Witnesses: Energy Speculation Not Evil

WASHINGTON (HedgeWorld.com)--The Agriculture Committee of the U.S. House of Representatives heard from two witnesses very familiar with the workings of the commodities markets Thursday [April 27], and each assured the committee members that futures speculation isn't an alien force hijacking the fundamentals of the energy markets, but is in fact part of the price-discovery mechanism of those markets.

In his opening statement, the committee's chairman, Robert Goodlatte (R-Va.), called for a continued debate on what the United States can do to reduce its dependence on foreign imports of oil--and spoke, in particular, of the folly, as he sees it, of leaving the Arctic National Wildlife Refuge and its potential petroleum reserves untapped.

After making that point, he turned to the subject of the hearing. "As the committee has oversight responsibility over the futures market, I want to ensure that activity on the futures market is not allowed in any way to unduly influence the high price of gasoline," he said. "There have been many theories generated about the causes of our current energy dilemma including the impact of the futures market and speculators on the gasoline market."

Walter L. Lukken, a commissioner of the Commodity Futures Trading Commission, told the committee that the CFTC has been paying particularly close attention to futures trading in energy commodities, "because of the importance of energy prices and supplies to the U.S. economy and to every U.S. citizen."

He said that in the course of this scrutiny, the CFTC has inferred that the crude oil and gasoline futures markets have been accurately reflecting the underlying fundamentals.

In making this point, he described the CFTC's Large Trader Reporting System, which requires clearing members of exchanges, futures commission merchants, and foreign brokers to file daily reports concerning their own and their customers' positions. The CFTC thereby becomes aware of concentrated and coordinated positions that might be used for purposes of manipulation. The staff can also issue special calls for supplemental information on a market participant's trading and delivery activity.

Data from this system, he said, can help sate the committee's curiosity about the role of non-commercial traders (also known as "speculators") in the energy markets. Speculators take the other side of commercial traders who go into the market to hedge the risks that they face in their day-to-day operations. "An 'all hedgers' market simply can not work."

In recent years, he said, increased economic growth in China has increased demand for oil and gasoline. Further, in the short run the supply curve for these goods is price inelastic--and by definition even a small change in the demand conditions, fed into an inelastic supply curve, can create a very large difference in price.

Mr. Lukken also said that methyl tertiary butyl ether (MTBE) is being phased out as an oxygenate in reformulated gasoline. During this phasing out, the spread between the value of crude oil and the value of refined products has widened, indicating that at least one of the causes of the dramatic recent increases of retail prices is the difficulty of this transition.

His bottom line, though, was that in the presence of such changing fundamentals, the futures markets are functioning properly, and that the CFTC will continue to conduct close surveillance of those markets to ensure that this remains the case.

The hearing's other witness was James E. Newsome, president and chief executive of the New York Mercantile Exchange. He told the committee that Nymex's core energy futures contracts trade through open outcry during the day and on an electronic platform, Nymex ACCESS, after hours. He observed "there can be at times significant differences between prices in our markets [by calendar month listed out into the future] and prices in the day-ahead cash market."

As to the analysis of the present market situation, Mr. Newsome cited an estimate by the Energy Information Association that 59 percent of the price of gasoline is attributable to the price of crude. Last week, crude oil prices exceeded $75 "due to continued concern about Mideast security and rising global oil demand."

Mr. Newsome acknowledged theories to the effect that speculation can drive up prices, but dismissed these theories as inattentive to the realities of the marketplace. "By the nature of their role, speculative traders seek to participate in price trends that are already under way, but because they lack the capacity to make or take delivery, they will never be in a position to hold a market position through to the delivery process. They create virtually no impact on daily settlement prices, the primary benchmark used by the marketplace."

CFaille@HedgeWorld.com

Contact Bob Keane with questions or comments at bkeane@investmentadvisor.com.

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