progress and potential impacts become
more clear, return to Congress and beg for exemptions and loopholes
citing extraordinary costs in jobs and profitability.
Gene Guilford - House Democratic
Caucus - May 16, 2012
25
Finally…Transparency – Accountability - Oversight
"This regrettable news from JPMorgan Chase [announcing its $2 billion loss] obviously
goes counter to the bank’s narrative blaming excessive regulation for the woes of
financial institutions,"
"The argument that financial institutions do not need the new rules to help them avoid
the irresponsible actions that led to the crisis of 2008 is at least $2 billion harder
to make today,“
"In other words, JPMorgan Chase, entirely without any help from the
government has lost, in this one set of transactions, five times the
amount they claim financial regulation is costing them,"
Representative Barney Frank, May 11, 2010.
Gene Guilford - House Democratic
Caucus - May 16, 2012
26