Well, such a report was released by the Senate. However, the president that signed the law in question was William Jefferson Clinton, and the company that strongly lobbied for its passage was Enron.
Yet, mysteriously, this study was almost completely ignored.
On June 26, Senators Norm Coleman (R-Minnesota) and Carl Levin (D-Michigan) released a comprehensive report detailing how speculation on various commodities exchanges around the world is impacting energy prices. Six weeks later, virtually no media coverage has been given to this bipartisan, 60-page study that should have been of great interest to Americans with gasoline over three dollars a gallon.
Even more curious than the lack of media attention to this report was its continued reference to Enron, a regular target of the press in the past five years. The Senate study strongly pointed an accusatory finger at “The Enron Loophole,” a part of the Commodity Futures Modernization Act of 2000, approved by Congress and signed into law by former President Clinton on December 21, 2000.
Modernization Sweeps The Nation
First, some background: in 1936, President Franklin Delano Roosevelt signed into law the Commodity Exchange Act, which was designed to create greater government oversight of commodities markets after the collapse of grain prices in 1933. This Act has been regularly amended by Congress as these markets have grown and evolved, and was set for reauthorization on September 30, 2000.
CFMA not only extended this 70-year old Act, but also detailed new regulatory authorities for the Commodity Futures Trading Commission, the government agency responsible for overseeing all futures trading in the United States. At the same time, various exemptions were either created or renewed that reduced CFTC’s jurisdiction over certain transactions. In particular, according to this Senate report:
The trading of energy commodities by large firms on OTC electronic exchanges was exempted from CFTC oversight by a provision inserted at the behest of Enron and other large energy traders into the Commodity Futures Modernization Act of 2000 in the waning hours of the 106th Congress.
One reason why most major media outlets might have ignored this report was the connection to President Clinton. After all, it makes it more difficult to blame today’s energy prices on President Bush if the public is aware that the loophole in question was enacted while he was still Governor of Texas. Imagine how much attention this report would have gotten if the company that had lobbied for this loophole was Halliburton, and the legislation had been signed into law by George W. Bush.
Regardless, the contention made in this Senate study was confirmed by a June 27, 2000, announcement by the House Committee on Agriculture that CFMA:
…allows bilateral transactions of certain exempt commodities, including energy derivatives, by eligible participants. With the exception of metal commodities, these futures may also be traded on an electronic trading facility.
The summary of CFMA from the Library of Congress also supported the Senate’s contentions:
(Sec. 103) Excludes from coverage under the Act a transaction in an excluded commodity: (1) entered into between eligible contract participants and not executed on a trading facility; or (2) executed on electronic trading facilities as long as the transaction is entered into on a principal-to-principal basis by eligible contract participants trading for themselves.
(Sec. 104) Excludes from coverage under the Act electronic trading of excluded and exempt commodities. States that a board of trade designated as a contract market or derivatives transaction execution facility may establish and operate an electronic trading facility.
One Step Forward, Two Steps Back
The key here is that CFMA allowed for the creation of electronic futures exchanges that would not be governed by the CFTC, and determined that energy futures and derivatives could be traded on such exchanges. In the view of this Senate report, this precipitated a tremendous expansion in the demand for energy related contracts – and the potential for manipulation by large investors around the world – that has likely increased the price of oil by as much as $25 per barrel.
This is important, because despite conventional wisdom, existing supply-demand ratios in oil and oil-related products in no way justify current prices. As the Senate report accurately stated:
While global demand for oil has been increasing – led by the rapid industrialization of China, growth in India, and a continued increase in appetite for refined petroleum products, particularly gasoline, in the United States – global oil supplies have increased by an even greater amount. As a result, global inventories have increased as well. Today, U.S. oil inventories are at an eight-year high, and OECD oil inventories are at a 20-year high.
The report also gave an accurate historical reference to current oil supply levels:
As a result, over the past two years crude oil inventories have been steadily growing, resulting in U.S. crude oil inventories that are now higher than at any time in the previous eight years. The last time crude oil inventories were this high, in May 1998 – at about 347 million barrels – the price of crude oil was about $15 per barrel. By contrast, the price of crude oil is now about $70 per barrel. The large influx of speculative investment into oil futures has led to a situation where we have high crude oil prices despite high levels of oil in inventory.
Similarly contrary to the recent hysteria surrounding this issue, supply is expected to grow faster than demand for the foreseeable future:
In its monthly report for March 2006, the International Energy Agency(IEA), stated, “Additions to OPEC and non-OPEC capacity are forecast to keep global supply trends broadly in line with global demand in 2007 and 2008.” The U.S. Department of Energy’s Energy Information Administration (EIA) recently forecast that in the next few years global surplus production capacity will continue to grow to between 3 and 5 million barrels per day by 2010, thereby “substantially thickening the surplus capacity cushion.”
Bad Medicine Worsens The Malady
Yet, despite this “thickening surplus capacity,” oil prices have still exploded, and increasing investor activity has certainly been a catalyst. However, speculation is not the only issue. It is the trading that occurs away from CFTC-regulated exchanges that is exacerbating the problem, for such facilities have no position limits on their contracts, or Large Trader Reports required of its participants.
Without getting overly complex, on every commodities exchange in America, futures and options contracts carry a finite limit as to how many an investor may hold. This is specifically designed to prevent anyone from cornering the market on a particular commodity, much as what the Hunt brothers did with silver in 1980.
Unfortunately, electronic exchanges do not have position limits on their contracts. This allows large investors and billion-dollar hedge funds to acquire a number of energy contracts significantly greater than what they could purchase on conventional exchanges, thereby creating an added demand on oil and oil-related products that, frankly, the system can’t handle.
Furthermore, these electronic exchanges require no Large Trader Reports from its participants. This means that there is no routine auditing of larger transactions that occur. The Senate report quoted CFTC Chairman Reuben Jeffrey specifically about this issue.
“The Commission’s Large Trader information system is one of the cornerstones of our surveillance program and enables detection of concentrated and coordinated positions that might be used by one or more traders to attempt manipulation.”
The absence of such reporting on electronic exchanges makes it easy for large speculators to carry positions significantly greater than what decades of commodities regulations in America have deemed appropriate for the best interest of consumers. Moreover, it allows investors to hide their true position in a particular commodity from regulators.
Bigger Isn’t Always Better
Adding insult to injury, this condition was further exacerbated in January of this year when the CFTC decided to allow the largest electronic energy exchange, the Intercontinental Exchange (ICE), to use its terminals to trade U.S. crude oil futures. Three months later, this was amended to also allow ICE trading of U.S. gasoline and heating oil contracts. As such, investors from all over the world can trade U.S. energy contracts without any oversight by an American regulatory body.
As the Senate indicated, this situation is rather dire:
As an increasing number of U.S. energy trades occurs on unregulated, OTC electronic exchanges or through foreign exchanges, the CFTC’s large trading reporting system becomes less and less accurate, the trading data becomes less and less useful, and its market oversight program becomes less comprehensive. The absence of large trader information from the electronic exchanges makes it more difficult for the CFTC to monitor speculative activity and to detect and prevent price manipulation. The absence of this information not only obscures the CFTC’s view of that portion of the energy commodity markets, but it also degrades the quality of information that is reported. A trader may take a position on an unregulated electronic exchange or on a foreign exchange that is either in addition to or opposite from the positions the trader has taken on the NYMEX, and thereby avoid and distort the large trader reporting system. Not only can the CFTC be misled by these trading practices, but these trading practices could render the CFTC weekly publication of energy market trading data, intended to be used by the public, as incomplete and misleading.
Taking advantage of this situation is BP Capital, a hedge fund managed by famed oilman T. Boone Pickens and estimated to be about $5 billion in size. Pickens is reported to be a huge participant on the ICE. Through the support of hedge funds like his, as well as major brokerage firms such as Goldman Sachs, about 30 percent of all U.S. crude oil futures now trade at the ICE.
This means that almost one third of U.S. crude oil futures are trading with absolutely no regulation by an American agency, and with absolutely no reports being audited by the CFTC to identify the potential for manipulation.
Contrarian Libertarianism
If that doesn’t scare even the most conservative of free market capitalists, the point needs to be made that trading restrictions on commodities have a different libertarian component than securities such as stocks and bonds. After all, commodities are things like corn, beef, pork, orange juice, lumber, and, yes, energy products. As these are items people have to purchase to support their very existence, regulations designed to prevent such markets from being cornered or manipulated are essential.
Now, I can certainly imagine the conservative reader wondering why any market needs to be regulated. However, given the typically finite amount of any commodity available at a certain point in time, without federal oversight and trading restrictions, it would be possible for an extremely wealthy investor or group to own such a large percentage of the visible supply as to be able to control virtually all of its sale. The term “cornering the market” has long existed to describe this phenomenon, one of the reasons regulations that would normally be eschewed by a free market capitalist have to exist in this market.
Taking this a step further, given the dollars involved in energy products today, the lack of adequate oversight could easily allow one of America’s enemies to acquire a large enough position in these unregulated futures as to effectively control the price of oil.
Sadly, to a certain extent, this is already happening. As the Senate report suggested, electronic transactions are artificially raising the price of oil futures contracts both here and abroad, thereby discouraging the immediate sale of oil being produced by oil companies.
The January 2007 crude oil contract on the New York Mercantile Exchange is trading for almost four dollars more than the September 2006 contract. As such, oil producers are encouraged to not sell their wares today, and, instead inventory their product for sale at a higher price in later months.
This condition is called a “contango,” and might explain why prices have been rising during the past couple of years, even as supply has grown quicker than demand. After all, if an oil company is exclusively selling product five and six months after it is drilled, it doesn’t in any way satisfy the public’s demand for that product today.
Past is Prologue
Unquestionably, billions, nay trillions of dollars are being sucked out of the American economy due to higher energy prices. Many retailers have reported lower operating results lately, which they attribute directly to slowing consumer demand as a result of rising gasoline costs. And, though still seemingly contained, inflation has been rising in the past twelve months, threatening the viability of the current economic expansion.
On top of this, there is already precedent for what unregulated energy trading can do to the public. As a result of such energy deregulation in California in the late ’90s, and the subsequent well-publicized manipulations by Enron and other energy traders, citizens of that state are paying exorbitant prices for electricity and home-heating that frankly would shock the rest of the nation.
A conceivably similar condition has been created in oil and gas futures in the past six years, and the table has been set for abuses that could dwarf what Enron and its accomplices did in the Golden State.
