We’re listening in on the Commodity Futures Trading Commission’s third day of hearings on energy market speculation this morning, which seem to have a heavy natural gas bias. One of the speakers will be Houston’s own John Arnold, head of Centaurus Energy Master Fund, a $5 billion energy hedge fund that focuses on natural gas and electricity trading.
Arnold will argue against some of the limits the CFTC is considering imposing on energy trades (which some of the exchanges have already implemented in anticipation of new rules). The text of his statement is below, but he will argue several points:
1. there should be hard limits on the number of physical commodity futures contracts that can be held by any one party, a limit that gets smaller as the expiration date approaches.
2. there should be no exemptions made to give larger limits to parties that are using the positions to hedge (he notes Centaurus has a hedge exemption).
3. there should be no hard limits on financially settled commodity futures.
This last point is already being undertaken by the New York Mercantile Exchange, where the natural gas futures price is considered the benchmark the whole market uses. Arnold argues this pushes trading activity away from exchanges to over-the-counter trades (i.e. private transactions directly between two parties, without the middleman of an exchange), increases price volatility (the amount prices swing up or down in a short period of time), and reduces liquidity.
These aren’t exactly new arguments, notes Craig Pirrong, a finance professor at the University of Houston who specializes in commodity markets (and other things), but he finds Arnold’s focus on how futures prices behave as the expiration date nears particularly interesting.
“He is right to focus on the issue of the integrity of the settlement price, and how to prevent distortions due to large traders stomping, taking advantage of rigidities in the delivery process to distort prices,” Pirrong said. “The key thing is to find the Goldilocks spot–enough activity in the market for the physical contract at expiration to ensure that the price accurately reflects supply and demand, but not so much activity of a type that can drive prices away from what fundamentals justify.”
Arnold’s prepared testimony also supports the arguments expected from John Hyland, the chief investment officer for U.S. Commodity Funds, an exchange traded fund that lets average investors play in the commodity markets without having to actually buy oil or gas futures directly.
Many believe such investors played a big part in last year’s oil and natural gas price run ups — including another panelist, Paul Cicio of the Industrial Energy Consumers of America, whose prepared statements are also below. But Arnold points to data showing that the volatility of natural gas has actually decreased as more investors have jumped in. Fellow panelist Phil Verleger will likely follow suit.
(Here are directions if you want to file comments with the CFTC on this topic.)
The question is whether CFTC commissioners will listen to a nuanced view like Arnold’s or just charge ahead on a mission to “Hang ‘Em (the speculators) High.”
The prepared statements from most of the participants are linked here, but below are Arnold and Cicio’s statements.
The first hour has been a sort of duel between Paul Cicio and John Hyland.
Cicio says the price run-ups of oil and natural gas last year and then the oil increase from $40 to $70 this year happened despite supply far outstripping demand. He has no smoking gun data that shows what’s driving it, but “common sense” would dictate it’s speculators.
Hyland says such claims are the same as one saying they “have no real data to back up my allegations” and are “little more than self-serving statistical gibberish.”
Here is John Arnold’s prepared testimony:
John Arnold Cftc August 3v3 With Appendix
Here is the prepared testimony of Paul Cicio of the Industrial Energy Consumers of America:
Paul Cicio CFTC Testimony August 5 2009