Mr. Chairman, Congressman Peterson and Members of the Committee, I appreciate the opportunity to testify on behalf of the Commodity Futures Trading Commission concerning our oversight of energy futures and options markets.
The CFTC has been paying particularly close attention to futures trading in energy commodities because of the importance of energy prices and supplies to our nation’s consumers, producers, and its economy in general. Based on our surveillance efforts to date, we believe that crude oil and gasoline futures markets have been accurately reflecting the underlying fundamentals of these markets.
Futures markets play a critically important role in the U.S. economy. They provide risk management tools that producers, distributors, and commercial users of commodities use to protect themselves from unpredictable price changes. The futures markets also play a price discovery role as participants in related cash and over-the-counter markets look to futures markets to discover prices that accurately reflect information on supply, demand, and other factors. Both functions would be harmed by manipulation of prices.
The CFTC’s primary mission under the Commodity Exchange Act is to ensure that the commodity futures and options markets operate in an open and competitive manner, free of price distortions. The CFTC fulfills this obligation through a comprehensive, multi-faceted program that is designed to identify and mitigate the potential for manipulation and other market abuses, and to ferret out and punish illegal behavior.
CFTC market oversight begins with a review of the terms and conditions of a contract to determine it is not readily susceptible to manipulation. Once listed, CFTC staff closely monitors, on a real-time basis, trading on the exchanges to detect unusual activity or price aberrations that may indicate actual or attempted manipulation. The cornerstone of our market surveillance program is the Large Trader Reporting System, which requires traders to file daily reports concerning their own and their customers’ positions in a particular contract. Through Large Trader Reports, the CFTC becomes aware of concentrated and coordinated positions that might be used by one or more traders to attempt manipulations. In addition, each futures exchange is required under the CEA to supervise trading, prices, and positions and must impose trade position limits, where appropriate, to guard against manipulation.
When the CFTC’s surveillance staff identifies a potentially problematic situation, the CFTC engages in an escalating series of communications to work to resolve the situation. Typically, the CFTC’s staff consults and coordinates its activities with exchange regulatory staff. CFTC staff may contact the largest long- and short-side traders to obtain information on their delivery intentions and capability, and their price objectives in liquidating trades. The traders are advised of the CFTC’s concern regarding the orderly expiration of the futures contract, and reminded that they are expected to trade in a responsible manner. This “jawboning” activity by CFTC staff and the exchanges is usually quite effective in resolving most potential problems. Should more action be needed, however, the CFTC has broad authority to limit, liquidate or halt trading through its emergency powers. Fortunately, most issues are resolved without emergency action. In fact, the CFTC has only taken emergency action four times in its history but this authority represents an important hammer in our toolbox.
Should a violation of our Act occur, the CFTC aggressively pursues any individual that intentionally seeks to disrupt or undermine the integrity of our markets. The CFTC’s Division of Enforcement investigates and prosecutes individuals and entities for violations of our Act, including manipulation, false reporting, and trade practice abuses. Sanctions in prosecuted cases serve as a powerful deterrent for would-be violators and send a clear message that improper conduct will not be tolerated.
These investigations may be conducted in cooperation with the applicable exchanges and other regulators such as the Federal Energy Regulatory Commission. I would note that the CFTC and FERC entered into a Memorandum of Understanding last October that coordinates our joint activities in assuring the price integrity of the energy markets.
Also, the CFTC is an active member of the President’s Corporate Fraud Task Force. The Commission has referred, and will continue to refer, criminal matters involving energy markets to the Department of Justice for their further investigation.
Our policing of the energy markets reflects an approach to regulatory oversight that emphasizes tough enforcement against proven malfeasants. Since December 2002, the CFTC has filed 32 enforcement actions charging 27 companies and 23 individuals for misconduct in the energy markets, resulting in nearly 300 million dollars in penalties. And the Commission continues to pursue potential violators of our Act. Currently, there are over one dozen open investigations involving the energy markets. Real-time enforcement continues to serve as an important compliment to our surveillance of these markets.
In recent years, with increased economic growth in China and elsewhere, demand for petroleum products has risen faster than have supplies of these commodities – supplies which have been impacted by geopolitical instability among oil-producing nations, limited refinery capacity caused by Hurricanes Rita and Katrina, and the transition from MTBE to ethanol as a component of reformulated gasoline. This has created very tight demand/supply balances in these markets. Both supply and demand for crude oil and unleaded gasoline are price inelastic in the short run. As a result, near-term changes in supply or demand can have disproportionately large effects on price.
Although U.S. energy prices have been volatile in recent months, it is precisely during such volatile times when the risk-management and price-discovery features of futures markets are needed most by commercial users of energy products. All the evidence that we have seen is consistent with the notion that futures markets for crude oil, unleaded gasoline and natural gas and other energy products have been properly performing their risk management and price discovery roles. The staff of the Commission will continue to conduct very close surveillance of these markets to ensure that they remain functioning properly. Improper conduct will not be tolerated, and the CFTC will continue to pursue aggressive enforcement actions against those who break the rules.
Mr. Chairman, some have said that blaming the futures markets for high commodity prices is like blaming a thermometer for it being hot outside. The CFTC’s role is to ensure that no one is holding a match under the thermometer and in my view, we are doing an effective job.
Thank you and I look forward to your questions.
Last Updated: July 22, 2007