Heating Oil Dealers vs. Wall Street: Battle Over Derivatives Reform Rages on as Deadlines Loom
Opaque swaps markets for energy commodity derivatives are targeted for reform. (image: nytimes.com)
As the Commodity Futures Trading Commission (CFTC) draws closer to announcing new regulations on commodity derivatives, the battle over the new rules is heating up, with end users of petroleum products like heating oil dealers calling for strict oversight and investment banks urging further investigation of derivatives markets and a delay in the process.
Heating oil dealers, gas station owners, airlines, and other end users have been calling for new regulations to address the extreme volatility in oil prices. Most of those end users cite the outsize influence of big-money speculative interests like investment banks and hedge funds as the main cause of inflated oil prices in recent years. Those speculators, however, beg to differ, saying that their activities are crucial to keeping commodities derivatives markets operating smoothly. That debate over commodities speculation and its effect on prices is heating up this week, as the deadlines for the announcement of new regulations as set by the Dodd-Frank financial reform bill draw near. According to a Bloomberg News article published on Wednesday, both sides of the debate are gearing up for a final battle as the mid-January deadline for the position limits (limits on how many futures contracts or other derivatives of energy commodities can be held by one party at one time) fast approaches. Delta Airlines’ general counsel Richard B. Hirst wrote a letter to the CFTC this week urging aggressive position limits, stating, “The speculative bubble in oil prices has concrete detrimental consequences for the real economy.” Hirst no doubt had the ballooning operating costs of commercial airlines tied to high oil prices in mind when he wrote that statement, but his argument extends to inflated heating oil and gasoline prices that have stretched the household budgets of millions of American households. Jim Collura of the New England Fuel Institute (NEFI), a coalition of heating oil dealers and other energy retailers, expressed frustration at claims that recent speculative activity has nothing to do with higher and less predictable oil prices in a statement prepared for his testimony before a House agriculture committee:
We see little merit to the argument that the CFTC has not sufficiently considered the imposition of such limits. We are discouraged that, despite ample evidence of excessive speculation in commodities markets that some continue to doubt, question and outright deny that speculation was and ever could be excessive.
Along with position limits, increased transparency in the multibillion-dollar swaps market (a secretive market for trading derivatives off of established exchanges like the New York Mercantile Exchange) is considered to be a key provision in forthcoming commodity derivatives regulation. An in-depth report on the market and how it functions published on Saturday by the New York Times revealed exchanges run by banks with no transparency or outside oversight whatsoever. Although heating oil dealers and other end-users may operate on swaps markets to manage financial risk, they never know how the price of the product they are buying or selling was arrived at, nor how much of that price is made up of transactional fees collected by the banks that run the exchanges. This extreme lack of transparency, while highly profitable for investment banks, drives up the cost of hedging for end users, which can lead to higher retail prices for fuel. CFTC Chairman Gary Gensler, as quoted by the Times, clearly understands this correlation and the need to address it through regulation:
The marketplace as it functions now “adds up to higher costs to all Americans,” said Gary Gensler, the chairman of the Commodity Futures Trading Commission, which regulates most derivatives. More oversight of the banks in this market is needed, he said.
In swaps markets, a central organization called a clearinghouse acts as an intermediary for all transactions by managing payment and ensuring sales go smoothly. However, the principal members of these clearinghouses are selected by banks—the same banks that reap huge profits by serving as middlemen in swaps transactions. Not surprisingly, clearinghouses and banks involved in swaps markets are resistant to attempts by the CFTC or other bodies to introduce greater transparency and increased competition into the markets, as they could hurt what has been a massively lucrative operation in recent years.
Although it is not clear whether the CFTC will or will not meet the mid-January deadline for unveiling new position limits and other reforms, it is certain that new regulation of commodity derivatives is on its way. While the battle between banks and heating oil dealers (and other end-users of petroleum products) will no doubt continue to intensify until the new regulations are finalized, the need for reform is clear, and that reform carries a legitimate hope for making heating oil and other commodities more affordable for consumers around the country.
See a graphic explanation of how swaps markets work at nytimes.com.
