Opaque Commodity Trading: You'll Be Paying for it at the Pump

01/25/2011 04:31 pm ET | Updated May 25, 2011

The final dam to stopping $120-a-barrel oil and $4-a-gallon gas is being breached, as financial regulation continues its daily erosion into worthlessness.

Yesterday, Ohio Senator Sherrod Brown demanded that the Commodity Futures Trading Commission (CFTC) use the Dodd-Frank tools at their disposal to protect consumers and small business from artificially inflated energy prices. Yet, watching the CFTC attempt to back up Dodd-Frank legislation since it was passed has been like watching salmon flop upstream as the water drains out -- it's slow, arduous and likely to lead nowhere.

It is clear now that we will instead be witness to the highest prices for commodities ever, fueled by the biggest influx of profit-driven trading and investment ever, unstaunched even in the slightest by financial regulation legislation.

In my upcoming book, Oil's Endless Bid, due out from John Wiley & Sons in March, I argue that financial influences from investors and traders and the massive growth of derivatives markets have been the single most important factor for oil's high and unreliable price, far outstripping fundamental arguments of emerging market growth, peak oil or any other supply constraints or a devaluing dollar.

Putting controls on at least some of these speculative influences was supposed to be one of the goals of Dodd-Frank, but the actual rule-making to put teeth behind the legislation has been left to the Commodity Futures Trading Commission (CFTC). But, since it began writing proposals for rules in July 2010, the CFTC has literally been buried by the pushback from industry lobbyists, hired-gun lawyers, derivatives broker/dealers and virtually every industrial corporation with a trading desk that depends even marginally on derivatives activity to protect or augment profits.

The problem has been the virtual avalanche of opinion that has descended on the commissioners has been almost entirely from the industry side; no one has bothered to speak for the American public -- the consumer -- and the industry is lobbying for Dodd-Frank and the CFTC's profit-dissolving proposals to go away.

Consequently, there has been no substantive rule writing to date, despite the mandate of the legislation to have rules for energy markets in place by January, a deadline that the CFTC has already indicated it will miss.

Two specific areas have already convinced me that the rules will ultimately be toothless, business will proceed as usual and whatever is implemented will do nothing to curb the explosive price rises we've seen not only in oil, but in copper, corn, coffee and cotton last year.

Proposals on contract position limits, necessary to avoid any single participant from having overwhelming influence on prices, were argued previously in December without resolution.

Bart Chilton, the one commissioner committed to strict position-limits in futures markets has given up on a hard limit, proposing a much weaker "point system" to monitor participants, without any authority to force any limits or liquidation of positions.

If Chilton has given in on this crucial point, we shouldn't expect substantial position-limiting rules in futures markets to come from the CFTC. Indeed, the commission has tabled the entire issue until 2012, a year past their mandated deadline.

Another issue defining new swaps clearinghouses and who can own them has generated similar industry interest and push back. Creating "aggregately"-owned clearinghouses would help in transparency, fairness of access and help keep the clearing business competitive.

Undue influence by a small group of banks in a new Swaps Execution Facility (SEF) threatens independent control of these new trade nexuses and gives far too much of a trading advantage for the bank owners.

Republican commission members have agreed with investment bank lawyers and the Futures Industry Association (FIA) that even the proposed 40% ownership limit for any one participant is still too low. A recent Department of Justice opinion advocating third-party ownership of new SEFs has been excoriated by industry spokespersons representing the banks saying: "The DOJ letter's analysis appears deficient and fails to consider the relevant history and features of the derivatives markets."

The intention of Dodd-Frank legislation to create transparent swaps clearing is being lost: If allowed to majority-own these new SEF's, banks will enjoy pass-through clearing that will in name only be at all different from the bilateral clearing system that is already in place and has sunk derivative markets in the past.

The bottom line is that commodity trading isn't about to change one iota from the mechanisms that have caused one boom and bust cycle for oil already and is currently causing others in corn, coffee, copper and cotton.

A great opportunity to avoid the similar problems in oil and other commodities we saw in 2008 with credit default swaps and mortgage securities is being lost. Get ready for $4 gas and your local Starbucks brew heading north of 5 bucks -- all courtesy of the financial lobbyists, hedge fund traders, industry spokesmen and a brow-beaten CFTC.

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