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Friday, 11 July 2008
Pricking the Oil Bubble

Last month we posted articles on the emergence of Congressional concerns about the speculation in energy futures and derivative markets, driven through several ‘loopholes’ and the lassitude of federal commodity trading regulators.  Senator Lieberman, as we pointed out in those New English Review and The Iconoclast  articles, had  conducted  substantive hearings on what lay behind the ‘oil bubble’, as we labeled it.

Today on NYMEX oil futures contracts spiked to a record $147.00 a barrel, driven by ‘war risk’ premiums as a result of Iranian ‘war games’,  alleged Israel attack scenarios  and thugs disrupting production in the important  Gulf of  Niger.  Yesterday, Senators Lieberman, Collins and Cantwell introduced a new bill to address adverse speculation: S 3248, the Commodity Speculation Reform Act of 2008.  The news release held out this hope:

Senator Lieberman believes the legislation will eliminate the excessive speculation in commodity markets that is contributing to food and energy price inflation, and at the same time, will not put U.S. regulated exchanges at a competitive disadvantage vis-à-vis the OTC markets or foreign boards of trade.  Moreover, the bill ensures that commodity markets will continue to provide adequate liquidity for commercial participants.

 In our original New English Review article we noted the following:

Senator Lieberman’s HSGAC hearing on oil and commodity future speculation identified the ‘swaps loophole’ as matters to be addressed. Masters in his testimony at the Senate Committee hearings recommended that Congress move to close the swaps loophole "which speculators use to roll over monthly future contracts, allowing them to 'effectively circumvent position limits.'"

The CFTC issued proposed rules in November, 2007 to address so-called excessive speculation as defined under 7 U.S.C. sec 6a.

Excessive speculation in any commodity under contracts of sale of such commodity for future delivery made on or subject to the rules of contract markets or derivatives transaction execution facilitates causing sudden or unreasonable fluctuations of unwarranted changes in the price of such commodity.

Senator Lieberman’s Committee may hold hearing on this remaining loophole to gauge ideas and proposals for closing it. Some ideas as to how to address this are contained in the proposed Consumer First Energy Act of 2008 S. 2991, released on May 8th. Title V – Market Speculation has two provisions that endeavor to limit use of overseas OTC exchanges such as the London International Exchange (ICE) and limit the speculation by increasing margin requirements. The following is an excerpt from the legislative history of the proposed measure:

The Consumer-First Energy Act of 2008 would amend the Commodity Exchange Act to limit the price impacts of excessive speculation by preventing traders of U.S. crude oil from routing their transactions through off-shore markets in order to evade speculation limits and also impose reporting requirements.

Additionally, the bill would require the Commodities Futures Trading Commission to substantially increase the margin requirement on crude oil future trades within 90 days to limit excessive speculation and protect consumers. The current margin requirement varies between five and seven percent which essentially means that a commodity trader can control $10 million worth of future oil contracts by only putting $500,000 to $700,000 down. 

In a follow up The Iconoclast blog post we cited what Senator Lieberman’s ‘thinking’ was as of mid-June.

Senator Lieberman has apparently reacted to the pain of his constituents and most Americans about the oil bubble. He announced additional hearings set for June 24th on the subject of curbing manipulation and speculation of the oil and food commodity markets.  Of interest he called for the aggressive banning institutional investors from the commodity markets.

He also proposed ,“strengthening existing regulatory limits on the size of the stake that each speculative investor can hold in a given market, called speculative position limits”.

And he plans to propose barring investment banks from using the regulated futures markets to hedge speculative bets their clients are making in the vast unregulated global swaps market — what he called the swaps loophole.

So, let’s see what S3248, the Commodity Speculation Reform Act of 2008 does to prick the oil bubble. 

According to the Committee’s release, the measure would:

Create a seamless system of speculative position limits applied to energy-related futures and derivative contracts held by financial speculators encompassing over-the- counter and positions on foreign exchanges.

Apply position limits beyond those of legitimate hedging activities specifically those risks associated with OTC derivatives, swaps and structured debt;

Clarify amounts of position limits no greater than those necessary to maintain commodity market liquidity in bona-fide hedging activities;

Repeals the Commodity Futures Trading Commission (CFTC) authority to set position limits on commodity exchanges;

Repeals CFTC authority to substitute so-called position accountability levels reporting for actual position limits;

Requires off shore futures exchanges to provide the CFTC daily with  comparable trading information; and

Authorizes new funding of the CFTC to carry out its expanded responsibilities under the bill.

As we noted in our original Oil Bubble article, the mammoth Farm Act of 2008 had effectively closed one of the more glaring loopholes, the so-called ‘Enron loophole’ that enabled highly speculative trading in the OTC markets that lead to the melt down of at least one hedge fund  in 2006, Amaranth.  S. 3248 would appear to address the swaps, speculative trading limits and reporting of OTC futures and derivative transactions in both US and overseas exchanges.  What appears to be ‘missing’ is the earlier suggestion of barring institutional investment in commodity index futures that had grown over 20 times from a base of $13 billion to over $260 billion in 2007.  The question remains as to whether the major investment banking firms will be effectively barred from using the swaps in the derivatives markets that benefitted financial speculators.

Assuming that S. 3248 becomes law in a form along the lines of this bill, let’s hope that the Oil Bubble is pricked by this measure and may be deflated to benefit all energy-related consumers.

Posted on 07/11/2008 4:54 PM by Jerry Gordon
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