Politics at play as CFTC tries to regulate excessive speculation of energy commodities
March 29, 2016
by Barry Schaps
The Federal Commodity Futures Trading Commission (CFTC) began addressing the issue of excessive speculation and its effects on energy commodities since Congress enacted the Dodd-Frank Act following the financial meltdown of 2008. The legislation, passed in 2010, ordered the CFTC to set limits on the number of futures contracts a trader could hold for some energy and agricultural commodities in order to fight “excessive speculation” which is viewed to be harmful to consumers and creates concerns about market integrity and stability. Market liquidity is essential for futures markets to function, and the fear of excessive speculation and enormous price swings scares away investors.
Due to the passage of Dodd-Frank, the CFTC proposed a position limit rule in 2012. The financial industry, however, sued to block its enactment, claiming the proposed rules were unfair and unnecessary. They successfully persuaded a federal judge who threw out the regulations. In response to this setback, the CFTC asked its Energy and Environmental Advisory Committee (EEAC) to review existing market data, interview market participants, and provide further recommendations to the CFTC Commissioners.
What seemed like a perfectly logical request of knowledgeable advisors did not turn out as the Commission expected. On February 26, 2016 the EEAC issued its report recommending that the CFTC drop all efforts to reform position limits on energy commodities.
Given the current political landscape and the makeup of the EEAC, however, this outcome should not have come as a surprise. The committee is stacked with members from energy and trading firms (e.g. Morgan Stanley), fuels industries (e.g. Conoco Phillips and the Natural Gas Supply Association), and members representing the exchanges on which the futures contracts were traded (e.g. the CME Group and the Intercontinental Exchange). The lone dissenting opinion on the committee came from Tyson Slocum – representing the consumer watchdog group Public Citizen – who stated that the report was “weighted in favor of interests that may have a predisposition to opposing the concept of position limits.” In fact, the advisory committee received testimony from a total of thirteen people, ten of whom were from the financial commodity industries, and two from the CFTC itself. “In other words, this is a group representing exactly the businesses the CFTC is supposed to regulate, and precisely the people who should not be dictating its policy decisions.”
The CFTC’s proposed position limit rules were targeted at speculators and not individuals or firms with vested interests in proper usages of futures contracts on energy and agricultural commodities. Natural market participants like farmers, small energy producers (crude oil and natural gas), and consumers (companies purchasing energy for use in their businesses) are identified as bona fide hedgers since they physically produce or consume the underlying commodity represented by the future contract. Such bona fide hedgers are exempt from these proposed position limit rules.
Also unaffected by the proposed position limit rules, are firms like ExxonMobil who tend not to utilize futures contracts for purposes of hedging energy commodity risks, since investors buy shares in these companies precisely because they are attached by the potential return (and volatility) from energy.
The EEAC report was not well received by CFTC Chairman Timothy Massad who only hours after its release rejected its recommendations.
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