Investigations Subcommittee Releases Levin-Coleman Report On Excessive Speculation in the Natural Gas Market

Finds Hedge Fund Amaranth Distorted Prices Last Summer

WASHINGTON – On Monday, Senator Carl Levin (D-Mich.), Chairman of the Senate Permanent Subcommittee on Investigations, and Sen. Norm Coleman (R-Minn.), Ranking Minority Member, will hold a hearing and release a 130-page report entitled, Excessive Speculation in the Natural Gas Market, examining how trading by a single hedge fund, Amaranth LLC, led to high prices and extreme price volatility in the U.S. natural gas market in 2006. “In 2006, excessive speculation by a single large hedge fund, Amaranth Advisors, altered natural gas prices, caused wild price swings, and socked consumers with high prices,” said Levin. “It’s one thing when speculators gamble with their own money; it’s another when they turn U.S. energy markets into a lottery where everybody is forced to gamble with them, betting on prices driven by aggressive trading practices. Current commodity laws are riddled with exemptions, exclusions, and limitations that make it virtually impossible for regulators to police U.S. energy markets, particularly the Enron loophole which means regulators can apply excessive speculation limits to regulated markets like NYMEX, but not unregulated markets like ICE.” Levin added, “We need to put the cop back on the beat in all U.S. energy markets with stronger tools to stop price manipulation, excessive speculation, and trading abuses.” “This Report represents the culmination of the Subcommittee’s extensive bipartisan investigation into the impact of speculative trading on U.S. energy markets,” said Coleman. “We agree on the need to protect the integrity of our markets and I join with Senator Levin in making several bipartisan recommendations to do just that. The ongoing shift of energy trading to unregulated, over-the-counter electronic exchanges undermines the CFTC’s ability to monitor and prevent excessive speculation and price manipulation. Having said that, we must ensure that any proposed cure is not worse than the disease. The implementation of these recommendations must be clearly defined and targeted to preserve the integrity of our energy markets. If we extend CFTC oversight and regulation to electronic, over-the-counter exchanges, we must avoid unintended consequences – namely, we cannot drive traders to the far less transparent and unregulated markets.” A nine-month bipartisan Subcommittee investigation examined millions of trading records from the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE) to track and analyze natural gas prices during 2006. The Subcommittee report found that, from early 2006 until its September 2006 collapse, Amaranth dominated trading in the U.S. natural gas market, buying thousands of contracts for future delivery of natural gas on a daily basis. At some points in 2006, Amaranth held 100,000 natural gas contracts in a single month, and held 40% or more of the outstanding contracts on NYMEX for 2006. Amaranth traded natural gas contracts on both NYMEX and ICE, the two main U.S. energy exchanges. NYMEX is fully regulated by the Commodity Futures Trading Commission (CFTC), but ICE is exempt from regulation under the so-called Enron loophole that exempts from CFTC oversight electronic energy exchanges used by large traders. Trading data analyzed by the Subcommittee proves that both exchanges affect energy prices, that prices on one exchange affect prices on the other, and that traders treat NYMEX futures contracts as equivalent to ICE swaps for purposes of risk management and profit-taking. The key difference between the two exchanges is that one is regulated and the other is not. Because Amaranth traded extensively on ICE, which operates outside CFTC authority, neither the CFTC nor NYMEX had complete information about its natural gas holdings or trades. NYMEX was forced to make significant regulatory decisions on Amaranth’s trading based upon incomplete information. In August 2006, NYMEX told Amaranth to reduce its positions in certain NYMEX natural gas contracts. In response, Amaranth reduced its NYMEX holdings, but increased its holdings on ICE, where there are no trading limits. Amaranth’s actions demonstrate the inability of NYMEX and the CFTC to stop excessive speculation in energy while energy trades can occur on ICE without limit. To stop price manipulation and excessive speculation, the report recommends that Congress close the Enron loophole, which would enable the CFTC police both markets. It recommends that the CFTC strengthen its policies to stop excessive speculation. It also recommends that Congress provide increased CFTC funding and authorize the CFTC to collect user fees from commodity markets to help pay the expense. The Subcommittee has scheduled two days of hearings. The first day, on Monday, June 25th at 11:00 a.m. in Room 106 of the Dirksen Senate Office Building, will hear from natural gas consumers, academics, and Amaranth. The second day, on Monday, July 9th at 2:00 p.m., in Room 342 of the Dirksen Senate Office Building, will feature the CFTC, NYMEX, and ICE. The findings and recommendations of the report are attached. Copies of the report may be picked up from the Subcommittee at 199 Russell Senate Office Building. The report will be available online Monday morning, June 25, at 11 a.m. on the Subcommittee’s webpage, which can be accessed via http://hsgac.senate.gov/. FINDINGS AND RECOMMENDATIONS A. FINDINGS (1) A single hedge fund, Amaranth Advisors LLC, dominated the U.S. natural gas market in 2006. (a) Amaranth accumulated massive natural gas holdings on NYMEX and ICE spanning five years, from 2006-2010. (b) Amaranth accumulated such large positions and traded such large volumes of natural gas in 2006, on both NYMEX and ICE, that it had a direct effect on U.S. natural gas prices and increased price volatility in the natural gas market. The larger than usual differences between winter and summer futures prices that prevailed during the spring and summer of 2006 were largely the result of Amaranth’s large-scale trades rather than the normal market interaction of many buyers and sellers. (c) Amaranth’s 2006 positions in the natural gas market constituted excessive speculation. (2) In August 2006, Amaranth traded natural gas contracts on ICE rather than on NYMEX so that it could trade without any restrictions on the size of its positions. (a) When NYMEX directed Amaranth to reduce its positions in September 2006 and October 2006 natural gas futures contracts, Amaranth simply transferred those positions to ICE, an unregulated market, thereby maintaining its overall speculative position in the natural gas market. (b) NYMEX’s attempt to limit speculative trading during the last day of trading on the September 2006 natural gas futures contract failed, because neither NYMEX nor the CFTC had any authority, mandate, or ability to limit trading on ICE that affected the pricing of the NYMEX futures contract. (3) Amaranth’s actions in causing significant price movements in the natural gas market demonstrate that excessive speculation distorts prices, increases volatility, and increases costs and risks for natural gas consumers, such as utilities, who ultimately pass on inflated costs to their customers. (a) Purchasers of natural gas during the summer of 2006 for delivery in the following winter months paid inflated prices due to Amaranth’s speculative trading. (b) Many of these inflated costs were passed on to consumers, including residential users who paid higher home heating bills. (4) The two major U.S. exchanges that trade natural gas – NYMEX and ICE – affect each other’s prices. (a) Significant volumes of natural gas are traded on both NYMEX and ICE, and both markets play a key role in setting U.S. natural gas prices. (b) The contracts used on NYMEX and ICE to trade natural gas, called futures contracts on NYMEX and swaps on ICE, are equivalent financial products that serve the same risk-management purposes. (c) Traders routinely buy and sell natural gas contracts on both NYMEX and ICE, and hold positions in both markets. (d) The price of NYMEX futures and ICE swaps are virtually identical up until the final half hour of the last trading day of the NYMEX contract, when NYMEX and ICE prices typically differ by a few cents at most. (5) Current restraints on speculative trading to prevent manipulation and price distortions are inadequate. (a) The CFTC lacks statutory authority to establish or enforce speculative position limits on the trading of natural gas on ICE or other Exempt Commercial Markets. (b) When large traders choose to trade on ICE rather than NYMEX, it is difficult, if not impossible, for NYMEX to prevent price manipulation or excessive speculation from distorting NYMEX prices, because NYMEX does not have information regarding, or the jurisdiction to limit, trading on ICE even though ICE trades affect NYMEX futures prices. (c) The CFTC’s primary strategy to stop excessive speculation has been to prevent manipulation of the final price of a futures contract that is about to expire, rather than to generally review speculative trades affecting a range of futures contract prices. (6) The CFTC is unable to meet its statutory mandate to prevent market manipulation and excessive speculation from causing sudden, unreasonable, or unwarranted energy prices. (a) The CFTC lacks statutory authority to effectively oversee U.S. energy commodity markets, because the “Enron Loophole” prevents the CFTC from overseeing ICE. (b) The CFTC lacks budgetary, staff, and technological resources to effectively monitor energy commodity markets. (c) As a result of the lack of legal authority and budgetary resources, the CFTC was unable to prevent excessive speculation in the natural gas market in 2006. (d) If the CFTC is not provided with additional legal authority and resources, the CFTC will remain unable to accomplish its statutory mission. (e) The inability of the CFTC to accomplish its statutory mission with respect to the trading of energy commodities presents a threat to the energy and economic security of the United States. B. RECOMMENDATIONS (1) Congress should eliminate the “Enron Loophole” that exempts electronic energy exchanges from regulatory oversight. Experience since passage of the Commodity Futures Modernization Act of 2000, demonstrates there is no sound rationale for exempting electronic energy exchanges from regulatory oversight. Excessive speculation that occurred on electronic exchanges in 2006 contributed to the overall distortion of energy prices in the natural gas market, to the detriment of American consumers, businesses, industry, and utilities. Exempt Commercial Markets, such as ICE, should be required to comply with the same statutory obligations as Designated Contract Markets, such as NYMEX, and should be regulated in the same manner by the CFTC to prevent market manipulation and excessive speculation. To ensure fair energy pricing, it is time to put the cop back on the beat in all U.S. energy commodity markets. (2) If given additional legal authority, the CFTC should monitor aggregate positions on NYMEX and ICE. The CFTC and exchanges should strengthen their monitoring and oversight to prevent excessive speculation for all of the months in which contracts are traded, not just for contracts near expiration. (3) Congress should increase the CFTC budget and authorize CFTC user fees to help pay for the additional cost. The CFTC’s budget should be increased to provide the staff and technology needed to monitor, integrate, and analyze real-time transactional data from all U.S. commodity exchanges, including NYMEX and ICE. Needed funding should be obtained from user fees imposed on commodity markets. Contact: Tara Andringa 202-228-3685 Tara_Andringa@levin.senate.gov