Wall Street Turns Heating Oil Dealers Against Financial Regulation

Posted by Jared Killeen on November 12, 2009 at 10:37 am

(image: jpellgen via flickr.com)

Displeased by the prospect of increased governmental regulation of derivatives trading, and hoping to fend off attempts by Congress to pass new, stricter legislation, banks and brokers have begun recruiting their clients to lobby on their behalf, the Huffington Post reported on Wednesday.

According to the article, banks are asking farmers, fuel companies, airlines, and municipal power companies to help dissuade Congress from reforming the derivatives market, assuring them that stricter regulation would lead to skyrocketing costs on their end. So far, the plan—which several analysts and congressmen have declaimed as a dirty trick—seems to be working.

Many analysts have attributed the Himalayan oil price spike of 2008 to unchecked speculation on Wall Street; despite moderate demand for oil, speculators were able to drive prices up by overwhelming the market. This year, there has been much talk among policy-makers—including the Commodity Futures Trading Commission—about imposing new limits on commodities trading meant to rein in excessive speculation; and while it now seems unlikely that CFTC Chairman Gary Gensler will succeed in pushing through such regulation, politicians like Barney Frank and Chris Dodd (D-Conn.), who unveiled a new regulatory bill on Tuesday, remain determined to see the job through.

Driven by the fear of seeing over-the-counter markets constrained, traders have decided to strike back. This has been done in large part by scaring heating oil dealers and other commodity-producers into believing that the end of speculation means the end of business altogether. That is, banks have begun convincing companies (who are the ‘end-users’ of financial derivatives) that it is in their own best interest to fight regulatory legislation. Earlier this month, the International Swaps and Derivatives Association put together a coalition of end-users, which in turn drafted a letter to Congress railing against regulatory oversight: “[S]ome reform proposals would place an extraordinary burden on end-users of derivatives in every sector of the economy—including manufacturers, energy companies, utilities, healthcare companies and commercial real-estate owners and developers.” The letter went on to claim that regulatory proposals would only “increase business risk and raise costs,” rather than “lowering systemic risk and promoting economic recovery.”

(image: life.com)

Among those end-users most aggressively courted by banks are oil and fuel companies. “Some of our heating oil dealers have heard directly from their investment companies and their traders that they work with,” said Sherri Cabrera of the Petroleum Marketers Association of America. Those traders, she said, have urged oil dealers to lobby their state representatives for an exemption from the regulated derivatives exchange for heating oil futures.

Indeed, Sean Cota, president of a Cota & Cota, a small fuel company in Vermont, has become rather popular lately. “We had a consensus amongst everybody that [regulation] was all a great thing,” he said,

until ISDA, the International Swaps and Derivatives Association, with the big players and the money in the over-the-counter market, said “You’ve got to figure out who your biggest accounts are and start telling them that it’s going to get really expensive to do these hedging programs for you folks in the physical market. So you need to make sure that financial reform doesn’t happen.”

However, policy-makers pushing for reform doubt the validity of the ISDA’s purported claims. In fact, it appears likely that many end-users, unfamiliar with the workings of the market, are being taken advantage of by their brokers. “There are many end-users who just don’t understand the issue, so they’re heavily influenced by anyone who does,” said Jim Collura of the New England Fuel Institute. According to Senator Dodd, “The end-users have been basically used by the major investment banks.” Contrary to what end-users might have been told by their banks, one purpose of regulating derivatives trading is to protect people like them against predatory banks. “When you tell them how they benefit from this, they say, ‘Well, no one told us this part,’” Dodd said.

In truth, the reforms proposed by Dodd and others would mean smaller profits for banks, but would require little—if any—sacrifice from end-users. Although many banks have begun warning their clients that regulatory reform will require them to put more money down up front, they don’t often tell them that the same amount of money—sometimes more—is often included in the fees and costs they already pay their brokers.

For more on the effects of speculation on the oil market—and what it means for consumers—please refer to this recent opinion piece by our own Steven Zweig.