In reversal, federal regulators now propose to limit oil and gas commodities

By Zachary A. Goldfarb
Washington Post Staff Writer
Friday, January 15, 2010; A18

With the price of gas at the pump at its highest point in well over a year, federal regulators moved Thursday to prevent excessive speculation by financial traders from driving the cost of oil even higher. The effort to adopt new limits on the trading of oil and other energy commodities is a sharp reversal after years when regulators left those markets alone.

The proposal from the Commodity Futures Trading Commission, which oversees oil and energy trading, would introduce new restrictions on what the largest traders can do. Concerned that some firms can amass such large holdings in energy commodities that their trades can have an outsize effect on the price of gasoline, heating oil or natural gas, officials said they would prevent traders "from establishing extraordinarily large positions."

New skepticism

The proposed limits highlight a newfound skepticism among regulators toward the financial sector. Big banks and Wall Street firms have transformed the marketplace for energy commodities into a high-stakes casino for speculation, a departure from its original role as a place where airline and shipping agencies, for instance, could buy contracts to keep the price of their fuel steady. Regulators are concerned that this betting has created too much volatility, sending the price of oil and other energy commodities up and down violently.

Oil prices hit a record high of $145 a barrel in 2008 before plunging to $33 a barrel in a matter of months. With the slow economic recovery, they have risen to about $80 a barrel. The instability in prices is caused by several factors, including overall economic conditions, the decisions of oil-rich nations and the weather -- in addition to financial speculation. So it remains difficult to determine how much any regulatory proposal would affect these price swings.

The agency's plan sets the new trading limits high enough that they would affect only 10 firms, agency officials said. They would not name the traders.

"While the proposed limits err on the high side, such levels would still ensure that the very largest traders' positions, those with the greatest potential for causing market contortions, would be limited," CFTC commissioner Bart Chilton said. "If limits were set too low, there would be a possibility" that traders would go overseas or to unregulated markets.

The CFTC voted to introduce the new proposal, and it is now open for 90 days of comment before the agency takes final action.

The agency's newly aggressive posture reflects the change of power in Washington. Democrats on Capitol Hill have long argued that Wall Street machinations led to volatile commodity prices, causing higher prices for consumers. President Obama's CFTC chairman, Gary Gensler, pledged early on to examine the issue. And the agency's chief lawyer, Dan Berkowitz, who has played a significant role in drafting the new proposal, was formerly a top aide to Sen. Carl M. Levin (D-Mich.), who ran investigations of commodity manipulation and has been calling for new limits.

"This proposal is mostly a signal that this administration is putting the cop back on the beat after a whole long window of lawlessness for energy exchanges," said John Parsons, the executive director of the Center for Energy and Environmental Policy Research at the Massachusetts Institute of Technology's Sloan School of Management.

Parsons said the proposal is a narrow attempt to block behavior by firms trying to manipulate the market and would not stop the price of oil and energy from rising and falling, sometimes rapidly. "This is preventing an individual trader from capturing a large enough position to manipulate or impact the price in an outsized way," he said.

Avoiding large positions

The proposed limit is designed to avoid a repeat of the experience with Amaranth, a $9 billion hedge fund that imploded in 2006. In a federal lawsuit, the CFTC alleged that Amaranth traders amassed such a large position in natural gas commodities that they were able to manipulate the price. The firm, which has become the poster child for this type of activity, agreed to pay $7.5 million to settle the charges. The agency said on Thursday that its proposed position limits would have constrained much of the hedge fund's activities.

Whether speculation drives up energy prices has long been in dispute. The CFTC itself issued a report last year saying there is no evidence that financial speculation has unhitched energy costs. Some critics of the new proposal argue that precipitous actions by the CFTC will drive trading away from the United States into less-regulated markets in Europe.

The proposal, which would take effect in March 2011, has limitations. It contains exemptions for companies that use energy contracts to offset real risks to their business, such as an airline, and it does not shed light on who the largest traders are. Nor does the CFTC's authority cover all trading in commodities, though financial reform legislation in Congress would change that.

The ultimate price of oil and energy commodities is determined far from wells in the Middle East or local gas stations or power companies. On electronic exchanges around the world, traders make bets every day on the future price of energy.

The CFTC used to regulate the energy market much more tightly, but it retrenched in the early 2000s as financial policymakers embraced a host of deregulatory measures they believed would lead to greater economic growth.

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