With $135 per barrel oil, and perhaps more importantly $4 gas at the pump, the Commodity Futures Trading Commission (CFTC) had no time to celebrate its reauthorization as Acting Chairman Walt Lukken was brought before an alphabet soup of Congressional committees to address the role of speculators in rising commodity prices.
Congress has turned up the heat on the CFTC since mid-May, as several experts during Congressional hearings blamed speculators in general and commodity index funds in particular for skyrocketing prices, while the CFTC maintained that traditional supply and demand factors are at fault.
“Index speculators are responsible for a big part of the commodity price increases, and we in Congress ought to do the best we can to protect the public interest in an effort to bring food and energy prices down,” Senator Joseph Lieberman (ID-Conn.) said in a statement after a May 20 hearing by the Senate Committee on Homeland Security and Governmental Affairs. At this hearing, Michael Masters of Masters Capital Management said that assets allocated to commodity indexes have risen to $260 billion in March 2008 from $13 billion at the end of 2003 and that the CFTC has invited increased speculation. Standard and Poor’s, operator of the S&P/GSCI Index, estimates the size at $185 billion as of May. Former CFTC Chairman Sharon Brown-Hruska says Masters’ testimony “shows a fundamental lack of understanding of that sector.”
The CFTC took action by releasing initiatives on both energy and agriculture. The ag initiatives, a response to the agency’s April forum to investigate record volatility, included a review of trader reporting and classification and a withdrawal of the proposals to increase spec limits and exempt certain risk management positions. The exemption would have exempted index funds from speculative position limits under certain conditions. The CFTC has issued two no-action letters on this, which are still valid. The proposal would have codified the exemption to all index funds.
Elaine Kub, analyst at DTN, says the ag initiatives “were really nothing more than lip service.” She says the expansion of trader data doesn’t fix the loopholes that allow some index funds or large swap traders to call themselves hedgers and that the initiatives will not affect volatility.
“I’d disagree with analysts who say that the CFTC isn’t doing enough on the agriculture front. We acknowledged price abnormalities promptly and began taking proactive steps,” says CFTC Commissioner Bart Chilton.
Senate criticisms continued even after the CFTC released energy market initiatives on May 29, implementing expanded information-sharing to provide the CFTC with daily large trader positions in ICE Europe’s West Texas Intermediate (WTI) crude oil contract and a continuation of an investigation on crude oil. At a June 3 hearing before the Senate Committee on Commerce, Science and Transportation, senators and panelists continued to attack speculators and said the CFTC needed to do more. Senator Olympia Snowe (R-Maine), who last month with Sen. Dianne Feinstein (D-Calif.) called for more control in regulation of global energy markets, said, “I’m concerned that the agencies aren’t aggressively pursuing” the issue of increased speculation.
Former CFTC official Michael Greenberger said at least 70% of the crude oil market is driven by speculators and that ICE’s WTI contracts are “robbing us blind.” Hedge fund manager George Soros said “outside speculators do distort the balance between supply and demand. There should be limits on speculative positions.” While senators suggested the CFTC do more to bring about lower prices, experts note that controlling prices is not the CFTC’s job. Kub says, “It is their job to stay far, far away from price-fixing and to facilitate free trade. Let the actual fundamentals play themselves out in the markets, of which speculators are a vital part.”
William Adams, managing director of JKV Global, says that supply and demand factors are to blame for rising commodity prices, adding, “On a daily basis, the world economy requires approximately a million more barrels of crude oil than it produces. With natural gas, we are 15.29% below last year’s levels. As for the grains, we have watched global consumption increase, experienced smaller and smaller carry-over, and [have seen] grains being ear-marked for fuel.”
Brown-Hruska says the CFTC does “a fine job” of monitoring speculative activity in the markets. “[Index traders are] very careful with how they conduct themselves and how they roll their positions,” she says. “There’s a lot of irrelevant legislation that’s being tossed around. Whenever a price is going in a direction that people don’t like, they want to blame the messenger. There’s a desire to find a scapegoat for high prices.”
But some insiders believe index funds are affecting price. “The ETFs and index funds combined have created a different trading atmosphere. [People are] investing in the price of crude oil like they’re investing in the price of IBM and McDonald’s with their 401(k)s. It’s a sophisticated form of hoarding. The index funds are not responsive to price,” says Tom C. Willis, vice president at Mesirow Financial Commodities Management.
Willis says index funds are “absolutely” affecting prices in the long term. “Forget about the word speculation. Think more about investing. The investing public has driven up the price of crude oil, gasoline, soybeans and corn.”
The CFTC has scurried about forming committees and task forces to study the role of speculators and index traders in the commodity markets trying to satisfy Congressional leaders seeking to assign blame. Chilton says, “I’m disappointed in our initial responses provided to the Hill and to the public. We [have not] taken as aggressive a position as we could have or exploring all possible reasons for these extraordinary price increases. We need to more definitively determine the rationale for the increases.”
But it appears Congress has already come to a conclusion as to who is to blame and they let CFTC Acting Chairman Lukken know, as he faced a hearing on his nomination for chairman in the midst of his numerous Capitol Hill appearances.
At long last
The long road to reauthorization is over for the CFTC. The agency, which was last reauthorized with the Commodity Futures Modernization Act of 2000 and had been operating under temporary spending bills since 2005, was reauthorized through 2013 with the passage of the Farm Bill. The reauthorization provisions outline criteria for when Exempt Commercial Market contracts should be considered a significant price discovery contract. The Exempt Commercial Market provisions enhance the CFTC’s “ability to monitor significant trading entities and better understand aggregate market risk and positions,” says Andy Nybo, senior analyst at Tabb Group, adding that reauthorization creates a level playing field in terms of transaction reporting and risk management, lowering risk across the futures industry.
Nymex President and CEO James Newsome said in a statement, “We believe that Congress correctly adopted a targeted approach in providing greater oversight and transparency for SPDCs which effectively had been off the CFTC’s radar screen.”
The reauthorization also enhances the CFTC’s authority over forex, closing a regulatory loophole created by the Zelener case of 2004. The agency’s anti-fraud authority now applies to certain retail off-exchange foreign currency transactions. Minimum capital requirements for futures commission merchants and retail foreign exchange dealers that act as counterparties in off-exchange retail foreign currency transactions also will be imposed. “This is an important piece of legislation to help the CFTC to go after illegal conduct in these markets,” says Brown-Hruska.