CFTC to shackle energy speculators

By Nicholas Zeman | December 21, 2009
Posted January 19, 2010

Some companies have lost billions of dollars betting the wrong way on agricultural and energy contracts. In the biofuels industries alone, there's VeraSun Energy Corp.'s corn bidding tragedy, which put it in the position for Valero Energy Corp. to swoop in. And certainly, biodiesel plants have been shuttered or sit idle because of "volatility in the marketplace."

But the Obama Administration has reinvigorated offices at the Commodities Futures and Trading Commission, which wants tighter restraints imposed on the big banks that often buy oil futures as a hedge against the weakening dollar. On Jan. 14, the CFTC held a public meeting in Washington where it proposed imposing position limits on the energy futures market.

CFTC's relatively new chairman, Gary Gensler, has been particularly outspoken against excessive speculation. Gensler was nominated by U.S. President Barack Obama and sworn in last May. Since then, he has also asked Congress for authority to regulate over-the-counter markets, where traders can sidestep restrictions.

If approved by the CFTC, the so-called position limits would apply to physically settled and cash-settled futures in light, sweet crude oil, Henry Hub natural gas, New York Harbor gasoline and No. 2 heating oil, a product that is often used as a price discovery mechanism in biodiesel trading.

Campaigns against excessive speculation are actually directed, however, at 10 of the biggest banks in the country, including JPMorgan Chase & Co., which retained its top spot among U.S. commercial banks, with $79 trillion in derivatives as of Sept. 30, as reported by the U.S Department of the Treasury. Goldman Sachs, Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. were the energy markets' next four biggest users. The five firms accounted for 97 percent of the notional amount of derivatives held as of September.

Realistically, there are only a handful of firms with bankrolls large enough and the potential to encroach on position limits. "Position limits are really meant to keep one player from wielding too much power in the marketplace," said Will Babler, a principal of First Capital Ag headquartered in Galena, Ill.

Biofuels production has contributed significantly to increasing links between agriculture and energy markets in recent years. Agricultural markets actually follow energy. When oil went up to $140 per barrel in the summer of 2008, corn, wheat and soybeans went right along with it to record historic figures between $8 per bushel and $15 per bushel. This was the culmination of the food-versus-fuel debate, which dogged the biofuels industry during that time.

"While we currently set and enforce position limits on certain agriculture products, we do not for energy markets," Gensler said at the close of the public meeting. "Though there are some differences between energy markets and agricultural markets, those distinctions do not suggest to me that the federal government should set position limits on one and not the other."

Speculators were blamed for the record busting prices and various shots have been taken at the group of traders who some believe drive up prices-standing long with an interest in seeing price spikes-while others say they perform an essential risk-absorption function in commodities trading.

"You have to be very careful about who you demonize in the marketplace," Babler said. "Risk transfer is the reason that the market exists."

In the biodiesel industry, its excessive capacity-not excessive speculation-that puts upward pressure on input prices. "The market is constantly rationing out feedstock demand," Babler said. First Capitol, a U.S. top 50 hedge broker and futures commission merchant, has been closely following this issue and the deliberations CFTC publicized last week. "There are too many biodiesel plants and there's not enough oil, so only the lowest cost producers can operate," he said.

Another Biodiesel Magazine source said he was "very uncomfortable" with the government deciding who was a speculator and who wasn't. Speculators in the futures market will no longer be lumped in with commodity-linked businesses, such as airlines and oil companies, which are allowed to exceed limits on the number of energy futures one trader can hold, according to the proposal.

"Nearly all economists that have carefully studied these markets have concluded that supply and demand fundamentals and other macroeconomic factors were the cause of these price movements," the Chicago Mercantile Exchange Group said in a 2009 report.

If enacted, new CFTC limits would apply to individual exchanges, spot-month contracts, all-months contracts, and would include a cumulative cap that would apply across the U.S. exchanges. "The basic formula for the level of the all-months-combined limit is the same-10 percent of the first 25,000 contracts of open interest plus 2.5 percent of open interest over 25,000 contracts," Gensler said. "The approach to setting the level of the spot-month limit in the physical delivery contracts is the same-25 percent of the estimated deliverable supply."
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