Statement Of Senator Carl Levin On Closing The Enron Loophole

December 13, 2007 -- "Mr. President, for the past five years, I’ve been working with my colleagues to close the Enron loophole that, since 2000, has exempted electronic energy markets for large traders from government oversight. This loophole opened the door to price manipulation and excessive speculation, and American consumers have been paying the price ever since with sky-high prices for crude oil, natural gas, gasoline, diesel fuel, home heating oil, propane, and other energy commodities vital to a functioning U.S. economy.

That is why I am pleased to stand before the Senate today in support of bipartisan legislation, sponsored by Senator Feinstein, myself, Senator Snowe and others, that will close the Enron loophole and put the cop back on the beat in all U.S. energy markets in an effort to stop price manipulation and excessive speculation.

I would like to thank a number of my colleagues for not only making this bipartisan legislation possible, but also agreeing to include it in the farm bill today. Senator Harkin, Chairman of the Committee on Agriculture, played a key role in getting us together and encouraging us to resolve our differences. Senator Chambliss, the Committee’s Ranking Republican, agreed to address the problems we identified and helped work through our differences. Senator Feinstein of California provided unending determination needed to get this problem solved. There are many more who played a critical role in this legislation as well, including Senator Bingaman, Senator Snowe, Senator Dorgan who cosponsored our original bill, S. 2058, the Close the Enron Loophole Act, and Senator Crapo who helped us produce a bipartisan product.

I thank not only the Senators, but also their staffs who put in many hours on this legislation, provided invaluable expertise, and repeatedly came up with creative solutions to tough problems. I would like to thank in particular Dan Berkovitz of my Subcommittee staff who has lived with this issue for the last five years and devoted so much time, work, and expertise to it.

A stable and affordable supply of energy is, of course, vital to the national and economic security of the United States. We need energy to heat and cool our homes and offices, to generate electricity for lighting, manufacturing, and vital services, and to power our transportation sector – automobiles, trucks, boats, and airplanes.

Over 80 percent of our energy comes from fossil fuels—oil, natural gas, and coal. About 50 percent is from oil and natural gas. The U.S. consumes around 20 million barrels of crude oil each day, over half of which is imported. About 90 percent of this oil is refined into products such as gasoline, home heating oil, jet fuel, and diesel fuel.

The crude oil market is the largest commodity market in the world, and hundreds of millions of barrels are traded daily in the various crude oil futures, over-the-counter, and spot markets. The world’s leading exchanges for crude oil futures contracts are the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange, known as ICE Futures in London.

Natural gas heats the majority of American homes, is used to harvest crops, powers 20% of our electrical plants, and plays a critical role in many industries, including manufacturers of fertilizers, paints, medicines, and chemicals. It is one of the cleanest fuels we have, and we produce most of it ourselves with only 15% being imported, primarily from Canada. In 2005 alone, U.S. consumers and businesses spent about $200 billion on natural gas.

Today, only part of the natural gas futures market is regulated. Natural gas produced in the United States is traded on NYMEX and on an unregulated ICE electronic trading platform headquartered in Atlanta, Georgia. The price of natural gas in both the futures market and in the spot or physical market depends on the prices on both of these U.S. exchanges.

The “Enron loophole” is a provision that was inserted at the last-minute, without opportunity for debate, into commodity legislation that was attached to an omnibus appropriations bill and passed by Congress in late December 2000, in the waning hours of the 106th Congress. This loophole exempted from U.S. government oversight the electronic trading of energy commodities by large traders. The loophole has helped foster the explosive growth of trading on unregulated electronic energy exchanges. It has also rendered U.S. energy markets more vulnerable to price manipulation and excessive speculation with resulting price distortions.

Since 2001, the Permanent Subcommittee on Investigations, which I chair, has been examining the vulnerability of U.S. energy commodity markets to price manipulation and excessive speculation. Beginning in 2002, we’ve held six days of hearings and issued four reports on issues related to inflated energy prices.

The Subcommittee first documented some of the weaknesses in U.S. crude oil markets in a 2003 staff report I released which found that crude oil prices were “affected by trading not only on regulated exchanges like the NYMEX, but also on unregulated ‘over-the-counter’ (OTC) markets which have become major trading centers for energy contracts and derivatives. The lack of information on prices and large positions in these OTC markets makes it difficult in many instances, if not impossible in practice, to determine whether traders have manipulated crude oil prices.”

In June 2006, the Subcommittee issued a staff report entitled, “The Role of Market Speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back on the Beat.” This bipartisan staff report analyzed the extent to which the increasing amount of financial speculation in energy markets had contributed to the steep rise in energy prices over the past few years. The report concluded that “[s]peculation has contributed to rising U.S. energy prices,” and endorsed the estimate of various analysts that the influx of speculative investments into crude oil futures accounted for approximately $20 of the then-prevailing crude oil price of approximately $70 per barrel.

The 2006 report recommended that the CFTC be provided with the same authority to regulate and monitor electronic energy exchanges, such as ICE, as it has with respect to the fully regulated futures markets, such as NYMEX, to ensure that excessive speculation in the energy markets did not adversely effect the availability and affordability of vital energy commodities through unwarranted price increases.

In June 2007, the Subcommittee released another bipartisan report, “Excessive Speculation in the Natural Gas Market.” Our report found that a single hedge fund named Amaranth had dominated the U.S. natural gas market during the spring and summer of 2006, and Amaranth’s large-scale trading significantly distorted natural gas prices from their fundamental values based on supply and demand.

The report concluded that the current regulatory system was unable to prevent these distortions because much of Amaranth’s trading took place on an unregulated electronic market and recommended that Congress close the “Enron loophole” that exempted such markets from regulation.

The repot describes in detail how Amaranth used the major unregulated electronic market, ICE, to amass huge positions in natural gas contracts, outside regulatory scrutiny, and beyond any regulatory authority. During the spring and summer of 2006, Amaranth held by far the largest positions of any trader in the natural gas market. According to traders interviewed by the Subcommittee, during this period natural gas prices for the following winter were “clearly out of whack,” at “ridiculous levels,” and unrelated to supply and demand. At the Subcommittee’s hearing in June of this year, natural gas purchasers, such as the American Public Gas Association and the Industrial Energy Consumers of America, explained how these price distortions increased the cost of hedging for natural gas consumers, which ultimately led to increased costs for American industries and households. The Municipal Gas Authority of Georgia calculated that Amaranth’s excesses increased the cost of their winter gas purchases by $18 million. Also at the hearing the New England Fuel Institute and the Petroleum Marketers Association of America made clear how rampant speculation in energy trading harms the smaller businesses that trade in energy commodities.

Finally, when Amaranth’s positions on the regulated futures market, NYMEX, became so large that NYMEX directed Amaranth to reduce the size of its positions on NYMEX, Amaranth simply switched those positions to ICE, an unregulated market that is beyond the reach of the CFTC. In other words, in response to NYMEX’s order, Amaranth did not reduce its size; it merely moved it from a regulated market to an unregulated market.

This regulatory system makes no sense. It is as if a cop on the beat tells a liquor store owner that he must obey the law and stop selling liquor to minors, yet the store owner is allowed to move his store across the street and sell to whomever he wants because the cop has no jurisdiction on the other side of the street and none of the same laws apply. The Amaranth case history shows it is clearly time to put the cop on the beat in all of our energy exchanges.

At the Subcommittee’s 2007 hearings, both of the major energy exchanges, NYMEX and ICE, testified that they would support a change in the law to eliminate the current exemption from regulation for electronic energy markets, in order to reduce the potential for manipulation and excessive speculation. Consumers and users of natural gas and other energy commodities—the American Public Gas Association, the New England Fuel Institute, the Petroleum Marketers Association of America, and the Industrial Energy Consumers of America—also testified in favor of closing the Enron loophole. That testimony helped galvanize the current effort to produce legislation in this area.

Just last week, my Subcommittee teamed up with Senator Dorgan’s Subcommittee on Energy to hold still another hearing examining how excessive speculation is continuing to add to crude oil prices, harming consumers and the American economy as a whole. During that hearing, Senators from both sides of the aisle expressed the need to develop new tools to address this problem. The legislation being added to the farm bill today will do just that. It will help fix a number of the problems identified in the Subcommittee’s hearings and reports. Most importantly, it will put an end to the Enron-inspired exemption from government oversight now provided to electronic energy trading markets set up for large traders. By ending that exemption, this legislation will restore the ability of the Commodity Futures Trading Commission (CFTC) to police all U.S. energy exchanges to prevent price manipulation and excessive speculation.

The legislation would do more than require CFTC oversight; it would also require electronic exchanges, for the first time, to begin policing their own trading operations and become self-regulatory organizations in the same manner as futures exchanges like NYMEX. Specifically, the legislation would establish five “core principles” to which electronic exchanges must adhere, each of which parallels core principles already applicable to other CFTC-regulated exchanges and clearing facilities. Implementing these core principles would require an electronic exchange to monitor the trading of contracts which the CFTC has determined affect energy prices, ensure these contracts are not susceptible to manipulation, require traders to supply information about these contracts when necessary, supply large trader reports to the CFTC related to these contracts, and publish daily trading data on the price, trading volume, opening and closing ranges, and open interest for these contracts.

In addition, the electronic exchanges would have to establish position limits and accountability levels for individual traders buying or selling these contracts in order to prevent price manipulation and excessive speculation. Electronic exchanges are intended to implement these position limits and accountability levels in the same way as futures exchanges like NYMEX. Moreover, it is intended that the CFTC will take steps to ensure that the position limits and accountability levels on all exchanges are comparable to prevent traders from playing one exchange off another.

In implementing these core principles, electronic exchanges are given the same flexibility accorded to other CFTC regulated entities, subject to CFTC approval. In addition, the legislation states explicitly that, when implementing the requirements for position limits, accountability levels, and emergency authority to require reductions of positions, the electronic exchanges are allowed to take into account differences between trades which are cleared and not cleared, and the CFTC would police implementation of those core principles in an appropriate manner recognizing those differences.

Although the legislation provides an electronic trading facility with flexibility to implement the core principles, in the same manner as futures exchanges have with respect to the core principles applicable to them, and the flexibility to take into account the differences between cleared and uncleared trades in certain circumstances, in all instances the CFTC has the ultimate responsibility and authority to interpret the core principles, establish rules or guidance as to how they should be applied, and determine whether a facility or exchange is complying with the core principles.

The legislation would also require electronic exchanges to establish procedures to prevent conflicts of interest and anti-trust violations in their operations. These provisions parallel core principles already applicable to other CFTC-regulated exchanges and clearing facilities and are intended to function in a similar manner. These provisions are not restricted to trades involving contracts that affect energy prices, but apply to the entire exchange to ensure it operates in a fair manner. In addition to requiring electronic exchanges to become self-regulatory organizations, the legislation would require the CFTC to oversee these exchanges in the same general way that it currently oversees futures exchanges like NYMEX. The legislation also, however, assigns the CFTC a unique responsibility not present in its oversight of other types of exchanges and clearing facilities. The legislation would require the CFTC to review the contracts on each electronic exchange to identify those which “perform a significant price discovery function” or, in other words, have a significant effect on energy prices. The CFTC would make this determination by looking at such factors as whether the electronic exchange’s contract is explicitly linked to a contract used on a futures exchange; whether the electronic exchange’s contract price is used by traders to set prices in other contracts; whether traders take positions in the contract and use those positions to arbitrage prices in other energy markets; and whether the contract is traded in sufficient volume to affect market prices. The CFTC can also look at other factors to determine if a contract is affecting energy prices. Contracts designated by the CFTC as performing a significant price discovery function are those that would be policed by both the exchange and the CFTC.

The legislation directs the CFTC to conduct a rulemaking to implement this requirement. The legislation also states clearly that a CFTC determination that a contract performs a significant price discovery function is a determination that is within the Commission’s discretion; this determination is not intended to be subject to formal challenge through administrative proceedings. The legislation would also require the CFTC to review the contracts at an electronic exchange on at least an annual basis to determine which perform significant price discovery functions. This review is not intended to require the CFTC to conduct an exhaustive examination of every contract traded on an electronic exchange, but instead to concentrate on those contracts that are most likely to meet the criteria for performing a significant price discovery function. The legislation also directs the electronic exchange to bring to the CFTC’s attention any contract which it believes is affecting energy prices.

To enable the CFTC to conduct oversight of its operations, in particular to prevent price manipulation and excessive speculation, electronic exchanges are required to file large trader reports with the CFTC for trades involving contracts that perform a significant price discovery function. These are the same large trader reports already filed by other CFTC-regulated exchanges and clearing facilities. In addition, electronic exchanges found to be trading contracts that perform a significant price discovery function are treated as a “registered entity” under the Commodity Exchange Act. This designation ensures that the CFTC has the same enforcement authority over electronic exchanges as it has with respect to other exchanges and clearing facilities to ensure compliance with its regulatory and statutory requirements.

One last issue. Another provision in the legislation states that its provisions are not intended to limit or affect the jurisdiction of the CFTC or any other agency involved with protecting our markets from price manipulation and excessive speculation. A legal battle is going on in the courts right now over enforcement actions by the CFTC and the Federal Energy Regulatory Commission accusing Amaranth of manipulating or attempting to manipulate natural gas prices. This legislation is not intended to affect that court battle in any way. We are all waiting to see how it plays out and how the courts will interpret the law. This legislation is intended to play an absolutely neutral role in those enforcement actions, and should not be interpreted as changing the status quo in any way.

The provisions I’ve just discussed are the product of lengthy negotiations and compromises over the best way to close the Enron loophole. They seek to provide stronger government oversight of U.S. energy markets, while preserving the legitimate trading operations of electronic exchanges like ICE. Senator Feinstein and I have introduced a number of bills over the years to tackle this problem, each of which took a somewhat different approach to strike the right balance. My latest effort, introduced a few months ago with Senator Dorgan and others, was S. 2058, the Close the Enron Loophole Act. While that bill is more comprehensive than the legislation being added to the farm bill today, the combined legislation before us now preserves our bill’s intent and ensures that both the exchanges and the CFTC can enforce prohibitions against price manipulation and excessive speculation. That, to me, is the most important aspect of the legislation and why I support it today.

The legislation reflects input from the CFTC, industry, consumer groups, and a wide range of Senators. Some compromises were made, but again, those compromises did not weaken the ability of the CFTC to police out energy markets – in fact, if this legislation is enacted into law, the CFTC will be in a stronger position since 2000 to protect our markets from trading abuses.

The House is working on similar legislation, so I am hopeful that we can get something enacted into law as part of the farm bill early next year. I will be working to ensure that the enforcement provisions we have worked so hard to include in this legislation are preserved.

In addition to these provisions closing the Enron loophole, the farm bill will include a host of other provisions to reauthorize and strengthen the Commodity Exchange Act. Those provisions include stronger civil and criminal penalties for manipulation, better enforcement authority for currency exchange trading abuses, among others, all of which I support. I thank my colleagues for including them in the farm bill as well.

Mr. President, preventing price manipulation and excessive speculation in U.S. energy markets is not an easy undertaking. I thank my colleagues, industry, consumers and others for their good-faith suggestions to improve the legislation that is now before the Senate. Recent cases have shown that market abuses and failures did not stop with the fall of Enron. They are still with us. We cannot afford to let the current situation continue, allowing energy traders to use unregulated markets to avoid regulated markets. It’s time to put the cop back on the beat in all U.S. energy markets. The stakes for our energy security and for competition in the market place are too high to do otherwise."

Source: Senator Carl Levin