Philip Verleger thinks the CFTC’s proposed position limits will be costly for consumers of heating oil and other exchange-traded commodities. (image: media.canada.com)

Economist and oil analyst Philip Verleger has a dire forecast regarding the CFTC’s proposed limits on energy trading: “Great harm to the American economy will result from these unenlightened actions.”

That’s just one of the highlights from the text of a speech Verleger will give today at the Futures Industry Association, BusinessWeek reported. According to Verleger, the oil markets have been functioning perfectly. He argues that record-high inventories in oil and gas kept energy prices stable this winter even as temperatures dropped and energy demand rose, demonstrating that the free-market incentives to store oil ended up benefiting consumers. “New regulations by the Commodity Futures Trading Commission guarantee that consumers will never again experience stable prices during a serious cold spell,” warns Verleger. If position limits curb the incentive to stockpile inventories, he proposes, there could be shortages during the next cold snap, sending prices spiking upwards and costing consumers as much as $20 billion.

The CFTC’s regulations aim to prevent such a disruptive price spike; it was 2008’s soaring oil prices, when a barrel of crude topped $147, that prompted renewed efforts to curb the speculative activity that many blame for record-high prices. While Verleger worries that the CFTC will cripple energy markets, others have criticized the CFTC’s position limits for being too soft—the limits would only affect the ten biggest position holders in the oil and gas markets.

Verleger correctly predicted that crude oil would reach $100 per barrel in 2007, but he also missed wildly when he predicted that crude would drop as low as $20 per barrel by the end of 2009, when oil price rose from $70 to $80 per barrel. The large inventories that Verleger credits with preventing a price spike this winter contributed to keeping crude far above $20 a barrel. By taking all that oil off the market, traders artificially shrunk supply and supported higher prices.

The CFTC’s proposals are currently in a 90-day public comment period. While oil traders have urged the CFTC to be cautious, the proposals have not caused great alarm—when they were unveiled in January, oil and gas prices showed little reaction. The doomsday scenario sketched out by Verleger puts him at one extreme of the debate over commodities regulation, even among free-market enthusiasts.

The official founding of the US Oil Fund (USO) in 2006 at the American Stock Exchange. USO could soon receive a reprimand from the CFTC for failing to properly report oil trades in February of last year. (image: ogfj.com)

Just days after the Commodity Futures Trading Commission’s announcement that it would fine investment bank UBS AG for exceeding position limits, a report from US Oil Fund said that it could be the next target of CFTC enforcement. The Wall Street Journal reported on Wednesday that the CFTC could soon bring charges against US Oil (USO) for failing to properly report trades made in February of 2009.

USO practices an investment strategy known as “rolling”: just before a front month (the current month) contract expires, the fund sells off all of its holdings of that contract and buys up contracts for the next month. As crude oil contracts are currently priced higher in future months than in the front month (a situation known as contango), USO’s practice of rolling has been and continues to be quite profitable, especially because the fund trades massive quantities of futures contracts at once. On February 6, 2009, USO rolled so many contracts that some market watchers believed the action distorted oil prices. This suspicion attracted the attention of the CFTC, which said it would investigate the action shortly after the USO’s roll took place. That’s the last the CFTC has said on the subject, staying true to its policy of not commenting on enforcement actions.

More than a year later, it was USO itself that brought the issue back into the spotlight with comments in its annual report. Perhaps to preemptively quell the concerns of its investors, USO noted that the CFTC could bring enforcement action against the fund soon, but that the agency had already made clear that it does not suspect any intentional wrongdoing on the part of USO. From the WSJ:

“The CFTC has told USO that they…believe that USO itself was not aware at the time that any of these trades may have been improperly reported,” Mr. Hyland said, adding “we do not know whether or not the CFTC will actually attempt to further pursue their claim.”

Interestingly, if the CFTC does uncover reporting violations of USO trades, it may not be USO that is held responsible. The reporting of trades is usually the responsibility of clearing firms affiliated with trading clients—in this case the clearing firm was investment bank UBS. The bank’s involvement and possible reprimand for poor reporting is unrelated to the CFTC’s fine levied against UBS for exceeding position limits from 2006 to 2008.

The possibility of yet another crackdown on oil traders breaking commodities trading rules reinforces the perception that the CFTC is ready to walk the walk of enforcement after talking the talk for more than a year. The new regulatory zeal of the commission, combined with the ratification of recently proposed position limits might very well succeed in cutting back speculation on crude oil, heating oil, and other energy markets. If so, heating oil users will have good reason to expect (or at least hope for) lower and steadier heating oil prices as soon as next heating season.

CFTC chairman Gary Gensler. (image: businessweek.com)

Last week, the Commodity Futures Trading Commission flexed its regulatory muscles and hit the Swiss investment firm UBS AG with a $130,000 fine for violating NYMEX position limits from 2006 to 2008. Reuters reported on February 24 that the firm had exceeded position limits on certain heating oil, natural gas, and platinum futures contracts.

Although the CFTC’s levying of fines remains extremely rare and the $130,000 sum amounts to less than peanuts for an international finance giant like UBS, Reuters’ Roberta Rampton published an analysis piece on Tuesday that highlighted the symbolic significance of the move. Clearly, the decision to fine UBS was orchestrated to coincide with the CFTC’s pledge to use its regulatory powers to curb excessive speculation on energy markets and reign in volatility. That pledge has been oft-recited by CFTC chairman Gary Gensler over the last nine months, but the UBS fine marks the commission’s first binding action toward those stated goals. If there was any doubt that the CFTC wanted to send a message with the UBS fine, Gensler dispelled it when he told the press shortly after the fine was announced, “I think that the announcement sort of speaks for itself. All market participants need to comply with the rules.”

Could this new tough stance by the CFTC, enforced by the new sheriff in town, Gary Gensler, signal a change in the regulatory landscape? Analyst Craig Pirrong of the University of Houston thinks so:

I see this as a harbinger of things to come. Chairman Gensler has made position limits a centerpiece of his more aggressive regulatory approach. As a result, it is almost inevitable that the Commission will take a hard line on any violations of existing limits.

To be clear, the UBS fine is a result of its violation of existing position limits, not to be confused with new, more specific position limits proposed by the CFTC in January that are currently in the midst of a 90-day public comment period en route to ratification. Although the pending limits have been criticized as too generous to deter excessive speculation, perhaps, combined with more judicious enforcement on the part of the CFTC, they could be more effective.

Assuming stepped-up enforcement of new rules does bring about the desired effect of reducing large-scale speculation on the commodities market, the question of whether or not it will result in steadier or lower oil prices is under debate. If there is more enforcement to come, opined former CFTC enforcement director Geoffrey Aronow, it could very well bring prices down. “It could be a price bearish specter haunting the market,” he told Reuters.

If the situation does play out that way, heating oil users would be direct beneficiaries. Heating oil futures contracts on the New York Mercantile exchange are among the products targeted by major speculators. With their activities scaled back, market prices could fall and those lower prices would trickle down to consumers. So if you’re a heating oil user, you’ll want to root for “Sheriff” Gensler as he tackles the difficult task of subduing the rustlers, er, speculators that have for a decade wielded considerable power over commodities markets.

A 2004 report from the Institute of Energy Economics Japan, host of last weekend’s summit on oil prices. (image:eneken.ieej.or.jp)

Government regulators of oil markets from around the world called for harmonized regulation of over-the-counter markets and greater transparency of supply and demand data in an effort to curb oil price volatility, BusinessWeek reported on Sunday.

Regulators convened in Tokyo last weekend for the International Energy Agency’s “oil price formation workshop” along with representatives from the financial sector and oil industry. Attendees included regulators from the US Commodity Futures Trading Commission (CFTC), whose members have repeatedly stated their intention to tighten regulation of energy markets.

At the conclusion of the meeting, statements from the IEA and others outlined two courses of action that would combat volatility in oil prices: coordinated regulation of over-the-counter (OTC) oil trades across all international markets and more complete and transparent data on supply of/demand for oil.

From BusinessWeek:

“Regulatory authorities in many countries are cautious about systemic risks that could be led by a lack of transparency in OTC transactions,” IEA Executive Director Nobuo Tanaka said in an interview in Tokyo today. “It is very important to expand the network of transparency.”

OTC transactions refer to the trading of commodities-based derivatives outside of regulated exchanges like the New York Mercantile Exchange that are not subject to oversight by the CFTC or any regulatory body. OTC trades allow for huge speculative bets to be placed on oil that could distort the market and bring about major price swings. With greater transparency and some oversight, regulators hope to reduce the influence of OTC trades on prices and reduce volatility. In January, CFTC chairman Gary Gensler advocated bringing OTC transactions under the purveyance of clearing houses—third-party companies that oversee derivative trades—that would provide needed oversight. Such a move would require close cooperation among international regulators to ensure that derivatives trading rules were consistent across international borders. A lack of such consistency would allow traders to circumvent regulators by simply taking their transactions to a different country. CFTC commissioner Scott O’Malia emphasized this point: “We need to make sure rules and standards are right. We are managing a risk appropriately and consistently because clearinghouses are very important and we can’t have any failures.”

A joint statement issued by the IEA and the Institute of Energy Economics Japan, which hosted the summit, also called for more accurate and transparent data on oil demand and oil supplies. Estimates of oil consumption and world stockpiles of petroleum products vary widely, making it difficult to get a clear picture of the oil market at any given time and evaluate whether or not prices reflect that picture accurately. For example, data on crude oil and product stockpiles in the US are released twice a week, first by the industry group API and then by the Department of Energy’s EIA. Even though these reports are released within less than 24 hours of each other and cover the exact same data, they consistently report wildly different numbers that often vary by several million barrels. Transparent and verifiably accurate data on how much oil is in storage would hopefully stabilize prices by reducing extreme speculative bets by big traders that may push prices up or down.

The positive outcome of the Tokyo meeting is what appears to be a consensus among regulators and market players as to what needs to be done to reduce oil price volatility that plagues heating oil users, drivers, and other petroleum product consumers worldwide. However, whether or not that leads to concrete action is a different question altogether. Here in the US, the CFTC has been talking tough about energy commodities regulation for almost a year. But with the exception of introducing generous position limits that critics say will have no effect on oil prices, the commission has done nothing to advance their stated cause.

If the CFTC’s inaction proves to be a model for regulators who attended the summit, consumers have nothing to look forward to but the same unpredictable and intractable gasoline, diesel, and heating oil prices that they have come to despise.

Energy Secretary Steven Chu meeting with King Abdullah of Saudi Arabia. (image: arabnews.com)

During his visit to Saudi Arabia, Energy Secretary Steven Chu declined to comment on what OPEC should do or whether current oil supplies could support global economic recovery, but he did weigh in on price swings in the oil market. According to Reuters, Chu said that “the volatility of the price seems to be far in excess of demand and supply.”

Echoing the Commodity Futures Trading Commission (CFTC), Chu wondered if “volatility [had] been increased by large financial institutions taking positions.” In January the CFTC proposed imposing position limits on energy futures markets, though some believe the limits are so generous that they will have little impact; the proposal set limits at 98 million barrels, which would only affect about ten of the biggest position holders. Chu said the role of speculation in oil markets was being studied.

Chu’s statements mark a clear contrast with the Energy Department under the previous administration, as The Hill’s E2 Wire blog points out. Samuel Bodman, the previous Energy Secretary, denied that speculation was driving oil prices to record highs.

Those incredible price swings of recent years convinced many others that the speculative activity of large financial institutions was to blame. During 2008—when a barrel of crude oil soared to a record $147 in July, only to fall to $32 a barrel by that December—the volume of futures contracts was eight times greater than the volume of actual oil. According to Chu, price swings are of more concern than the absolute price of oil, because such sudden changes discourage investment in future oil production. “Whatever the price, you don’t want sudden changes,” he said.

While heating oil consumers are rightly concerned about high prices of their heating fuel, volatility of the type that Chu sees in oil markets can also create problems. Like oil companies and national economies, the average household works on a budget, and unpredictable heating oil prices make it difficult to know how much money can be spent elsewhere.

Sen. Cantwell and a coalition of end-users want more oversight of commodity markets. (image: apolloalliance.org)

A press conference on Wednesday showed the diversity of interests that support stronger regulation of commodity markets by the Commodity Futures Trading Commission (CFTC), as representatives of heating oil companies, trucking companies, manufacturers, farmers, and other end-users of commodities joined Sen. Maria Cantwell (D-WA) to call for limits to speculation. The press conference represents the latest step in an effort by end-users to expand the CFTC’s powers to curb speculation and create lower and more stable prices in commodity markets.

The heating oil industry occupies a conspicuous place in the coalition. Among the speakers at Wednesday’s press conference were Sean Cota, president of Cota & Cota, Inc., a heating oil company in Vermont, and James Collura, a lobbyist with NEFI (New England Fuel Institute) and a spokesman for the Commodity Markets Oversight Coalition. Cota called for position limits to prevent financial institutions from distorting commodity markets and driving up prices. Collura compared the current commodity market to a “casino” and said businesses and consumers had been hurt by “irrational price increases.”

In January the CFTC proposed position limits on traders in energy markets, but critics have said the limits were too generous to have any real impact. The proposal is now in the middle of a 90-day public-comment period, and Sen. Cantwell and the coalition of end-users have made it clear they are not satisfied with the CFTC’s cautious proposal. HeatingOil.com will keep you up-to-date with the proposal’s progress as it develops.

IEA Executive Director Tanaka feels that continuing to allow unbridled energy speculation is a losing proposition. (image: dlcache.indiatimes.com)

Bloomberg reported Wednesday that the International Energy Agency intends to meet with OPEC, banks, and regulators to discuss ways to curb speculation’s impact on oil prices. The proposed meeting, called for next month in Tokyo, was instigated by the IEA’s Executive Director, Nobuo Tanaka. Among other attendees, Tanaka has specifically invited CFTC head Gary Gensler, whose agency recently proposed position limits on energy futures.

There has been a rising tide of concern over the impact of speculation on energy markets. It’s based in the belief espoused by many market participants, including OPEC, that oil prices are higher than they should be in the face of persistently weak economic fundamentals; the cause, many believe, is speculation by financial investors. The concern is that speculation has led to unjustifiably high prices that have harmed consumers and the economy, such as 2008’s peak price of $147.27 per barrel. However, another fear is that market volatility caused by speculation increases the likelihood of wild price swings and disrupts the stable investment climate needed for massively expensive, long-term energy projects. In this view, the problem is not that oil prices are too high or too low, it’s that energy investment is “adversely affected by oil price volatility. . . when long-range commitments of adequate and timely investment flows are need to ensure future supply,” in the words of Saudi Arabia’s oil minister.

To put it another way: how can you engage in vital long-term planning when the economic basis for your plans—the price of your commodity (oil)—can double, then fall by three quarters, all within less than a year?

It may be time for speculators and financial investors to stop opposing regulation. So far, all they’ve had to deal with are CFTC proposals widely denounced—even by members of the President’s own party—as anemic and largely ineffectual. But with most large market or industry organizations and regulators embracing the need for limits on speculation, and with President Obama calling for major changes in the ability of banks to engage in proprietary trading (including in commodities), it might make sense for the financial industry to support meaningful but manageable regulation now, rather than continue to oppose all regulation and risk a backlash that sweeps in truly draconian limits.

Whether or not next month’s meeting results in any enforceable or effective limits, it should be viewed as evidence that sentiment against speculation continues to mount.

Analyst Rachel Ziemba delivers her 2010 oil price predictions on CNBC. (image: cnbc.com)

The forecasts for oil prices in 2010 just keep coming. At the end of last week, CNBC checked in with Rachel Ziemba, a senior analyst at Roubini Global Economics, to get her predictions for the commodities trade over the next 11 months.

During her interview (watch the video below), she warns that there could be a more serious downward correction in the commodities market in the near future, although she does not offer any guesses as to exactly when. Among the factors Ziemba cites as cause for concern are: the pace of growth in China, as well as worldwide production surpassing demand and resulting swollen inventories.

The clip also touches on Obama’s recent challenge to the financial industry in the form of fees imposed on banks as well as the new regulations under discussion by the CFTC to limit speculation. Ziemba hedges a bit on what she believes the impact of these two developments will be, but does say that the uncertainty will likely contribute to any volatility in the market.

Having trouble seeing the video? Watch it on CNBC’s website here.

(image: mercpartnersny.com and Nicholas Whitaker via heatingoil.com)

Oil prices continued to fall on Friday, pressured by weak demand and losses in the stock markets. Equities dropped after President Obama proposed limits on commercial banks’ trading in an effort to curb risk-taking by large financial institutions. Investors worried that this would cut profits, and their concerns have led to selling in stock and commodity markets, which has lowered crude and heating oil prices.

Today’s average retail heating oil price in the Northeast is 4 cents lower than Friday’s average price.

The CFTC has proposed barriers against excessive speculative investment in heating oil and other energy commodities, but some member of Congress and regulators see it full of holes. (image: Orin Zebest via flickr.com)

Many lawmakers, including Democratic lawmakers, and even one member of the CFTC itself, are concerned about the Commission’s recent proposal to limit speculation, Reuters reported on Friday.

According to these critics, the CFTC’s proposed limits on oil futures positions have two significant problems. The first is the size of the limits—it’s not actually very “limiting” to allow a single investor to hold positions equal to more than a day’s oil consumption for the entire world. As the spokesperson for Senator Maria Cantwell said, “[W]e are concerned that the proposed limits may be too high to rein in damaging speculation in oil and gas markets.”

However, the second concern is actually more significant—the CFTC can’t regulate a significant portion of the market, meaning that their regulations may be as easily bypassed as a fence full of holes.

The problem is that while the Commission can unilaterally regulate commodities exchanges, it has no authority over the OTC, or “over-the-counter,” markets. These are off-exchange transactions, typically bilateral (directly between two parties) that occur off the regulatory radar screen. As Senator Jeff Bingaman, Chair of the Senate Energy and Natural Resources Committee said, “[w]hile over-the-counter markets remain invisible to regulators, we cannot expect the position limits to be effective.”

Indeed, the limits may be counterproductive: if they push speculators away from the exchanges to OTC transactions, they will reduce the ability to even track or be aware of dangerous—overly large—oil futures positions. That was a concern of the CFTC commissioner, Jill Sommers, who voted against the proposal. She did not want to implement limits on one trading arena (exchanges) while leaving another (OTC markets) unchecked, fearing that “forging ahead with federal limits in a piecemeal fashion is unwise.”

It would take federal legislation to give the CFTC the authority to regulate the OTC markets. Such legislation “may be enacted this year,” in Commissioner Sommer’s words, but “may” is a thin reed to hang a vital regulatory framework on.