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.

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.

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.

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.

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. 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.

The CFTC ruled to regulate seven electronic natural gas contracts traded on the IntercontinentalExchange (ICE). (image: money.cnn.com)

The Commodity Futures Trading Commission (CFTC) ruled on Tuesday to extend its regulation to seven natural gas contracts that are traded electronically on the IntercontinentalExchange (ICE), reported Reuters. The CFTC concluded that the contracts played a significant role in setting the price of a commodity, which means they merit the CFTC’s oversight and could be subject to position limits.

The CFTC’s decision to increase regulation of these electronic contracts is separate from its proposal to establish position limits on energy commodities, including heating oil futures. However, the public comment period on that proposal concluded on Monday, and the CFTC’s move to extend its oversight into electronic markets like ICE could be a clue that the CFTC remains bent on tightening regulation of all trading of energy commodities.

Electronic markets are typically subject to lighter regulation than traditional futures exchanges (like the New York Mercantile Exchange, or NYMEX), says Dow Jones Newswires, but a 2008 law granted the CFTC the ability to regulate contracts traded on electronic energy markets if it determines that the contract plays a role in setting price.

On Tuesday the CFTC deliberated over 24 energy contracts, and decided that only seven met the criteria for increased oversight. The contracts that did not warrant oversight were other natural gas contracts on ICE and on the Natural Gas Exchange, and one carbon contract on the Chicago Climate Exchange.

This ruling by the CFTC to bring additional energy contracts under its purview adds momentum to the push for financial reform taking place now in the Senate and to the newfound regulatory zeal in the SEC and the CFTC itself. Most end users of commodities like heating oil desire curbs on speculation in commodity markets, which should lead to stable, and quite possibly lower, heating oil prices.