gene@icpa.org
chris@icpa.org
10 Alcap Ridge, Cromwell, Connecticut
06416
Connecticut General Assembly Gasoline Questions
1. Q: Should we impose a national wholesale cap (temporary)?
The price of energy is a reflection of supply and demand, and that fact is truer
today than was the case thirty years ago. Thirty years ago energy cost was a
function of control by producers and even the Texas Railroad Commission. To
break cartels and infuse the energy markets with greater transparency and
competition, energy began to be traded as commodities.
Energy today is traded worldwide as commodities on open, transparent
exchanges from New York to London to Singapore. Increasingly, efforts to
“control” one part of this system ignores the fact that New York can’t say crude
oil is $40 a barrel when the rest of the world says the commodity price is $65.
America sustained embargoes on imported crude oil from foreign producers in
1948, 1956, 1967, 1973 and 1979. In the embargoes of 1948, 1956 and 1967 the
United States had surplus capacity to increase domestic production to make up
for the loss of foreign supply so the temporary loss of foreign supply never
touched prices or consumers.
However, in 1970 President Richard Nixon imposed wage and price controls on
the economy and then those controls were lifted they unfortunately were left on
crude oil and natural gas. As a result of the signal to producers that domestic
energy was to be controlled and foreign energy was left to supply and demand,
no significant increase in domestic production occurred after 1970.
When the embargo of 1973 hit the United States, we had no surplus capacity to
bring online and the result were shortages, significant price increases and an
economic recession that lasted until 1982.
Our objective nationally should be to encourage more domestic production and
increase incentives for conservation. Artificial price caps or controls have
resulted, unequivocally as evidenced by what the United States did in 1970, in
worsening our energy situation not improving upon it.
A cap on the price of gasoline for one state opposed to a national cap would
likely lead to supply problems for the state that elected to implement it. Take the
example of Hawaii’s wholesale cap. Hawaii has no contiguous gasoline market
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ICPA Addresses Energy Questions For the Connecticut General Assembly
as it is surrounded by thousands of miles of Pacific Ocean. Given that, Hawaii
may be able to control wholesale prices but even Hawaii has set the cap at a
very high level to ensure that Hawaii continues to receive supply – Hawaii does
not refine all its own gasoline and relies on imports.
If Connecticut controlled its wholesale price at $1.50, while Boston and
Providence and New York were all at prevailing market prices of a wholesale at
$2.22, then who would bring gasoline to New Haven for wholesale sale?
2. Q: What is the impact of ethanol on gasoline?
Connecticut and New York, being the only two states on the eastern seaboard
to mandate the use of ethanol as the oxygenate in gasoline, have seen
unintended negative consequences as a result of being the only two states that
use ethanol.
When Connecticut switched from MTBE to ethanol, a heating oil storage facility
in New Haven was converted to MTBE blended gasoline to allow for
Massachusetts gasoline stations that are supplied out of Connecticut to have
access to supply, reducing Connecticut heating oil storage.
Another unintended consequence of using ethanol is the actual weight of
gasoline has increased. This weight increase reduces the amount of gasoline
that can be transported (because of motor vehicle weight laws) this increase
has increased the amount of trips that haulers have to make to deliver the same
amount gasoline that as delivered prior to the switch to ethanol. More trips equal
increased traffic, increased diesel emissions, and increased risk of accidents.
An unintended consequence of using ethanol is reduced gasoline mileage.
More ethanol blended gasoline needs to be used to operate a motor vehicle
than if MTBE blended gasoline was being used, thus increasing Connecticut
motorists use of gasoline.
Finally, we return to the market. Even as corn futures on the Chicago Board of
Trade [CBT] were going down, ethanol made from corn was rising in price along
with gasoline recently. Why? A good question to pose to ethanol producers as
even with a total switch to ethanol we wouldn’t have saved any money in the
price per gallon.
3. Q: Should we ration gas?
Rationing is common at the wholesale level and was voluntarily implemented in
the 10 days after hurricane Katrina hit. Connecticut wholesalers put their
customers on rationing or allocations. Gasoline dealers were reduced to as low
as 87% allocations in order to prevent supply shortages.
The Governor, under emergency energy situations, has the authority to impose a
rationing scheme. Our present situation doesn’t dictate that as necessary but
that authority could be used in the event a shortage developed that was so
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ICPA Addresses Energy Questions For the Connecticut General Assembly
severe that only Government could set the rules of distribution to make sure
critical needs were met in a priority over less critical needs.
4. Q: Explain zone pricing?
Zone pricing is a marketing tool used by wholesaler of gasoline to aid gasoline
dealers in competitive markets. For instance, zone pricing can be used to lower
the price of gasoline for gasoline dealers on the Massachusetts boarder who are
at a disadvantage because the Massachusetts gasoline tax is lower than
Connecticut’s. Our border stations regularly lose business in the absence of
zone pricing and the state loses revenues from state taxes in the lost sales
[excise tax at 25c per gallon and gross receipts tax at 5.8% of the sale].
Banning the use of zone pricing would have a negative effect on the growth of
the independent gasoline distributors here in Connecticut. If the practice of zone
pricing were to be banned it would take away the independent jobber’s
flexibility to meet competition within the state and, even more importantly, along
state borders where a difference of just a few pennies can mean the life or
death of a gasoline station. It would also hinder their ability to recoup the costs
of building or renovating stations.
With the cost of doing business (labor, property values, taxes, etc.) being
different from municipality to municipality, gasoline station owners must not have
the ability to recoup their costs and meet competition. There is a perception that
zone pricing raises the cost of gasoline in certain areas of the state. However,
more often than not the ability for independent jobbers to price regionally to
meet specific competitive markets lowers the price of gasoline in different
regions throughout Connecticut.
The best way to keep gasoline prices low in any region of Connecticut is to
encourage growth and competition. More stations, not fewer, provide
consumers with the choice to buy gasoline from whomever they chose. Banning
zone pricing discourages growth and competition and would in all likelihood
lead to a reduction in the number of gasoline stations in Connecticut.
While we respect the question, the issue has no bearing on the present situation.
Further, this issue has been raised and defeated in at least seven sessions,
including the session that ended four months ago, of the General Assembly. A
hurricane did not change the fundamental economic fact that, despite the
dealer organization’s protests, zone pricing does not address what we are going
through now.
5. Q: Can we provide gasoline assistance to the poor?
Connecticut currently conducts the low income energy assistance program for
heating fuels. Although well intentioned, this program has seen reduced
participation of fuel vendors over the last couple of years due to the rising cost of
fuel and difficulty for vendors to get paid in a timely manner. Another challenge
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ICPA Addresses Energy Questions For the Connecticut General Assembly
for the state and federal government is adequately funding this program to
maintain benefits to low income recipients. Lack of sufficient funding and
dwindling vendor participation continue to be a challenge and until they can
be properly addressed gasoline assistance seems to be a distant reality.
6. Q: Do additives raise the price of gas and why are they in there – how
much would be saved if additives were taken out?
Additives that are mandated for specific states or regions are referred to as
“boutique fuels” because of their uniqueness. These additives are usually added
to comply with local or state environmental regulations. Boutique fuels more
often than not cost more than widely used gasoline blends and limit supply
options for the region that mandated their use. Connecticut’s use of ethanol
only blends allows Connecticut to access supply only from New York.
Massachusetts and Rhode Island do not store ethanol-blended gasoline thus
reducing Connecticut’s points of supply.
Prior to Connecticut’s switch to ethanol gasoline stations were able to access
supply from Springfield and Providence.
We have urged the Governor, and further urge this Legislature, to work with other
states in achieving a regional compact on a preferred, environmentally cleaner
fuel and have that one fuel used region-wide.
7. Q: What would be the impact of right of first refusal if passed?
The gasoline dealer’s organizations have advocated for the “Right of First
Refusal”. Giving gasoline lessee dealers the right of first refusal when a gasoline
station is sold would enhance the rights of franchise gasoline dealers at the
expense of the owners / sellers of gasoline stations and the potential buyers of
those stations.
The ICPA firmly believes that the right of property owners to sell their gasoline
stations to which they choose outweighs the desires of dealers who operate the
stations under a lease agreement to usurp that right. When individuals decide
what class of trade they want to operate their businesses under, they have many
choices. In this case a group of dealers choose, among many options, to
operate their gasoline stations under lessee contracts. This choice was likely
based upon the degree of risk and flexibility the individual wanted to undertake.
These contracts provide the dealers with a set of rules and conditions that guide
the operation of the gasoline stations and the relationships between the owners
of the property and the lessees. The contracts protect both parties from any
changes that may be conceived during the term of these contracts and
beyond.
In addition to the protections provided in the franchise contracts, the federal
Petroleum Marketing Practices Act (PMPA) and the Connecticut “Right of First
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ICPA Addresses Energy Questions For the Connecticut General Assembly
Refusal” law further insulates lessee dealer rights from being impinged upon.
Lessee dealers had a choice to buy property and build gasoline stations, but
they choose to enter into contracts with existing gasoline station owners instead.
Why should property owners’ rights be stripped away to enhance the rights of
lessee dealers, who made the decision to operate their businesses under a set of
rules that were established prior to entering into a contract?
If lessee dealers want to buy a group of gasoline stations that are for sale, they
have that right today. No law prohibits a lessee from biding on gasoline stations
that are for sale. Why should a law be passed that gives them rights over and
above other potential buyers? A competitive marketplace, with as many
potential buyers as possible, contributes to property owners investing in
communities to maximize the value of their assets. If passed, the right of first
refusal was given to lessee dealers it would diminish the market of potential
buyers by granting an advantage to the lessee dealer that other buyers would
not have.
Connecticut has gone through a recent issue with eminent domain, where
government decided that private property could be taken for an alleged higher
and better use than that of its present owner. This Legislature reeled from that
court decision.
ICPA believes that if the right of first refusal were given to lessee gasoline
dealers it would unduly interfere with the property owners’ right to sell their
gasoline stations and the ability of potential buyers to purchase those stations.
No one deserves, not should any preference be granted by law, to one party
over another.
8. Q: What is being done about gas stations raising prices based on
competition?
Gasoline retailers base the price of gasoline on several factors – wholesale price
of gasoline, state excise tax, gross receipts tax, federal excise tax, property
taxes, insurance, labor, transportation cost, utilities, credit card fees, competition,
dealer margin etcetera. While many of these costs are fixed, competition tends
to drive the final retail price that is set on the street. Today we see that areas of
the state with the highest concentration of gasoline stations (Berlin Turnpike,
Bristol, etc.) have some of the lowest gasoline prices.
Conversely, areas of the state with lower concentrations of gasoline stations
higher prices exist. While nothing is “being done” about gasoline stations raising
prices based on competition it is likely that nothing should be done considering
that competition tends to keep retail prices lower. One also can’t only look at
raising prices based on competition without looking at lowering prices based on
competition. If a station owner loses money Monday if a competitor went down,
and made money on Tuesday when the opposite were true, then the
combination of the two needs to be viewed – not just what happened Tuesday.
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ICPA Addresses Energy Questions For the Connecticut General Assembly
9. Q: Any alternative fuel sources available?
If you mean alternative sources of gasoline, yes. Europe became a major
exporter of gasoline immediately following Katrina and that additional supply will
help through the period when the Gulf state’s refining capacity is restored. Those
imports have already started driving the NYMEX down and taking some of the
heat out of the market.
As for alternatives to gasoline as an energy source for transportation, that is one
for others to address.
10. Q: Explain replacement cost?
Replacement cost is a method of purchasing gasoline based on the cost of the
next load that will be delivered to the gasoline dealer. Retail gasoline dealers are
notified by their wholesaler during that day that the price of gasoline is going up
for the next load of gasoline that they are receiving. In order for that gasoline
dealer to cover their costs and pay to fill up their tank they must raise the price of
gasoline to pay for the next load of gasoline.
11. Q: Why do prices go up faster than they go down?
Although the perception is that prices rise faster than they fall, the competitive
market place prevents retail prices from rising as fast as wholesale in many
cases. The recent spike in gasoline wholesale prices as reported from New
Haven harbor was increasing faster than the AAA retail gasoline price survey.
To restate, retailers WERE NOT passing on the full extent of wholesale price
increases as fast as they were receiving wholesale price increases.
The rise and fall in gasoline prices do not normally rise penny for penny or fall
penny for penny. Competition prevents gasoline retailers from keeping up with
quickly rising wholesaler prices and forces the retail price of gasoline to move
down as wholesale prices fall. Gasoline retailers lose customers to competition if
they are not responding to price changes of competition.
12. Q: What can we do to reduce the price and use of gasoline?]
The State of Connecticut can help reduce the use of gasoline by reducing the
speed limit. According to the Department of Energy gasoline mileage decreases
rapidly when motor vehicles travel above 60 miles per hour. EIA reports that for
each additional 5 mph over 60 mph increases the cost to the motorist by $0.15
per gallon of gas. If the state reduced the speed limit from 65 mph to 55 mph
that would save consumers $0.30 per gallon. That’s 30c per gallon on 1.6 billion
gallons – an enormous savings.
Another way that the state could reduce the cost of gasoline would be to
suspend taxes that apply to gasoline or change the petroleum gross receipts tax
from a percentage tax to a cents-per-gallon tax. The gross receipts tax impacts
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ICPA Addresses Energy Questions For the Connecticut General Assembly
the price of gasoline harder than that of the excise tax because, being a
percentage of the sale, as the price of gasoline rises the tax increases.
13. Q: How do we even out gasoline price spikes?
Price spikes are a function of extreme moves in the NYMEX that flow down to the
wholesale and retail level. The only way to control price spikes would be to have
government control of gasoline pricing similar to the Department of Public Utility
Controls regulation of the natural gas and electric markets. DPUC spreads
spikes in natural gas costs and electric costs over time rounding out spikes in the
market.
Consumers end up paying higher natural gas and electric costs overall,
but on a monthly basis. In other words, as the supply and demand of energy
changes so does its price and eventually that fact makes its way into what we
pay for energy.
Natural gas commodity prices and electric energy commodity prices have risen
and those price increases have found their way through Public Utility Commission
ratemaking proceedings and, as a result, into consumer prices. PUC’s aren’t
designed to look at a dollar of cost and make it fifty cents. PUC’s are designed
to determine if a dollar of cost is real and, if so, how that cost is passed on to
consumers.
To the extent we are paying more for energy as a result of a dramatic shock to
energy production, that is a reflection of a tremendous loss of this country’s
capacity to meet short-term demand. As we said in September, as that loss of
productive capacity is restored, prices will decline.
14. Q: Any increase in drive-offs and what effect does it have?
ICPA has received no reports of any increases in drive offs. Two years ago
Connecticut passed a law that assesses higher criminal penalties to motorists
that drive off without paying for gasoline helping convey the message that drive
offs are not tolerated.
Another reason that drive offs have been reduced is the increasing requirement
for motorists to prepay for gasoline before filling up. Owners of gasoline stations
have installed multiple product dispensers [MPDs] with credit card purchase at
the pump. These MPDs cost $20,000 each, and allow motorists to pay with
credit cards at the pump. While the MPDs are expensive and credit card fees
are imposed on the retailer, it serves to reduce theft. Use of these devices also
raises our cost of doing business as we employ technology to reduce theft.
15. Q: How much oil is in SPR?
Today, the SPR has the capacity to hold 727 million barrels. It is the largest
emergency oil stockpile in the world. Together, the facilities and crude oil
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ICPA Addresses Energy Questions For the Connecticut General Assembly
represent a more than $21 billion investment in energy security ($4 billion for
facilities and $17 billion for crude oil).
As an initial response to oil supply shortfalls at refineries affected by Hurricane
Katrina, the Secretary of Energy used his authority to release 12.6 million barrels
of oil from the Reserve under short-term exchange agreements that call for an
equivalent amount of oil to be returned at a later date. These agreements
provided an initial flow of oil to critical refineries in advance of President Bush's
order for a full-scale sale and drawdown of emergency oil:
• ExxonMobil has contracted for 6 million barrels, half sweet and half sour
from the Bayou Choctaw storage site. Oil began flowing on Saturday,
September 3;
• Valero has contracted for 1.5 million barrels of sweet crude oil. Its oil will
follow the initial flow to ExxonMobil;
• Placid Refining has contracted for 1.0 million barrels of sweet crude from
the Bayou Choctaw site. The oil will start flowing the week of September
4, at a rate of no more than 50,000 barrels per day;
• ATI (Total) has contracted for 600,000 barrels of oil from the West
Hackberry storage site (150,000 barrels of sweet crude and 450,000
barrels of sour crude). This oil began flowing on Friday, September 2;
• BP has contracted for 2 million barrels of Bayou Choctaw sweet crude;
• Marathon has contracted for 1 million barrels of sweet crude and
500,000
barrels of sour crude from the Bayou Choctaw site.
16. Q: How can we attack gas price at wholesale level?
Important first is to look at how wholesale prices are set. The New York
Mercantile Exchange [NYMEX] is the world’s largest clearinghouse for the
trading of energy commodities and is the center of energy price discovery in the
United States. That description is how the NYMEX describes itself. That means that
prices for natural gas, electricity, propane, crude oil, gasoline, heating oil and
such are first set through the daily trading of energy futures contracts at the
NYMEX.
Wholesale prices for virtually every energy source used in the United States key
off of NYMEX daily values. In addition to futures trading, even cash energy
markets for prompt delivery or availability of energy keys off of NYMEX values
expressed in either discounts off of or premiums to, “the screen,” which means
where the NYMEX prices for energy are at any given time. The NYMEX is the
largest open, transparent and most active marketplace for the buy and selling of
energy in the world.
See the answer to question #13 as well.
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ICPA Addresses Energy Questions For the Connecticut General Assembly
17. Q: How much would a gas tax reduction help?
Reducing the gasoline tax or the petroleum gross receipts tax would help reduce
the spike in prices that motorists have experienced over the pas couple of
weeks. Some of the dramatic swings that gasoline retail prices have
encountered may virtually eliminate any savings that consumers would see if
gasoline taxes were suspended or reduced.
Connecticut gasoline buyers pay a combined 49c per gallon in state and
federal excise taxes on every gallon they buy. 18.4c of this is federal excise tax,
the rest is state. Connecticut has the third highest per-gallon tax burden on
gasoline in the Northeast.
18. Q: Why was the price of gas rising to $3.00 per gallon before the
hurricane?
First, return to the answer in question 13.
In August of 2003 the price of a barrel of crude oil was roughly $35. By August of
2005 that had risen to over $65. Gasoline is made from crude oil, so as crude oil
increased in price so did gasoline.
19. Q: How can legislators influence suppliers to lower cost of gas?
During the oil crisis in the 1970’s legislators in Connecticut asked this same
question and at the time the answer that they came up with was to prohibit
refiners like Mobil, Shell and others from directly setting the retail price of
gasoline.
In 1979, Connecticut passed major divorcement in an attempt to limit refiners
from controlling the price of gasoline. Although Divorcement was successful in
prohibiting refiners from setting the retail price of gasoline it was unsuccessful in
influencing supplier to lower the cost of gasoline.
The only effective way in lowering the cost of gasoline is through encouraging a
vibrant competitive market with as many competitors as possible. Prior to 1979
refiners or majors, jobbers, and dealers competed – today jobbers and dealers
compete for the same market that existed prior to the divorcement law.
20. Q: Why do prices go up when there is no delivery for 7 days?
Gasoline stations receive deliveries based on the volume of gas they sell. High
volume stations can get a delivery every day while low volume stations get them
less frequently.
Deliveries are also made at different times of the day. While the perception is
that a gasoline station is not getting a delivery very often, the explanation could
be that the delivery was made at 3:00am when less people are around. When a
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ICPA Addresses Energy Questions For the Connecticut General Assembly
tanker of 6,000 gallons of gasoline pulls into a yard it’s safer to have less traffic
around.
Whether deliveries are being made daily, or less frequently if prices are rising,
the gasoline station owner still needs to adjust their price so that they can pay for
the next load that will cost them more. [see replacement cost] If the dealer does
not raise the price of gasoline and cannot afford to replace it then the public
would not have gasoline to purchase.
If the station owner charged $2.75 a gallon and had paid $2.50 for it, and was
informed that the next load was going to cost $2.80 – if the dealer didn’t raise
the retail price where would the dealer go to get the money to pay for the next
load?
21. Q: How do we calm the public when the industry can’t tell us how high
the price will be?
Some confuse the panic of topping off with logic. If we want to create a
shortage then the surest way to do that is to tell everyone to start buying as
much as they can as often as they can. That would put people in the position of
doing something they wouldn’t normally do, and force us to serve more people
with more gallons than we are prepared to do even under normal
circumstances.
Katrina was a short-term event. Prices spiked for ten days and then leveled off,
and have begun to come down. We advised people not to run out and do
things they would not normally do. What is broken will be fixed. What was shut
down will be restored. In over 100 years of serving the public we have, from time
to time, run into temporary supply or price issues and we’ve managed our way
through every single one of them. Be calm, we will get through this one too.
The industry can’t tell how high is high as the industry doesn’t set the price [see
the answer to question 13].
22. Q: The franchising law in Connecticut was last changed in 1979, what
would we have to do today to have a level playing field and encourage
open competition?
The Divorcement law that passed in 1979 did not accomplish increasing
competition; it reduced competition by prohibiting refiners from directly retailing
gasoline to the public.
Three classes of trade competed in Connecticut prior to Major Divorcement in
1979, majors/refiners, jobbers, and dealers. Today, only jobber and dealers
compete. Government allowing all competitors to compete, and ensuring that
larger competitors do not predatorily price their products with the intention of
driving the competition out of business, can achieve open competition.
In short, the answer to competitive issues is not, as the dealer’s organization
would have you do – reducing competition. The answer is to have as many
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ICPA Addresses Energy Questions For the Connecticut General Assembly
competitors as possible allowed to operate in this marketplace and allow
consumers to decide who wins and loses. The dealer’s organization wants a
guarantee of success, something that no one has or should have.
23. Q: What effect does speculation (futures and derivatives) have on price
of oil?
Not just oil. Broaden your review as ALL major energy sources are traded on the
NYMEX and ALL major energy sources are open to speculative pressures. ICPA
is the only organization in Connecticut that has asked Congress to look into the
role of speculation in the trading of energy commodities on the NYMEX. Here is
why we believe such a review is necessary.
Between the summer of 2004 and August 30, 2005 we have seen significant
increases in prices for energy commodities as reflected in trading at the New
York Mercantile Exchange [NYMEX]. The NYMEX is where prices are set, or to
use their term where price discovery is established, for all major energy
commodities used in the United States. See the following charts from the
NYMEX to illustrate just how significantly energy prices have accelerated during
the past year: [from August 30, 2005 briefing to Governor Rell]
Natural Gas / October 2005 Contract / $11.139 mmbtu / 56% +
56% increase in price since July of 2004. For a home in Connecticut that spent
$1,200 in 2004/05, this means an increase to $1,872, or an additional $672.00 at
these levels.
Crude Oil / October 2005 Contract / $68.05 / 52% +
52% increase in price since June of 2004.
Gasoline / October 2005 Contract / $2.10 / 59% +
59% increase since December of 2004. Based on an annual Connecticut
consumption of 1.6 billion gallons, and an increase in price of $0.86 per gallon,
this has cost Connecticut consumers $1.34 billion. With the increase in the gross
receipts tax passed in the last session of the General Assembly, this also means
an increase in gross receipts tax collections for the state.
Heating Oil / October 2005 Contract / $1.93 / 56% +
56% increase since August of 2004. For the average heating oil consumer of 700
gallons, what cost $763.00 in 2004 will cost $1,200 in 2005.
There is little question that some of this increase was grounded in fundamental
supply-and-demand issues.
Analysts on Wall Street attribute some of the increase in crude oil prices to what
appears to have been the rather sudden emergence of China as a world
competitor for crude oil, as well as India. In addition, political uncertainties in the
Middle East with Iraq exacerbated the worldwide crude oil supply picture.
How much of crude's big bounce is also because of speculation -- hedge funds
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ICPA Addresses Energy Questions For the Connecticut General Assembly
and other financial players pushing up the price in futures markets irrespective of
whether energy “fundamentals” would justify the price increases? That's tougher
to answer, but these traders are surely adding froth to an already superheated
market.
New players are helping to push up the volume of crude-oil
contracts traded on the New York Mercantile Exchange (NYMEX).
Such trades are on their way to an all-time record. Data from the
Commodity Futures Trading Commission show that the amount of
money flowing into commodity funds -- many of which include a
good chunk of oil investments -- has surged whenever the stock
market has swooned over the past five years. Today there are
more than 3,200 funds registered with the CFTC, almost twice the
number in 1999.
Most of the speculators, moreover, are betting that prices are
going even higher in the short term. So-called noncommercial
traders -- hedge funds and other financial players that don't use or
produce oil -- added 7,453 contracts of crude-oil futures and
options on the NYMEX as of Aug. 3. And their purchases of crude
outnumbered their sales by about 79,000 contracts, the largest
such position since the first week in June, according to Platts. This
recent buying helped propel crude oil prices. /Business Week,
8/30/04
Many people think that futures markets are just about speculating or
“gambling.” While it is true that futures markets can be used for
speculating, that is not the primary reason for their existence. Futures
markets are actually designed as vehicles for hedging and risk
management, that is, to help people avoid “gambling” when they don’t
want to. For example, a wheat farmer who plants a crop is, in effect,
betting that the price of wheat won’t drop so low that the farmer would
have been better off not planting at all. This bet is inherent to the farming
business, but the farmer may prefer not to make it. The farmer can hedge
this bet by selling a wheat futures contract. This document discusses how
futures markets work and how they are used for both hedging and
speculating. /CFTC
The issue we seek investigation of rapidly becomes clearer when you examine
the role between the management of energy risks on the commodities markets
with those trading houses whose clients hold paper in energy commodities, or
whose own financial interests may be tied to come extent with the daily
movement of commodity prices.
Although the trade in futures is defended on the grounds that it results in better
"price discovery" and provides a hedge to cover risk, there are fears that it is a
device for rampant speculation. Referred to as "paper barrels" each futures
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ICPA Addresses Energy Questions For the Connecticut General Assembly
contract represents a transaction in 1,000 barrels. In 2003, betting in "paper
barrel" contracts amounted to transactions involving over 100 billion barrels. In
contrast, the total supply in 2003 was about 2.9 billion barrels. The traders
transact a large volume of derivatives bets. Speculators purchase future
contracts on the IPE and NYMEX exchanges; each single contract is a bet on
1,000 barrels of oil. More than 100 million of these contracts were traded on
these exchanges in 2003, representing 100 billion barrels. A study conducted in
2000 showed that there was one underlying barrel of real oil that backed 570
"paper barrels" that were traded. Market sources have argued that in the oil
market, which is characterized by relatively inelastic demand, if speculators bet
long the piling volume of bets can actually result in even higher prices. In effect,
betting activity on its own can cause prices to spiral.
When Goldman Sachs issues a statement predicting the potential of $105 per
barrel crude within a year, to what extent does that act in and of itself contribute
to the realization of the estimate? Increasingly, it is our contention, these
markets focus less on energy fundamentals [supply, demand, refinery runs,
weather, physical inventories of refined products, transportation] and more on
the speculation of future events that may or may not happen.
The Role and Impact of Speculation
NYMEX wants to be the price discovery point for energy in the world. Having an
open, liquid, transparent marketplace for establishing energy prices works to
everyone’s advantage – as long as transparency is maintained and the markets
are free from undue influence.
Seats on the NYMEX floor are twice the value of the NYSE as a result of the
money that can be made in commodities currently. Unlike stocks that have a
50% margin requirement, commodities generally have a margin of 10%.
Remember with a 10% margin and investment can be leveraged 10 times.
NYMEX believes that the more volume in the market the better. Volume
increases liquidity. Volume in their opinion reduces volatility and not increases it.
Regardless of the volume of hedge fund volume, NYMEX says that margin is set
as a result of volatility. They told us that the margin requirements are the option
costs. Options are the markets calculation of volatility. When I asked about daily
volatility within the day of as much as 5-10 cents on 2 oil between the high and
the low, they agreed that is was a significant number and they would get back
to us on how that should be added in. They have not.
The daily volume of NY harbor delivery of heating oil paper contracts is
equivalent to 25% to 45% of the ANNUAL heating oil market for the entire United
States.
NYMEX margins are to protect the broker from investors who cannot pay the
broker back if the market moves to quickly. NYMEX does not care how high or
how low a price goes, just as long as it is done orderly. If you believe their analysis
and policy on margin, this is how we would calculate
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ICPA Addresses Energy Questions For the Connecticut General Assembly
the margin requirements:
These calculations are based on the December 2005 #2 oil contracts for
Wednesday March 16, 2005. (December is a good indicator as it is a high
volume month that is outside the near months)
Open High Low Settle
1.5196 1.5707 1.5276 1.5707
A. The value of the #2 oil contract that day closed at $65,969.40.
(1000 barrels {42,000 gallons}).
B. A call option and a put option that day "at the money" was
approximately $.13 for each or a total of $.26 per gallon.
C. The difference between the high and the low move for the day
was $.0431.
D. My margin calculation would be $.26 option costs, + $.04 daily
move = $.30 x 42,000 gal = $12,600. This is a 19% margin
amount.
E. On February 16, 2005, the heating oil margin for a customer for
the month in question was $3,375.00. or 5% margin.
F. The difference between the open and the close was $.0511 per
gallon.
This on a day where that had a 3% move in the day. With a 5% margin
(assuming all energy moved similarly) you could leverage that investment 20
times. If every thing moved similarly hypothetically, you could have made
$2,146.20 on the contact and if you had leverage that fully 20X = $42,924.00. for
a $3,375 investment. Not bad!
This is why no one with a lot of cash is in the stock market. They are in the
commodity market. A higher margin requirement would move some of the
speculation out of the market. NYMEX is not walking the walk on margin. We
know we have oversimplified margin. They have complex algorithms for what is
the appropriate amount of risk for margin. The volatility of our commodities is
just a risky to the long term of our business as new environmental regulations.
The CFTC is not monitoring margin, nor the daily speculation that occurs within
the day (They do for what is held overnight, but not what is opened within the
day and then closed out before the close). There are large amounts of
speculative data that is not shared with the public or the CFTC. The NYMEX
report "A Review of Recent Hedge Fund Participation in NYMEX Natural Gas and
Crude Oil Futures Markets", is a weak excuse for impacts of the hedge funds.
We need to demonstrate how and why.
Recommendation
Fed Chairman Alan Greenspan in his remarks to the National Petrochemical and
Refiners Association [NPRA] warned policy makers against interference in the
marketplace. We agree.
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ICPA Addresses Energy Questions For the Connecticut General Assembly
However, we find that, given the degree of extraordinary volatility seen in the
commodities markets during the past two years coupled with the emergence of
literally thousands of hedge funds pouring billions of dollars into these markets,
there is cause for concern that undue speculation is driving the markets more
than market fundamentals.
The least intrusive, and most responsible, initial action of the Congress would be
to ask its General Accounting Office to investigate the Commodities Futures
Trading Commission and its oversight of the commodities markets in two specific
areas:
• Determine whether the CFTC is providing adequate and appropriate
oversight of the trading of commodities on the New York Mercantile
Exchange; and
• To further determine whether the rules of the NYMEX are both being
followed and remain adequate given the volumes of trades routinely seen
there.
We received confirmation from Congressman John Larson that the Government
Accountability Office [GAO] has indeed agreed to initiate an investigation of
the CFTC, this after receiving more than 50 separate inquiries from Members of
Congress concerning the increases we have seen in energy prices.
24. Q: Is a windfall profit tax helpful to prevent gouging?
Over the last decade the Connecticut General Assembly’s General Law
Committee, the Attorney Generals Office, the Department of Consumer
Protection, and Governors Office has investigated gasoline prices.
None of these investigations have ever found any form of gouging. Competition
prevents any gasoline dealer from making excessive profits. Market conditions
that affect one gasoline retailer tend to affect them all at the same time. As
wholesale prices rise they rise for all retailers. If one retailer were to rise faster
and higher than their competition consumer would not purchase gasoline from
them forcing them to adjust their price to remain viable.
25. Q: What can consumers do to reduce use of gas?
Consumers can do the following to reduce their use of gasoline:
• Observe the speed limit – driving in excess of the speed limit increases
consumption
• Remove excess weight from your car – the heavy the car the more fuel
it takes to drive
• Avoid excessive idling
• Use mass transit
• Carpool
• Maintain your car – vehicles with clean air filters, properly inflated tires,
and get regularly scheduled maintenance will run at a higher efficiency.
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ICPA Addresses Energy Questions For the Connecticut General Assembly
26. Q: Can state help curb use of gas by large users (UPS fleets, etc.)?
Here is the issue. Consumers of extremely large quantities of commodities go
into markets and make arrangements frequently. When circumstances such as
those surrounding Katrina occur, these large consumers effectively bid up the
price of commodities, such as gasoline, because they have the position and
market influence to be able to essentially pay whatever is necessary to get what
they need, when they need it.
In an open market, the very frenzy of apportioning supply by its price during a
potential shortage can have the same affect seen during an auction. Literally, a
consumer bidding up the price to win supply and that drives the market upward.
27. Q: What is the effect of increasing global use of fuel (China, India, etc.)?
Analysts on Wall Street attribute some of the increase in crude oil prices to what
appears to have been the rather sudden emergence of China as a world
competitor for crude oil, as well as India. Recently China has itself denied that it
has a material effect on world markets and the Chinese Energy Ministry has said
that speculation has played a larger role in driving up energy prices than has
Chinese participation in the world market for energy.
28. Q: Should state upgrade state oversight of gasoline station to ensure
that gouging is not occurring?
Current oversight from the Department of Consumer Protection, the Attorney
Generals Office, and other state entities provide oversight of the
gasoline industry. The fact that the last several investigations yielded no
sanctions against any gasoline retailer for gouging speaks volumes for the work
that Connecticut state government does to ensure that consumers are
adequately protected.
However, if more agencies are assigned to watch what is an open, transparent
market we think that’s fine.
If you have any further questions or would like to meet with us feel free to
contact me at 860-613-2041 or gene@icpa.org.
Respectfully,
Gene Guilford
Executive Director
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ICPA Addresses Energy Questions For the Connecticut General Assembly