Government Considers Limits On Energy Trading, Faults "Excessive" Speculation

08/29/2009 05:12 am ET | Updated May 25, 2011

WASHINGTON — With consumers hit by oil price swings, federal regulators may be moving toward imposing limits on speculative energy trading, which some blame for price volatility.

The head of the U.S. agency weighing new curbs on Tuesday faulted "excessive" speculation but also underscored the role of financial investors in helping set fair prices that can benefit consumers.

As the WSJ reports this morning, the Commodity Futures Trading Commission is now admitting that oil speculators "played a significant role" in a sudden spike in the price of oil in the summer of 2008. That summer oil reached $147 per barrel, and the CFTC claimed the price increase was due to the forces of supply and demand. In an interview with the WSJ, Bart Chilton, one of the agency's four commissioners, said that analysis was based on "deeply flawed data."

Gary Gensler, chairman of the CFTC, said his agency must "seriously consider" imposing stringent limits on speculative trading of energy futures contracts, a move that would mark a major shift for the government.

At a hearing organized by the agency, Gensler said the futures exchanges have generally not used their authority to limit the size of positions taken by speculative players – something the Chicago Mercantile Exchange on Tuesday expressed willingness to do. And he cited the CFTC goal of preventing market power from being concentrated in a small number of powerful financial players.

"I believe we must seriously consider setting strict position limits in the energy markets," Gensler said.

Gensler said last week the agency may propose new rules setting limits in the fall, timing he didn't dispute on Tuesday.

However, he said, the agency has opened the debate to determine how new limits could reduce excessive speculation, "not how we can eliminate speculation." He said the CFTC recognizes the positive role played by the Wall Street firms and other speculators in the futures markets, which enable farmers, oil producers and oil users to hedge their risks and "have a marketplace where prices are determined in a fair and orderly way."

The CFTC is hearing from consumers, business, traders and big financial firms in a series of public hearings as it weighs whether to restrict the amount of trading in energy futures by those who are solely financial investors.

The volatility in oil prices "is totally unacceptable to the airline industry," testified Ben Hirst, general counsel of Delta Air Lines Inc., who was representing the industry's Air Transport Association. Delta itself consumes about 4 billion gallons a year of jet fuel and is hit with hundreds of millions in higher costs when crude oil prices rise, Hirst said. Any exemptions from limits on the size of trading positions should only go to companies in the energy industry and users of oil such as airlines, he said.

The futures contracts are supposed to reduce price volatility. But speculators use them to bet on market prices, and critics say this magnifies price swings. Regulators, they maintain, have long let speculation in energy markets inflict financial pain, triggering wild price swings, hurting gasoline wholesalers, damaging airlines and squeezing consumers at the gas pump and airline ticket counter.

Craig Donohue, the CEO of CME Group Inc. – owner of the Chicago Mercantile Exchange where energy futures are traded – said it is his firm, not the government, that is the proper authority to set new limits on energy trading. The CME is "prepared to act in the near term, before the (CFTC) or Congress," Donohue said.

By law, the CFTC sets limits on the amount of futures contracts in agricultural products like wheat, corn and soybeans that can be held by each market participant to protect the market against manipulation. But for energy commodities – crude oil, heating oil, natural gas, gasoline and other energy products – it is the futures exchanges themselves that set the position limits.

That divergent approach has prompted the examination by the CFTC of whether it should step in. The CFTC could adopt the new restrictions by late summer or early fall.

Commissioner Jill Sommers said the agency should carefully approach such intervention in the market. "It's clear to me that the unintended consequences can be significant."

But Bart Chilton, another commissioner, warned that speculative activity left unchecked "could have the same dangerous consequences."

In addition, Gensler said, the CFTC must ask Congress for new authority to set trading position limits in all commodities to prevent market players from moving to non-U.S. exchanges or to markets outside of exchanges.

Sen. Bernie Sanders, a Vermont independent, urged the CFTC commissioners to set strict limits on speculative oil trading. Americans are tired, he said, "of being ripped off at the gas pump by the same Wall Street gamblers" that brought the meltdown of financial markets.

Experts and economists are divided on whether speculative trading in the futures markets fans price volatility. Part of the confusion is that "hot" speculative money flows into energy commodities in numerous ways. The CFTC doesn't track all of them. So it's hard to quantify the impact of speculation.

The agency doesn't, for example, keep records of the speculative side bets that traders make. Nor does it monitor markets that include over-the-counter swaps – those that aren't traded on exchanges – by pension funds and other investors.

The free-market sentiment that held sway in Washington for years helps explain why regulators kept their hands off the volatile oil futures markets. The Bush administration generally opposed tighter regulation in the financial industry.

Among hedge funds and Wall Street banks that invest in and manage billions in commodities trading, the shift to a Democratic White House and a CFTC chairman appointed by President Barack Obama has raised fears of tighter regulation.

Gensler's confirmation was held up for months by senators who felt his stance had been overly deregulatory when he served in the Clinton administration's Treasury Department. But now Gensler seems eager to cast himself as a tough overseer.

Another reason why the agency's hands-off approach prevailed for so long, critics say, was the deep-pocketed financial industry and its lobbying muscle. The industry opposes new limits on speculative trading, arguing they would crimp the cash flowing through the market and drive business overseas.

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