CFTC Regulators Call for Better Oversight of High-Tech Trading
CFTC Commissioners Scott O'Maila (left) and Bart Chilton (right) agree that Infinium's "haywire" algorithm is proof that greater oversight of electronic trading methods is required on commodities markets. (images: cftc.gov)
In response to a report last week on a flawed trading algorithm that caused a spike in oil price volatility, two members of the Commodity Futures Trading Commission called for tighter regulation of computer-based trading. Reuters reported on Thursday that commissioners Scott O’Malia and Bart Chilton both characterized the flawed algorithm created by the Infinium trading company as an example of the dangers posed to market stability by increasingly computer-based trading practices. The commissioners went on to say that new regulations should focus on computer-based trading, as current regulations meant to govern in-person, open outcry trading of oil and other commodities are inadequate.
In recent years, commodities trading has been increasingly conducted electronically, and as trading software has become more sophisticated, traders are now able to execute hundreds of trades per second in a practice known as high-frequency trading (HFT). The computer algorithm created by Infinium Capital Management was used for HFT for only five seconds before its operators shut it down on February 3. But five seconds was enough time for the out-of-control algorithm to place thousands of buy orders that drove up the price of crude by $1 per gallon in less than four minutes. The following day, chaos generated by the faulty algorithm led to a sharp drop off in oil prices as wary traders sold off positions.
Neither Chilton nor O’Malia went so far as to condemn HFT outright, but both agreed that new regulations are required to keep up with rapidly evolving technical trading practices. The financial reform bill signed into law by President Obama on July 21 grants wider power to the CFTC in its regulation of commodities and derivative markets. The commissioners’ recent comments made it clear that specific regulations of HFT and other computer-based practices are at the top of the commissions to-do list. O’Malia told Reuters,
Whatever we do, the risks posed by high speed and algorithmic trading must be handled with great care because when things go wrong, five seconds can generate a lifetime’s worth of trading, not to mention a toxic trail.
New regulations will hopefully provide some protection from the wild volatility that has marked crude and heating oil prices in recent years by reigning in electronic trading’s influence over prices and limiting market participation by big-money speculators. A little bit of added oversight could go a long way toward making the prices that heating oil dealers and consumers pay for their fuel more predictable and less disruptive to their bottom lines.
Souvenir-Seeking Oil Trading Group Fined $12 Million for Illegal Trade
A commodities trading group seeking the shiny first-ever $100-per-barrel crude oil contract disrupted the market in 2008 and is now paying for it. (image: proactiveinvestors.com.au)
First prints can be valuable collectors items. First editions of classic books can fetch several thousand dollars, and first prints of certain works of art can be worth much more. Apparently, first prints of oil futures contracts can also be attractive collectors items. The Wall Street Journal reported on Tuesday on a $15 million fine levied against an oil trading group for illegal trades it made in pursuit of the very first $100-per-barrel crude oil future contract in 2008.
The CFTC filed and immediately settled charges against ConAgra Trade Group, the former commodities trading division of mega corporation ConAgra Foods for causing a “non-bona fide price” on the New York Mercantile Exchange oil market on January 2, 2008. According to the CFTC, the NYMEX floor trader for ConAgra had been directed by his superiors to buy the first $100 oil contract for a full three months before the transaction took place. On January 2, the price of crude was rising toward the $100 level, with the electronic price at $99.60 and trading floor prices around $99.90. To ensure winning the golden ticket that was the first $100 contract, the ConAgra trader proceeded to buy up all of the available contracts at $99.90 a barrel, which prompted an offer from a seller at $100 a barrel. The sudden snapping-up of contracts at $99.90 disrupted the oil market, causing widespread confusion over the “true” price of crude and leading another NYMEX floor broker to file a complaint that he was offering the contract at a lower price.
The disarray the action set off on the oil markets was apparently of little concern to ConAgra, which was obviously focused on the prize of a freshly-minted $100 oil contract. According to the CFTC, a ConAgra trader boasted in an email, “some people collect art prints, we collect price prints.” The ConAgra Trade Group no longer exists, as it was sold off to hedge fund Ospraie Management for $2.8 billion in June of 2008, and now operates as the Gavilon Group.
While the incident’s effect on oil prices was short-lived and had little to do with the price of crude reaching its all-time peak of $147 six months later, it offers a glimpse into the reckless mentality of certain commodities investors. ConAgra Trade Group was so fixated on gaining a shimmering business souvenir, that its management and traders did not care how their efforts to secure the contract would affect other hedgers and investors in crude. In theory, ConAgra’s off-the-cuff crusade may have caused an end-user of crude oil to pay hundreds of thousands or even millions of dollars more for oil that it purchased on the day in question.
Certainly, the fine levied against the trading group for its selfish and irresponsible actions is a sign that the CFTC is taking on a more active role in enforcing trading regulations and clamping down on self-serving actions in the commodities markets that result in artificially high prices or other disruptions to the free market. But if one company was willing to cause temporary chaos on the oil market just to get its hands on a collectors’ item, chances are that a $15 million fine (chump change by Wall Street standards) won’t do much to deter a like-minded company from taking similar action in the future.
Like Oil Speculators, Cocoa Speculator Could Drive Up Product Prices
A company in London bought 240,000 tons of cocoa, which could give it control over the price of cocoa in the retail market. (image: thechocolatelife.com)
Crude oil and heating oil aren’t the only commodities traded on futures exchanges. There’s also cocoa. And just like in the oil market, people are worried that financial interests are leading to artificially high prices.
As NPR’s Planet Money blog reported on Monday, “Somebody bought almost all of the cocoa registered in European warehouses last week.” A company called Armajaro bought contracts for 240,000 tons of cocoa on the London market, worth about $1 billion. That’s about 7 percent of the total global supply of cocoa, which could give the buyer enough influence to raise the price of cocoa around the world, which would hit consumers any time they bought chocolate.
In the US, groups that want to curb speculation on energy commodities have called for position limits—caps on how many contracts any one trader can have. Now some in the cocoa business are asking for the same thing, says the Wall Street Journal:
Trade groups have criticized the exchange because it hasn’t implemented limits on the number of contracts a single trader can hold, which in the U.S. is regarded as a key check on participants’ ability to manipulate prices.
Whether it’s heating oil or candy bars, prices climb when large financial institutions buy up as much of the commodity as they can.
Congress Passes Financial Reform, Expands Regulation of Commodity Markets
Senate and House leaders gathered at the signing of sweeping financial reform, which could have a large impact on the heating oil futures market and heating oil prices. The bill still needs to be signed by the president to officially become law. (image: pbs.org)
The US Senate passed the financial reform bill on Thursday, sending the sweeping legislation to the president’s desk where it awaits Barack Obama’s signature. The bill includes a wide range of measures, but one of its centerpieces is the increased transparency and scrutiny of derivatives, including heating oil futures contracts.
The legislation on derivatives originated in the Senate Agriculture Committee, which oversees commodity futures trading. Derivatives are a category of financial instruments whose value is based on (that is, derived from) an underlying asset, such as futures contracts for commodities like heating oil. Derivatives also include vastly complex financial instruments that many believe sparked the financial crisis, such as credit-default swaps, and the new bill aims to bring more transparency to derivatives markets and curb the influence of speculative traders.
Sen. Blanche Lincoln (D-AK), chair of the Senate Agriculture Committee, introduced a bill that would limit and regulate speculative trading in commodity futures, a proposal that quickly won the support of end users such as heating oil dealers and airlines. These end users buy futures contracts to hedge their risks against changes in the price of fuel, and are hurt by the excessive price volatility caused by speculation. The Agriculture Committee approved Lincoln’s bill, which was then combined with legislation from the Senate Banking Committee to form a comprehensive financial reform bill.
The Senate’s version of the financial reform bill, passed in May before it was combined with the House bill and sent back to both chambers, incorporated a regulation that the Commodity Futures Trading Commission proposed in January: position limits. The CFTC had been considering enacting position limits on energy futures, which would restrict the number of contracts an investor could hold at a given time, on its own but preferred that Congress make clear the CFTC’s authority to enforce position limits by inscribing it in federal law. Members of CFTC commissioner Bart Chilton’s staff worked with Sen. Lincoln to make sure of just that.
While we know that the financial regulation bill will increase the transparency of derivatives trading, curb speculative investment, and increase the power of regulators over commodity trading, many of the details of exactly how the new rules will be implemented will be left up to a variety of regulatory agencies. Critics contend that too much power is being placed in the hands of regulatory agencies, some of which are the same agencies that failed to prevent the financial crisis of 2008.
Despite the lack of details, some who have been affected by volatile and record-high oil prices are happy to see regulators given the tools to police derivatives markets. Jim Collura, vice president for the New England Fuel Institute and spokesman for the Commodity Markets Oversight Coalition, wrote in the Huffington Post that today’s oil markets were like the Wild West and that financial reform would help the end users (“hedgers”) who buy and sell derivatives:
If the “Wild West” was tamed by law and order, then the derivatives markets will be tamed by increased transparency, stability and confidence that legislative reform will bring. An important and reliable tool that hedgers have relied on for years will be returned to them and for this reason, end-users will benefit—not be burdened by—long overdue and comprehensive reform.
Hopefully Collura and other supporters of financial reform are correct and this legislation will bring stable and lower prices to commodity markets. Stay tuned to HeatingOil.com for more updates on how financial reform unfolds and how it will affect home heating oil prices.
Plan to Update EIA’s Oil Inventory Reporting System Stalls
The EIA’s plans to fix major deficiencies in its data collecting and reporting systems have been held up, but the agency continues to release inventory reports every week. (image: eia.doe.gov)
The system for reporting supplies of crude oil, heating oil and other petroleum products in the US is far from perfect. Each week, two organizations—the industry group American Petroleum Institute (API) and the Department of Energy’s Energy Information Administration (EIA)—release reports on stockpiles of crude oil, gasoline, and distillates (a category that includes heating oil and road diesel). The numbers in those reports, released 16 hours apart, are almost always wildly different. Last week, both organizations agreed that crude oil supplies dropped, but showed a 2.3-million-barrel discrepancy in their estimations of how much those supplies declined. Despite 2-million-barrel (and higher) margins of error, both the API and EIA reports are relied on heavily by oil traders and can bring about huge swings in oil prices. Clearly, the US oil industry is in urgent need of more reliable and accurate petroleum supply reporting.
With that need in mind, the EIA set out to improve its out-of-date and deeply flawed data collection processes in March, but has run into problems that has kept those updates from happening, the Wall Street Journal reported on Tuesday. Last September, an independent consulting firm found “critical” errors in the EIA’s systems for collecting and reporting inventory data. By March, the EIA had laid out a plan to fix many of those errors quickly and easily by “asking oil companies to report inventories at each facility, rather than aggregate them by region.” Unfortunately that solution only led to a new problem: more data broken into smaller parts that had to be entered into the EIA computer system by hand. Changes to address the new problem would require a major overhaul of the EIA’s data system, a process that would take years and need several million dollars to fund, said Stephen Harvey, director of the EIA’s office of oil and gas.
While the time and money required for the major overhaul will come eventually, it won’t be any time soon, as a request for funds to fix the system was denied in 2009. The agency is slated to receive an additional $18 million next year, but most of those funds are earmarked for other projects, Harvey said.
Last August, the Federal Trade Commission, in an effort to reduce instances of market manipulation, took steps to tighten regulation of oil companies that reported their own inventory data to the EIA. Today, the EIA is ready to reform its own methods in pursuit of fairer, more transparent, and more accurate petroleum supply data but is hindered by a lack of two crucial ingredients: funding and political support.
Until the EIA gets what it needs to make the changes, swings in crude and heating oil prices based on inaccurate inventory data will continue to affect heating oil users and all other consumers of petroleum products.
Maine Congresswoman Calls for End to Crude Oil Speculation
Maine Congresswoman Chellie Pingree has boldly and somewhat overzealously called for an outright ban on oil speculation. (image: mpacampaignmaine.org)
US Representative Chellie Pingree, Democrat from Maine’s 1st District, is calling for an end to all speculative investment in crude oil, Maine Public Broadcasting Network (MPBN) reported on Wednesday. Pingree says that an outright ban on oil speculation should be included in the current financial reform package under consideration in Congress.
While Pingree’s cause is a noble one, its radical nature almost certainly precludes it from ever being adopted or even considered by the House or Senate. The financial reform package includes language on derivatives trading written by Senator Blanche Lincoln of Arkansas that would limit how many crude oil and energy contracts one speculative investor could hold at once. Those curbs on derivatives trading have become a major point of contention in debate over the financial reform package, and may or may not make it into a final bill. The fact that the very provisions that include limits on oil speculation are the most controversial part of financial reform further prove that the Pingree proposal to ban oil speculation outright is clearly a non-starter. So while Pigree’s idea would be great news for heating oil dealers, it is appears to be more of a political move to win support of Maine’s many heating oil users than a serious proposal.
The MBPN report also stated that, “Experts say speculation can add up to as much as $1 a gallon and makes prices unstable.” While the citation of exactly which “experts” made such a claim is conspicuously absent, the estimated $1 speculation premium on heating oil prices falls loosely in line with the results of a Reuters survey of oil experts that showed speculation costs US consumers (users of heating oil, gasoline, and other petroleum products) $300 billion a year.
Yes, it seems likely that oil speculation is a cause of higher and more volatile heating oil prices. Heating oil users should support limits on speculation—they are already widely supported by heating oil industry groups around the Northeast. But heating oil dealers and consumers alike are better off encouraging their Senators and Representatives to support the derivatives oversight provisions in the existing financial reform package than clamoring for an outright ban on speculation that will never happen.
Position Limits Proponent Chilton Advocates from Inside of CFTC
CFTC Commissioner Bart Chilton is a consistent voice of support for imposing position limits as mechanisms to reign in volatile energy prices. (image: Commodity Futures Trading Commission via flickr.com)
The Wall Street Journal published a profile of Bart Chilton on Saturday, reporting on his tenacious efforts as a member of the Commodity Futures Trading Commission to enact position limits on energy futures. Chilton (like many others) believes that such position limits will curb speculators’ influence over energy markets and moderate the prices of heating oil, gasoline, and other heavily traded energy commodities. In Chilton’s view, hedge funds and other big-money energy speculators with no interest in buying or selling physical oil—Chilton calls these market players “massive passives”—have enjoyed outsized influence over oil prices for at least the last two years.
The debate over what (if any) part activity by massive passives and other speculators played in sending oil prices to record highs two years ago, and in the more modest price increases of the last few months, rages on. In April, a Reuters survey of energy experts found that a majority of respondents believed speculation has caused otherwise unjustifiably high oil prices in recent years. Last month, executive heads of commodities exchanges around the world told Reuters that speculation has nothing to do with oil price increases and expressed doubt that position limits would be effective in moderating prices.
Chilton, who was appointed to the CFTC by President Bush in 2007, has made his position on commodities speculation abundantly clear in public and private: massive passives have too much influence over prices, and position limits are needed curb that influence. It is nearly impossible to determine exactly what caused oil prices to spike in July of 2008, and Chilton’s understanding of that fact is reflected in his statements on the subject. He told the Journal,
I’ve seen nobody who can justify $147 [a barrel for crude oil]. It doesn’t mean the massive passives are the sole culprit. I think they’re having an impact. As regulators, it’s our job to be asking these questions.
Chilton believes that the sheer size of major speculators on the commodities markets is what gives them the power to influence prices. Massive hedge funds, for example, have access to billions of dollars if investment capital. When they use a portion of those billions to buy up huge quantities of energy futures contracts, their action can generate false demand for products like heating oil and drive up prices.
It concerns him when a “massive passive” might come to own 20% of one market. A 20% stake “gets to be where you might not be able to control prices, but you have the possibility of moving them.”
When those speculators drive up prices, they increase their profits at the expense of average Americans who buy heating oil and gasoline as fuels for transportation and heating, not as paper investments. Opponents of position limits take issue with this view and claim that such regulations would be overly restrictive to the market and could result in higher prices for products like heating oil. Economist and high-profile investor Philip Verleger credited speculators with creating a supply cushion that prevented major heating oil price spikes during the extreme cold spells of last winter. Verleger argued, “position limits could consign us back to a world where, when it gets cold, people have to use more natural gas and electricity and they’ll see prices double simultaneously.”
Whichever side ultimately claims victory in the debate over position limits, Chilton’s side has made incremental progress toward his goal in recent months. Members of Chilton’s staff worked closely with Senator Blanche Lincoln’s office to help craft new limits on derivatives trading that include position limits on energy commodities. Those proposed limits made it into a broader financial reform bill that was passed by the Senate on May 20. The bill will have to be reconciled with a House financial reform bill before it can be voted on—a process that could take months.
Until that vote, believers in stricter oversight of financial markets and advocates of using position limits to reign in volatility in crude and heating oil prices will have a tireless advocate in CFTC Commissioner Bart Chilton.
Commodities Exchange Executives Reiterate Claim That Speculators Don’t Affect Oil Prices
Julie Winkler of CME Group, which owns the New York Mercantile Exchange, is one of several exchange executives opposed to tougher limits on commodities speculation. (image: cns.jrn.msu.edu)
Executives from world commodities exchanges fired the latest salvo in the debate over speculation’s effect on oil prices, telling Reuters Global Energy Summit that speculators are being unfairly blamed for higher and more volatile oil prices. The heads of several different commodities exchanges forcefully expressed their shared view that speculation has not caused extreme volatility in oil prices, and that efforts by the US and other governments to curb commodities speculation are misguided. One executive went so far as to say that governments fail to understand how commodities exchanges work, and should therefore not burden them with new regulations:
“Effective regulation is great but any time a politician gets involved, frankly they will screw it up,” Thomas Leaver, Chief Executive of the Dubai Mercantile Exchange, said. “They are throwing more regulation at markets rather than making more effective the regulation that have already got,” he said. “I just don’t think governments have got a clue. Speculators are the great scapegoat. They are easy to identify: the guy with the black hat in the corner.”
Leaver and other executives also cited the lack of empirical evidence that speculation caused the 2008 crude oil price spike as reason to hold off on increased regulation. The Reuters article did not include any explanations from the quoted executives of what did cause the oil price spike.
Most notably, the US Commodity Futures Trading Commission has considered imposing position limits on the speculative traders in the New York Mercantile Exchange and other exchanges, which would limit the number of contracts one speculator could hold at a time. Those position limits have been folded into the financial reform bill now under consideration in the US Senate. David Peniket, president and chief operating officer of ICE Futures Europe told Reuters that position limits would not be effective in reducing oil price volatility: “If they (position limits) are being used as a tool to reduce volatility or price levels, then we fear those who are using them will be disappointed.”
While the exchange executives’ pro-speculation and anti-regulation statements are consistent with those made in recent months by traders, hedge funds, and investment banks, they contradict the results of a Reuters survey on the issue released last month. The survey of various high-up officials involved in the trading of energy commodities found that nearly 75 percent of respondents believed speculation had inflated oil prices in recent months and years. Respondents in that group believed that speculation had lifted the price of crude oil 10 to 30 dollars above its nominal, supply-and-demand-determined price, costing consumers of products like heating oil and gasoline $300 billion per year.
Until position limits on energy commodities are imposed, the debate will rage on over the influence of speculation on oil prices. Investment banks, hedge funds, and commodities exchanges will continue to defend speculation against new regulation, as they have a strong financial interest in trading energy commodities as they please. Airlines, heating oil dealers, and other parties who deal in physical commodities like crude and heating oil will continue to call for move oversight to curb speculation, as they become increasingly desperate for steadier and more affordable prices for energy products.
For heating oil dealers and consumers, any action that succeeds in bringing lower and less volatile oil prices will likely win their firm support.
Position Limits on Heating Oil Contracts Included in Approved Senate Reform Bill
Senators Chris Dodd (D-CT) and Blanche Lincoln (D-AK) were early backers of derivatives regulation that was included in the bill that passed the Senate on Thursday (images: tsfiles.wordpress.com and Alex Wong/Getty Images via politidsdaily.com)
The best hope for position limits aimed at curbing speculators’ influence over the prices of heating oil and other energy commodities was approved by the Senate on Thursday as part of a financial overhaul bill. After months of public comment and internal debate, the Commodity Futures Trading Commission’s (CFTC) January proposal to limit how many energy futures contracts speculators can hold at a given time has been rolled into a sweeping financial reform bill, Bloomberg BusinessWeek reported on Friday.
The passage of the reform bill by the Senate provides some explanation as to why the CFTC has delayed any action on position limits (the public comment period on the proposal ended in late April). The CFTC would prefer that position limits be enacted by Congress in the form of federal law rather than declare their own regulations, which would leave them open to future legal challenges. Greenhouse gas emissions regulation is in a similar state of limbo: the EPA has affirmed its authority to enforce limits on emissions, but is holding off on doing so to give Congress a chance to legislate such limits with a broad energy/environment bill.
With strong public support for a major overhaul of the US financial system and approval of reform legislation from both houses of Congress (the House passed its own version of financial reform last year), enactment of position limits on energy futures appears to be within reach. Former CFTC director Michael Greenberger explained to BusinessWeek:
The chances that position limits will pass now are stronger than they were in January. If [CFTC commissioners] are waiting for a signal from Congress as to what the scope of their power will be long term, this is a pretty powerful signal.
Despite this recent step forward, the effectiveness and appropriateness of position limits and other regulations covering commodities-based derivatives is still the subject of much debate. A prevailing argument against the limits is that regulation of US commodities markets will only drive traders to trade on other international markets that are not governed by such regulations. CFTC chairman Gary Gensler has evidently had that criticism on his mind as he has traveled to London and Brussels, the locations of major international commodities markets, and advocated for harmonization of derivatives oversight. Gensler no doubt found a receptive audience in Europe, after “[t]he European Commission said in October that it would introduce in 2010 ‘ambitious legislation to regulate derivatives,’ including giving regulators the ability to set position limits.”
If the European Commission and US Congress do adopt derivatives regulation, coordinated oversight of the massive and opaque “over-the-counter” markets could begin. Greater oversight of the trading of commodities-based derivatives that includes enforcement of speculative position limits would bring more order and clarity to the trading of energy futures and, proponents claim, result in less volatility in the prices of heating oil, gasoline, and other exchange-traded products.
Even though both houses of Congress have passed their own version of financial reform, final passage of a reform package is anything but assured. The bills will have to be combined before coming to final votes in the House and the Senate. Wall Street lobbyists and other financial interests are working overtime to make sure their interests are represented in the reform package, essentially guaranteeing a contentious battle over the specifics of the legislation.
Despite the political uncertainty attached to the regulation of energy commodities like heating oil, the Senate’s passage of the bill last week was a crucial step toward new regulations intended to provide retailers and consumers with lower and more predictable heating oil prices. If those regulations survive the bitter debates in congressional committees and on the House and Senate floors, dealers and consumers could reasonably hope for more predictable heating oil prices as the next heating season begins.
New Documents Highlight Rift Within CFTC on Position Limits
Newly uncovered documents reveal divisions within the CFTC. (image: wikimedia.org)
Ever since the Commodity Futures Trading Commission (CFTC) first floated the idea of imposing position limits on energy commodities in order to curb price spikes caused by speculation, critics have insisted that there was no clear link between speculative investment and the price swings of 2008, when crude oil soared to $147 a barrel only to collapse and hit $33 a barrel. Now the Wall Street Journal reports that the CFTC faces critics among its own staff.
Through a Freedom of Information Act request, the Journal has obtained internal documents demonstrating that a number of CFTC staff members disagree with the CFTC Chairman Gary Gensler’s claim that speculation caused volatility in commodity markets.
In one instance, two CFTC economists wrote a memo in August 2009 saying that there was “little evidence” that removing position limits in 2000 had led to volatility in energy or agricultural commodities. That same month, the CFTC’s deputy chief economist, James Moser, wrote an email that said, “we have no statistical evidence of a problem.” The final document acquired by the Journal was the draft of an interagency report, led by staff at the CFTC, on the role of commodity index funds, which remove any risk that investors would have to actually take physical delivery of oil. Gensler has specifically attacked commodity index funds for their contribution to a speculative bubble in energy prices. The interagency report came to the starkly opposite conclusion:
There is not enough evidence to support the argument that the commodity index funds cause price spikes in commodities.
The Futures Industry Association (FIA), a group of commodity traders that has already spoken out against position limits, cheered the release of the report. However, end users of energy products, such as airlines and heating oil dealers that were hurt by skyrocketing oil prices, overwhelmingly support position limits and have called on the CFTC to enact even stricter regulations than are currently under consideration.
This is not the first indication of a difference of opinion within the CFTC—as the Journal notes, three of the five commissioners have already expressed reservations about position limits—and it remains unclear whether or not the proposal to establish position limits is going to be carried out. Commissioner Bart Chilton, an advocate of position limits, was unconvinced by the conclusions of the interagency report: “I think it was political and the spin on it was political.”
Between Chilton’s easy dismissal of the report and the CFTC’s recent aggressiveness in clamping down on illegal trades, there is some indication that the CFTC is serious about taking a more forceful role in overseeing commodity markets.
The true test of position limits and other potential CFTC regulations on the trading of energy commodities will only come if and when such regulations are implemented. If steadier and/or lower crude and heating oil prices come about weeks or months after implementation, there’s a good chance that critics will silence themselves.
CFTC Fines Noble Americas for Illegal Sale of Heating Oil Contracts
Noble Americas Corp., a subsidiary of Hong Kong-based Noble Group Ltd, has been fined by the CFTC for deceptive trading of heating oil and gasoline contracts. (image: thisisnoble.com)
The Commodity Futures Trading Commission (CFTC) has fined the financial firm Noble Americas Corp. $130,000 for a “wash sale” of heating oil and gasoline contracts in 2007, Reuters reported on Monday.
A wash sale is a practice that securities traders employ to reduce tax liability that involves selling assets at a loss (thereby avoiding tax payments on the transaction) and re-buying identical or very similar assets later. Essentially, a trading firm buys contracts from itself at a loss with the expectation that the contracts will recover their initial value and can be re-sold in the future at a profit. The practice is illegal under US tax code, specifically the “30-day wash rule,” which forbids the purchasing of assets that are identical to assets sold by the same trader within the past 30 days.
In a statement explaining the regulatory action quoted by Reuters, the CFTC said,
“[Noble Americas Corp.] intended to negate market risk and price competition, and thereby avoid a bona fide market transaction.” As a result, non-bona fide prices were reported, violating the Commodity Exchange Act and CFTC regulations, the agency said.
The fine marks the continuation of a recent trend of the CFTC taking a more aggressive approach to regulation. Last week, the commission fined investment banks Morgan Stanley and Moore Capital $14 million and $25 million (respectively) for not reporting futures trades made last year. The agency’s new stance seems to be sending a message to financial players who deal in commodities: we’re watching, and willing to use our full power to enforce the rules. Despite a more diligent posture in its enforcement practices, the CFTC has still not announced a final decision on imposing position limits on energy commodities that many believe will reduce the volatility of crude and heating oil prices.
The wash trade perpetrated by Noble Americas in an example of speculative activity on commodities that is often blamed for inflating prices: by performing a fictitious trade, the company not only “negate[d] market risk and price competition,” but also increased market activity around heating oil contracts, making them more attractive to other investors. In doing so, the company contributed encouraging more speculation in heating oil that can drive prices higher despite flat or declining demand for the physical product.
While the CFTC’s willingness to stand up to financial giants like the China-based Noble is heartening to end users of heating oil like dealers around the Northeast, it’s worth considering that a $130,000 fine levied against a company that reaped $577 million in profits last year is unlikely to be an effective deterrent against similar market manipulation in the future.
The more comprehensive policy of position limits would be much more effective at changing the behavior of huge energy speculators like Noble and tamping down price volatility. Heating oil dealers and consumers alike will continue to wait anxiously for that announcement of such a policy, and hope for its implementation before the next heating season.
Financial Regulation Bill Advances to Senate Floor
Jimmy Stewart filibusters in Mr. Smith Goes to Washington. For now, the Republicans have ended their filibuster of financial reform. (image: bcblue.wordpress.com)
Republican senators ended a three-day filibuster on Wednesday that had kept a financial reform bill from being debated on the Senate floor, reported the New York Times. While the bill is no longer blocked from floor debate, it may still be a long way from being approved. And while the end of the filibuster may be a victory for Democrats, Republicans said they won significant concessions before moving the bill to the floor.
The legislation is sponsored by Sen. Chris Dodd (D-CT) and proposes what the Times called “the most far-reaching overhaul of the nation’s financial regulatory system since the aftermath of the Depression.” Part of that overhaul would involve the increased regulation of derivatives, the financial instruments blamed for triggering the recession. Dodd’s bill is currently separate from a bill proposed by Sen. Blanche Lincoln (D-AK), which is aimed more squarely at curbing speculation in commodity futures markets, including speculation on crude oil and heating oil, but the two bills will likely be incorporated into a single reform package.
The Republican filibuster, which began on Monday, had been against cloture, a procedural motion that would have officially started debate over the financial regulation bill. Democratic senator Jeff Merkley from Oregon told the Huffington Post that the filibuster forced financial reform to be negotiated behind closed doors:
By voting against cloture, Republicans are voting to keep Wall Street negotiations behind closed doors, demanding changes to the bill without public scrutiny. Instead of closed-door deals, they should support open floor debate.
Democrats say they made no promises to change the bill and that Republicans relented because it looked bad to discuss Wall Street regulations in secret. However, Republicans claim that they wrung real concessions from the Democrats, including an agreement to nix a provision for what had been tagged a “bailout” fund, according to the Times:
In particular, Republicans said they had won the elimination of a proposed $50 billion fund that would be paid for by big financial companies and would be used to help pay for putting failed banks out of business.
Though the filibuster of the cloture motion has ended, another filibuster could block the bill from passing. Before any final vote takes place, though, representatives from both sides of the aisle have promised a genuine debate. Sen. Bob Corker (R-TN) said, “This may be a real debate, which might shock America,” and Dodd called for “a serious, vigorous debate.”
With the price of heating oil consistently climbing based on an expectation that demand for diesel fuel is about to rise—a price increase that may make sense to commodity traders, but not heating oil consumers—a vigorous debate is the least the Senate could do for consumers.
CFTC Fines Morgan Stanley $14 Million for Unreported Crude Oil Trade
The investment bank Morgan Stanley owes $14 million for violating the NYMEX rules on block crude oil trades. (image: thisislondon.co.uk)
The CFTC hasn’t made any announcement yet regarding position limits on energy commodities, but the commission is already showing its teeth, reports Reuters. On Thursday the CFTC fined leading investment bank Morgan Stanley $14 million for its failure to report an oil trade in 2009. In a separate settlement, the CFTC fined Moore Capital $25 million for trades that attempted to manipulate palladium and platinum prices.
The fines were the result of settlements that followed CFTC investigations of the trades. Neither Morgan Stanley nor Moore Capital admitted to or denied the charges, and both released statements that pinned the blame on former employees. From Morgan Stanley:
As the CFTC indicates, this matter concerned an isolated request by a former Morgan Stanley trader.
From Moore Capital:
Neither Moore Capital’s principals nor its current management were involved in any improper trading, and none have been accused of any wrongdoing.
Morgan Stanley’s fine resulted from a block crude oil trade with UBS in February 2009. Block trades, which involve large numbers of contracts, have to be reported to the New York Mercantile Exchange (NYMEX) within five minutes of the transaction. The CFTC alleged that a trader with Morgan Stanley and a UBS broker agreed not to report the trade until after trading had closed for the day. The Wall Street Journal reported that Morgan Stanley sold 33,110 April 2009 crude oil contracts and bought 33,110 March 2009 contracts in the trade. UBS faces a $200,000 fine for its role in the deal.
In addition to the penalty, the CFTC told Morgan Stanley to improve its training for traders and tighten its monitoring of block trades at the NYMEX for three years.
The public comment period on the CFTC’s proposed position limits on energy commodities ended on Monday, and the commission has yet to say whether or not it will seek to carry out its proposal. However, between Thursday’s fines and Tuesday’s ruling to bring seven electronically traded natural gas contracts under its regulation, the CFTC has been active and shown a readiness to flex its regulatory muscle. This could be a sign that oil traders like Morgan Stanley and Goldman Sachs may soon face position limits and a stronger, more assertive CFTC that will hopefully bring lower and steadier crude and heating oil prices.
Survey: Speculation Is Cause of High Oil Prices, Costs Consumers $300 Billion a Year
Speculators’ dollar involvement in the US commodity futures market has ballooned in the last decade. The majority of experts believe this trend is a direct cause of higher and more volatile oil prices. (image: dinocrat.com via Bloomberg and the CFTC)
It’s official: the view that increased speculative activity in oil markets has brought higher prices and more volatility is the majority opinion.
Reuters reported on Tuesday that a survey of professionals in all segments of the oil industry showed that nearly 75 percent of respondents believed that speculation has raised oil prices above the level determined by supply and demand alone. According to the report, the extra boost to oil prices provided by speculators costs consumers of oil products $300 billion per year.
Among those surveyed, estimates of how much speculation has inflated oil prices ranged from $10 to $30 per barrel. Using the low-end estimate of $10 per barrel, Reuters found that oil producers reap $300 billion in extra profits per year—profits that come directly out of consumers’ pockets. Although speculation in commodities markets has been growing since major deregulation in 2000, close examination of its effects on prices only began after the price of crude spiked at $147 per barrel in July 2008. Speculation has been linked to the price spike, and 73 percent of respondents in the Reuters survey said that the spike was not caused by factors related to supply and demand.
Scrutiny of speculation’s influence on oil prices has intensified in the last six months, as low demand and overflowing supplies pointed to lower oil prices but the prices of crude and other oil products steadily increased.
Reuters surveyed “40 major figures in the oil industry,” including “bank analysts, traders, hedge funds, brokers, refiners, exchanges, consumers, consultants and academics.” The results of the confidential survey pointed to a clear consensus in the industry:
73 percent thought increased speculation had boosted prices above the level dictated by supply and demand, with only 17 percent saying it has had no impact.
Analyst Eugen Weinberg of Commerzbank offered his take on the subject, which provides a good summary of the majority view:
investment inflows into the market over the last years did contribute to the price increases, and heightened speculation brought more volatility.
In public discourse, financial interests continue to deny speculation’s influence on oil prices and cast speculators as important market players that allow for hedgers and other business interests to make sound investments. Analyst Phil Flynn of PFGBest told Reuters that speculators are currently serving to ready the market for a soon-to-come upswing in demand:
With the huge growth of China in recent years, we have had some of the greatest demand growth ever for commodities. The value of speculators coming into the market is that they allow the needed investment in future supplies.
The survey results were released as many business interests and market players eagerly anticipate announcement of new energy trading regulations by the Commodity Futures Trading Commission (CFTC), which wrapped up a three-month public comment period on the regulations on Monday. The CFTC has proposed “position limits” on certain energy commodities (including crude oil and heating oil), which would cap the amount of contracts one party could hold at a time.
Most survey respondents echoed initial reactions to the CFTC’s announcement of position limits: they are too generous and will therefore be ineffective at reining in price volatility.
But while 64 percent of those surveyed favored increased regulation, only 41 percent said the current CFTC proposals would be successful. Almost a quarter said the limits did not go far enough or saw ways for traders to circumvent the rules, while 35 percent said they risked doing more harm than good.
Through a confidential survey of experts, Reuters has made clear the consensus view on speculation and its relation to oil prices:
- 1. Speculation has significantly inflated oil prices in recent months and brought more volatility to the energy markets
2. Increased regulation is needed to curb speculators’ influence
3. Regulations proposed by the CFTC are too weak to address the issue
The first and second points above fit in with the larger trend toward tighter financial regulation marked by reform bills currently under consideration in Congress, and it seems momentum is building toward reforms that could actually bring lower and more stable prices of crude, heating oil, and gasoline in the near future. Perhaps this momentum will allow for new steps to be taken that will address or supersede the CFTC position limits that many view as inadequate and bring the real change consumers so desperately need.
Derivatives: Used by the Heating Oil Industry, Abused by Speculators
As the use of derivatives expanded beyond their use by businesses hedging risk, derivative speculators built up a massive house of cards that collapsed in 2008 and brought the global economy down with it. (image: dailymail.co.uk)
In the debate over financial regulation that’s currently heating up in Washington, the investment products known as derivatives have taken center stage. Derivatives constitute a broad and widely traded category of investments that are based on (derived from) other products that could be anything from heating oil futures contracts to home loans. Because mortgage-based derivatives were the main culprits in causing the global economic downturn, they have become prime targets of legislators for tighter regulation that proponents believe will help avert future economic catastrophes.
On April 15, Arkansas senator Blanche Lincoln (D) introduced a bill that proposes major increases in the transparency and oversight of derivatives trading that could help reduce the volatility of oil prices.
Last week, President Obama offered general support for the derivative-related provisions of Lincoln’s bill, but also acknowledged that derivatives do play an important role in the US economy by allowing end users of products like heating oil to hedge their financial risks.
Writing for the New York Daily News on Monday, investment manager Peter Siris expanded on Obama’s acknowledgment in an article titled “Derivatives for dummies: Thousands have bought them without even realizing it.” His central point is that, in their simplest form, derivatives are common and vital financial products that allow businesses like heating oil dealers to protect themselves against the rapidly changing market price of a product. In that context, derivatives amount to a prudent investment that serves as an insurance policy against rapid and unforeseen price increases. The kind of financial security provided by derivatives hedging allows heating oil dealers to stay in business and offer consumers price-lock contracts and other payment options.
The problem with derivatives in the recent economic meltdown, Siris explains, was that they became too complex and too intertwined with other financial products (mostly bad mortgages). As derivatives became more complex, they multiplied and became more popular, occupying an increasingly outsized portion of the world financial system:
Here’s a frame of reference: The total value of all goods and services produced globally is estimated at $70 trillion. The value of all the financial assets in the world is about $150 trillion. The value of all the derivatives in the world is about $700 trillion. That means financial institutions are betting 10 times the value of the world’s economic output and more than four times the value of the world’s assets on these insurance policies.
All of that buying and selling of derivatives by speculators—investors who are not businesses protecting themselves, but financial players seeking profit—grew into an elaborate and extremely unstable house of cards. When the piece of that house’s foundation made up of bad mortgages was removed, the entire structure collapsed in a heap, ushering in the global recession.
Siris’s point is an important one: derivatives have their place—it is in industries like heating oil where they can help keep retailers in business and prices steady. For this reason, they simply cannot be banned outright. But they can be regulated in a way that will make them more transparent and straightforward to prevent them from causing another global economic meltdown.
Armed with this knowledge, heating oil consumers can think for themselves and avoid being swayed by extremists on either side of the debate that call derivatives all good or all bad. And with the battle over financial regulation and derivatives getting more contentious every day, it’s a safe bet that those extremists will very soon increase the volume and frequency of their attacks in the fight for headlines.
CFTC Weighs Comments from Industry Groups, Commodity Traders on Energy Trading Limits
The CFTC is in the process of evaluating comments for and against position limits on energy commodities. (image: securitygoldandsilver.com)
Thousands of individuals, businesses, and trade and industry groups have submitted comments to the Commodity Futures Trading Commission (CFTC) regarding its proposal to establish position limits on energy commodities. On Thursday, Reuters examined some comments by key organizations on both sides of the debate, leaving aside the majority of the comments, which strongly favored stricter regulations of commodities markets and were submitted as part of a campaign led by Stop Oil Speculation Now, a group composed of end users of petroleum products.
Reuters highlighted the opposition of trade groups representing commodity traders, the International Swaps and Derivatives Association (ISDA) and the Futures Industry Association (FIA), and of the Intercontinental Exchange (ICE), a company that operates online commodity exchanges. These groups objected to the CFTC’s claim that speculation affected oil prices, and said that regulation would limit market liquidity or force traders into unregulated markets overseas. In sum, the opponents of position limits worry that added regulations will hamper the smooth functioning of markets where energy commodities are traded.
The rest of the comments synopsized by Reuters favored position limits, and in some cases criticized the CFTC for being too lenient. The proponents of position limits were trade groups representing industries harmed by the high price of oil or other commodities. The Industrial Energy Consumers of America (IECA), which represents manufacturing firms, said the position limits proposed by the CFTC were too high. The IECA is worried about fluctuating prices in natural gas, which could determine whether or not many of its members are profitable. The Mediterranean Shipping Company, the second largest shipping container company in the world, voiced the same criticism of the CFTC’s proposal, as did the joint comment by the Petroleum Marketers Association of America (PMAA) and the New England Fuel Institute (NEFI).
The American Feed Industry Association, which represents makers of animal feed, and the Institute for Agriculture and Trade Policy, a fair trade advocacy group, also supported the position limits. The support of groups primarily affected by the price of agricultural commodities, where position limits are already enforced, reflects their concern that volatility in the prices of energy commodities has also brought volatility into agricultural commodities.
The CME Group, which operates the New York Mercantile Exchange (NYMEX), has yet to comment, but will likely oppose any new CFTC regulations.
The trade groups that support position limits represent a wide variety of companies that engage in commodities trading to manage risk, so the division is not between those who participate in commodity markets and those who don’t. As Reuters makes clear, businesses that are harmed by high or volatile energy prices support the CFTC’s proposal to establish position limits, and in many cases want the CFTC to take even more drastic action.
Committee Approves Bill Regulating Financial Derivatives
Sen. Charles Grassley was the only Republican on the Agriculture Committee to vote in favor of the financial regulation bill. (image: Chip Somodevilla/Getty Images via nytimes.com)
The Senate Agriculture Committee approved a bill on Wednesday that would regulate derivatives, reported Politico. Derivatives are a set of financial products that include commodity futures and are often implicated as causes of the financial crisis of 2008. Sen. Blanche Lincoln (D-AK) introduced the bill (the Wall Street Transparency and Accountability Act) on April 15 in an effort to, among other things, clamp down on speculation in the oil markets. Her bill quickly won the support of end users of petroleum products, such as the airline industry and heating oil users.
The bill passed by a vote of 13 to 8, with Sen. Charles Grassley (R-IA) joining all 12 Democrats on the committee. Grassley’s vote could indicate that financial reform has a chance of garnering some Republican support. The New York Times quoted Senate Majority Leader Harry Reid’s, endorsement of the bill’s advancement as a “bipartisan committee vote.”
The challenge of regulating derivatives fell to the Senate Agriculture Committee because it oversees commodities futures trading, but the bill it passed on Wednesday will be incorporated with legislation emerging from the Senate Banking Committee to form a more comprehensive overhaul of financial regulation. The combined effect of the bills, their supporters argue, will be more stable and transparent financial markets and less volatile oil prices.
Obama’s Financial Reform Speech Includes Respectful Nod to Oil Hedgers
President Obama speaking at New York’s Cooper Union on Thursday. (image: Reuters via wsj.com)
In a speech at Cooper Union in downtown New York on Thursday, President Obama briefly touched on petroleum-dependent businesses’ participation in financial markets. In the middle portion of a speech calling for comprehensive reform to protect Americans against reckless activity on Wall Street, Obama used businesses hedging oil prices to moderate costs as example of fair and honest use of commodities markets:
So I want to reiterate: there is a legitimate role for these financial instruments in our economy. They help allay risk and spur investment. And there are a great many companies that use these instruments to that end—managing exposure to fluctuating prices, currencies, and markets. A business might hedge against rising oil prices, for example, by buying a financial product to secure stable fuel costs. That’s how markets are supposed to work. The problem is, these markets operated in the shadows of our economy, invisible to regulators and to the public. Reckless practices were rampant. Risks accrued until they threatened our entire financial system.
End users of petroleum products, as hedgers, serve as the counterparts to speculators, who have no interest in the physical products and trade futures or options contracts in pursuit of financial gain. Heating oil dealers often act as hedgers to protect themselves from unpredictable swings in heating oil prices. Obama’s comments allude to speculators using oil (and other commodities) as part of opaque investment activities that contributed to the financial collapse of 2008.
Watch the full speech on the Fox News website. The reference to oil hedging begins at the 13:54 mark.
Flood of Comments Support CFTC Regulation that Could Moderate Oil Prices
![The number of comments sent to the CFTC skyrocketed in April, led by groups who support more stringent regulations on commodities trading. (image: John Kemp via ft.com)]](http://www.heatingoil.com/wp-content/uploads/2010/04/cftc-comments-graph.gif "cftc-comments-graph")
The number of comments sent to the CFTC skyrocketed in April, led by groups who support more stringent regulations on commodities trading. (image: John Kemp via ft.com)
The Commodity Futures Trading Commission (CFTC) proposed position limits on energy commodities in January, and then initiated a 90-day public comment period so that anyone interested could weigh in on the proposal (all comments are available for viewing on the CFTC’s website). Comments slowly trickled in, but, as the Financial Times’ Energy Source blog reports and the graph above shows, in April the CFTC began receiving hundreds and even thousands of comments per day.
Responsibility for the deluge goes to a campaign by industry groups to generate support for the CFTC position limits before the comment period ends on April 26, and the number of comments shows that the campaign has been successful. On April 13, the day that HeatingOil.com reported on the effort by the Petroleum Marketers Association of America (PMAA) and the New England Fuel Institute (NEFI) to convince their members to contact the CFTC, 4,485 comments were lodged with the regulatory agency.
In particular, the comments came from a form letter available at the website of Americans for Fairness in Lending. The group Stop Oil Speculation (SOS) Now has also been linked to the effort, though their website currently displays a form letter to be sent to each sender’s senators in support of Sen. Blanche Lincoln’s financial regulation bill.
For Platts’ The Barrel blog, the fact that all this support for position limits comes via form letters undercuts its significance. The economist Philip Verleger, who writes extensively on oil prices, is also eager to point out that many of these comments are part of a single campaign, and FT’s Energy Source characterizes him as “exasperated by the vast number of comments from people who presumably have little understanding of commodities markets.”
FT’s Energy Source points out that the support for position limits to curb speculation—whether its grounded in a sophisticated understanding of commodities markets or not—is nonetheless real and widespread. Congress is accountable to voters, and because CFTC commissioners are political appointees they are not free from political concerns.
While opposition to position limits is led by oil traders, commodities exchanges, and economists like Verleger, it’s not clear that their credentials alone make them right. After all, it’s not just individuals upset about the rising cost of heating oil, gasoline, other oil products that want to curb speculation by establishing position limits; it’s also the PMAA, the airline industry, and the CFTC.
Heating Oil Dealers, Airline Industry Endorse Financial Regulation
Sen. Blanche Lincoln, flanked by Sens. Tom Harkin and Bob Casey, stumps for her financial regulation bill. (image: Luke Sharrett via nytimes.com)
Democratic supporters of Sen. Blanche Lincoln’s proposed financial regulation bill held a press conference on Tuesday, and invited business owners affected by speculation in oil markets, one of the derivatives markets that the bill seeks to regulate, to explain the need for more stringent regulation. Sean Cota, a heating oil dealer in Vermont and vice chairman of the Petroleum Marketers Association of America (PMAA), was among those who described how speculation on oil futures had increased costs to businesses and consumers, and called for the Senate to support Lincoln’s bill.
Cota said that for the amount of oil needed to produce every tank of gasoline, there are 2,000 to 3,000 contracts traded on that oil, reported the New York Times. That volume of speculative activity has increased the expense of Cota’s own hedging against price swings. In 2003, Cota paid 3 to 6 cents on the gallon to buy the derivatives contracts needed to hedge. On Tuesday, he said the same contract now cost him 50 to 75 cents on the gallon, and businesses were forced to pass these costs on to consumers.
Lincoln’s bill, the Wall Street Transparency and Accountability Act of 2010, would keep purely speculative traders, like investment banks, from buying commodity contracts such as oil futures. She introduced the bill on Thursday and quickly won the support of the Air Transport Association, a group that represents the airline industry. Tuesday’s press conference also featured representatives of the airline industry, including Robert Fornaro, the head of AirTran Airways.
While end users of oil products, such as heating oil dealers and airlines, quickly and enthusiastically embraced financial regulation, the bill does not enjoy the support of the oil industry as a whole. As the Rutland Herald reports, a Vermont lobbyist for the American Petroleum Institute (API) disputes the claim made by Cota and the Vermont Fuel Dealers Association—whose executive director is Sean Cota’s cousin, Matt Cota—that speculation is generating higher prices. According to Joe Choquette, who works for a law firm in Burlington, “the changes [in oil prices] appear to reflect an increase in demand for gasoline in the U.S. and increased demand for crude oil worldwide.” In contrast, Sean Cota told the Herald that “the speculative premium caused by unregulated derivatives today is over $1 a gallon for heating oil, gasoline and diesel.”
The API finds itself opposing heating oil dealers because it has members from all sectors of the oil industry, including oil producers who benefit from higher prices. No matter what the price for a barrel of crude oil is, it costs the same to pump it out of the ground. The division between oil industry trade groups reveals that what’s in Exxon’s best interest is not always in the best interest of heating oil dealers or consumers.
