Market Speculation
and Energy Prices:
A Congressional Perspective
Presentation to UH-GEMI Energy Trading
Conference
January 25, 2007
Dan M. Berkovitz
Counsel
Permanent Subcommittee on Investigations
United States Senate
(Senator Carl Levin)
Outline of Presentation
• I. What is the Senate Permanent
Subcommittee on Investigations?
• II. PSI Report (2006) on Speculation and
Energy Prices
• III. Prospects for Legislation Affecting
Energy Trading
2
Senator Harry Truman’s investigation during WWII of war profiteering
led to the creation in 1948 of the Senate Permanent Subcommittee
on Investigations (PSI).
3
PSI Energy Price Investigations
• In the mid-1970s, PSI jurisdiction expanded to include energy
supplies and prices under chairmanship of Senator “Scoop”
Jackson.
– Investigated national security implications of Arab oil embargo
– Investigated structure of the oil industry and role of oil majors in pricing
• Recent investigations under Chairman and Ranking Minority
Member Carl Levin:
– Gasoline price report and hearings (2002).
– Report on oil prices and regulation of energy markets (2003).
-- Report on the role of speculation in rising energy prices (2006).
4
2006 Report: Findings on Speculation
1.
There has been a large increase in the amount of financial
speculation in energy markets.
2.
This increase in speculation contributed to increased prices.
3.
This increase in speculation shifted traditional price-inventory
relationships.
4.
Electronic markets involve the trading of standardized, cleared
contracts that are functionally equivalent to futures and perform a
price discovery function.
5.
The disparity in regulation of various energy markets (Designated
Contract Markets vs. Exempt Commercial Markets) impedes
market oversight and the ability to prevent price manipulation.
5
What is Speculation?
• A speculator “does not produce or use the commodity, but risks his
or her own capital trading futures in that commodity in hopes of
making a profit on prices changes.” --CFTC.
• Potential benefits of speculation:
– Increases liquidity.
– Commercial entities are able to transfer risk of price changes.
– Finances storage.
• Potential disadvantages:
– Excessive speculation can cause prices to deviate from the
fundamentals of supply and demand.
– Increased volatility increases costs of hedging and makes it
more difficult for commercial participants to determine when to
hedge.
6
CFTC Has Mission
to Prevent Excessive Speculation
• Section 4a(a) of the Commodity Exchange Act directs the CFTC to
establish limits on speculation:
“Excessive speculation in any commodity under contracts of sale of such
commodity for future delivery made on or subject to the rules of contract
markets or derivatives transaction execution facilities causing sudden or
unreasonable fluctuations or unwarranted changes in the price of such
commodity, is an undue and unnecessary burden on interstate commerce in
such commodity. For the purpose of diminishing, eliminating, or preventing
such burden, the Commission shall, from time to time, after due notice and
opportunity for hearing, by rule, regulation, or order, proclaim and fix such
limits on the amounts of trading which may be done or positions which may
be held by any person . . . .”
• CFTC imposes speculative limits on energy futures just prior to
contract expiry to ensure orderly trading near expiry.
7
Speculative Limits for Energy Contracts
Market
Net All Months
Combined
Net Single
Month (Other
Than Spot)
Spot Month
Crude Oil
None
None
3,000 for last 3 days
Reformulated
Unleaded Gasoline
None
None
250 for last 3 days
RBOB Unleaded
Gasoline
None
None
1,000 for last 3 days
Natural Gas, Henry
Hub
None
None
1,000 for last 3 days
Natural Gas, Basis
Swaps
None
None
500-2,500, depending
on contract
No. 2 Heating Oil
None
None
1,000 for last 3 days
Electricity
None
None
500-3,000, depending
on contract
8
Increase in Speculation
• Commodity Indexes
– Goldman Sachs estimates that approx. $110 billion now invested in GSCI
and other indexes, up from $70 billion in 2005 and $15 billion in 2003.
– Index investments are generally long investments.
– Marketed as portfolio diversification.
– Pension funds, large institutions, and hedge funds are major investors.
• Hedge Funds
– In 2006, NY Times reported an estimate of at least 450 hedge funds with
$60 billion in assets focused in energy and environment; including 200
devoted exclusively to energy.
– News reports of energy hedge fund collapses in 2006 indicate some
funds use highly speculative strategies.
– Absence of reporting requirements makes increased hedge fund
investment difficult to quantify.
9
Increase in Energy Trading:
Increase in Open Interest in Futures Contracts
Crude Oil and Natural Gas
Open Interest
1998 - 2006
Number of Contracts
(thousands)
2500
2000
Crude Oil
1500
1000
500
Natural Gas
0
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
10
Increase in Non-Commercial Trading in
Natural Gas Futures
Natural Gas Futures and Options
Commercial and NonCommercial Positions
1998 -2006
Number of contracts
(thousands)
1000
Non-Commercial Long
900
Non-Commercial Short
800
Non-Commercial Spread Positions
Commercial Long
700
Commercial Short
600
500
400
300
200
100
0
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
11
Increase in Non-Commercial Trading in
Crude Oil Futures
Crude Oil Futures and Options
Commercial and NonCommercial Positions
1998 - 2006
Number of contracts
(thousands)
1400
Non-Commercial Long
Commercial Long
1200
Non-Commercial Spread Positions
Non-Commercial Short
Commercial Short
1000
800
600
400
200
0
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
12
Increase in Crude Oil Prices
Crude Oil Prices
(Price of NYMEX Near-Month Contract)
$/barrel
90
July 14, 2006
$77.03
80
Katrina
70
60
50
Iraq war
begins
9-11-01
40
30
20
10
0
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
13
Crude Oil Prices Hit Record Highs
Despite High Inventories
U.S. Crude Oil Inventory (excluding SPR)
January 1998 - December 2006
crude oil inventory
(millions of barrels)
370
350
May 29, 1998
347 million barrels
$15
April 9 1999
345 million barrels
$16.45
May 12, 2006
347 million barrels
$72
330
310
290
270
250
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
14
Speculation: A Contributor to High Oil Prices
•
“With the demand from the investment community, oil prices have moved up
sooner than they would have otherwise.” –Former Federal Reserve
Chairman Alan Greenspan (2006)
•
“Senator, the facts are—and I’ve said this publicly for a long time—the oil
prices have been moving steadily up for the last two years. And I think I
have been very clear in saying that I don’t think that the fundamentals of
supply and demand—at least as we have traditionally looked at it, have
supported the price structure that’s there.” --Lee Raymond, Chairman and
CEO, ExxonMobil (2005).
•
“There has been no shortage and inventories of crude oil and products
continue to rise. The increase in price has not been driven by supply and
demand.” --Lord Browne, Chief Executive of BP (2006).
•
“In summary, increased purchases of long-dated crude lift the forward price
curve. The rise in prices is reflected back to contracts maturing in a few
months. . . . [T]he impact of increasing stocks has been overwhelmed by
the strong demand for forward crude, which has added as much as $24 per
barrel to prices.” --Philip Verleger, Petroleum Economist
15
Speculation Shifted the Relationship Between
Crude Prices and Inventory
Figure 6
Prices v Total US Stocks
January 1998 - May 2006
Price of U.S.
crude oil, $/barrel
80
70
60
50
1998 - 2003
2004
40
2005
30
2006
20
10
0
260
270
280
290
300
310
320
Total U.S. Crude Oil Inventory, Millions of Barrels
330
340
350
360
16
Speculation Helped Elevate
Crude Oil Forward Curves
Forward Price Curves
1999 - 2006
Difference in Price from First Month
Contract (dollars)
4
2006
2005
Contango
2006
2
2005
2001
2001
0
Backwardation
2004
2002
2004
2003
-2
2000
2002
1999
2003
-4
2000
1999
-6
2
3
4
5
6
7
8
9
10
11
12
Number of Months in the Future
For years 1999-2002, the dates reflect the forward curve as of
December 1. For other years, the dates reflect the forward
curve as of Dec. 2, 2003; Dec 6, 2005, and April 1, 2006.
17
Speculation Helped Elevate
Natural Gas Forward Curves
dollars per MMBTU
12
Natural Gas Futures Prices
Forward Curves
June, 2002-2006
10
2006
8
2005
6
2004
2003
4
2002
2
6/17/2002
6/16/2003
06/18/2004
06/15/2005
06/20/2006
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42
months forward
18
Increase in Speculation on ICE
(Intercontinental Exchange)
ICE Participants
OTC Participants Trading
(as % of total commissions)
Year ended December 31,
2003
2004
2005
Commercial companies (including
merchant energy)
64.1%
56.5%
48.8%
Banks and financial institutions
31.3%
22.4%
20.5%
Hedge funds, locals and proprietary
trading shops
4.6%
21.1%
30.7%
Source: ICE, Form 10-K (2006).
19
Disparity in Regulation Between NYMEX and ICE
Futures and Exempt Commercial Markets:
Differences in Oversight to Prevent Price Manipulation
Does the Measure Apply to the:
Futures Market
Exempt
Commercial
Market
· CFTC staff monitoring of daily trading reports
Yes
No
· Weekly reports and reviews for expiring contracts
Yes
No
· Option of special data call by CFTC
Yes
Yes
· Large trader reporting by clearing members
Yes
No
· Large trader reporting by exchanges
Yes
No
· Filing of information about trading accounts by
traders
Yes
No
· Exchange is responsible for monitoring compliance
with market rules
Yes
No
· Exchange can only list contracts for trading that
are not readily susceptible to manipulation
Yes
No
· Exchange must monitor trading to prevent
manipulation, price distortion, and disruption of
the delivery or cash-settlement process
Yes
No
· Position limits for speculators to reduce the
potential threat of manipulation or congestion
Yes
No
Emergency authority, in consultation with the
CFTC, to liquidate positions, suspend trading, or
impose special margin requirements
Yes
No
Daily submission of trading information to CFTC
Yes
Limited
· Daily publication of trading information
Yes
Limited
· Exchange must keep records of trading
Yes
Yes
Measure to Prevent Price Manipulation
CFTC Market Surveillance Program
Large Trader Reporting
Core Principles for Exchange Operations
·
·
20
PSI Report Recommendations
• Require Large Trader Reports for futures “look-alike” trades (e.g.,
ICE Henry Hub natural gas swaps) on electronic exchanges.
• Require Large-Trader Reports for U.S. energy commodities traded
from a domestic terminal on a foreign board of trade (e.g., WTI on
ICE Futures).
• CFTC should issue regulations to increase dissemination of daily
trading from the ICE electronic exchange.
– CEA §2(h)(4)(D) requires CFTC to issue regulations to provide for
public dissemination of trading data (e.g., volume, open interest, price
data) for electronic trading facilities that perform a price discovery
function in the cash market for the commodity.
• Close “Enron loophole”.
21
Subsequent Relevant Developments
•
CFTC-FSA agreement to share data.
–
•
The agreement is vague as to the
extent of sharing of real-time trading
data.
CFTC modification of COT reports.
–
–
–
COT reports provide key information
about speculative investments in
commodity futures but have not kept
pace with market changes.
New COT report provides Increased
detail on nature of non-commercial
hedging.
Changes apply only to COT reports for
agricultural commodities.
22
Senate Legislation
•
S. 2642 (109th Congress) (Sens. Feinstein,
Snowe, Levin, Cantwell):
–
–
•
Would require Large Trader Reports for futures-like
trades on electronic markets
Would require Large Trader Reports for trading
within the U.S. of U.S. energy commodities on
foreign exchanges
Anticipate re-introduction of the same or
similar bill.
23
Support for S. 2642
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Agricultural Retailers Association (ARA)
Air Transport Association (ATA) of America
American Public Gas Association (APGA)
American Public Power Association
Consumer Federation of America
Consumers Union
Industrial Energy Consumers of America
National Association of Wheat Growers
National Barley Growers Association
New England Fuel Institute (NEFI)
Pacific Northwest Oil Heat Council
Petroleum Marketers Association of America (PMAA)
Petroleum Transportation and Storage Association
30 State Petroleum Marketing Associations
24
House Legislation
• Previous Congress: House-passed CEA reauthorization
bill contained an amendment sponsored by Rep. Graves
– Requires CFTC to review “significant and highly unusual” price
changes in natural gas futures contracts to determine whether
manipulation has occurred.
– Enhanced recordkeeping and reporting for all natural gas
positions.
• Current Congress: H.R. 594 (Rep. Stupak + 18
cosponsors)
– Eliminates “Enron loophole.”
– Recordkeeping and reporting for large trades in all electronic and
OTC energy markets that perform a price discovery function.
25
References
• PSI Report on Speculation
http://hsgac.senate.gov/index.cfm?Fu
seaction=Subcommittees.Home&Sub
committeeID=11&Initials=PSI
(scroll down the page)
• Data sources:
NYMEX, CFTC, ICE, EIA.
• dan_berkovitz@hsgac.senate.gov
26