[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]



 
         HEARING TO REVIEW TRADING OF ENERGY-BASED DERIVATIVES

=======================================================================


                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                        GENERAL FARM COMMODITIES
                          AND RISK MANAGEMENT

                                 OF THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                        THURSDAY, JULY 12, 2007

                               __________

                           Serial No. 110-26


          Printed for the use of the Committee on Agriculture
                         agriculture.house.gov


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                        COMMITTEE ON AGRICULTURE

                COLLIN C. PETERSON, Minnesota, Chairman

TIM HOLDEN, Pennsylvania,            BOB GOODLATTE, Virginia, Ranking 
    Vice Chairman                    Minority Member
MIKE McINTYRE, North Carolina        TERRY EVERETT, Alabama
BOB ETHERIDGE, North Carolina        FRANK D. LUCAS, Oklahoma
LEONARD L. BOSWELL, Iowa             JERRY MORAN, Kansas
JOE BACA, California                 ROBIN HAYES, North Carolina
DENNIS A. CARDOZA, California        TIMOTHY V. JOHNSON, Illinois
DAVID SCOTT, Georgia                 SAM GRAVES, Missouri
JIM MARSHALL, Georgia                JO BONNER, Alabama
STEPHANIE HERSETH SANDLIN, South     MIKE ROGERS, Alabama
Dakota                               STEVE KING, Iowa
HENRY CUELLAR, Texas                 MARILYN N. MUSGRAVE, Colorado
JIM COSTA, California                RANDY NEUGEBAUER, Texas
JOHN T. SALAZAR, Colorado            CHARLES W. BOUSTANY, Jr., 
BRAD ELLSWORTH, Indiana              Louisiana
NANCY E. BOYDA, Kansas               JOHN R. ``RANDY'' KUHL, Jr., New 
ZACHARY T. SPACE, Ohio               York
TIMOTHY J. WALZ, Minnesota           VIRGINIA FOXX, North Carolina
KIRSTEN E. GILLIBRAND, New York      K. MICHAEL CONAWAY, Texas
STEVE KAGEN, Wisconsin               JEFF FORTENBERRY, Nebraska
EARL POMEROY, North Dakota           JEAN SCHMIDT, Ohio
LINCOLN DAVIS, Tennessee             ADRIAN SMITH, Nebraska
JOHN BARROW, Georgia                 KEVIN McCARTHY, California
NICK LAMPSON, Texas                  TIM WALBERG, Michigan
JOE DONNELLY, Indiana
TIM MAHONEY, Florida

                                 ______

                           Professional Staff

                    Robert L. Larew, Chief of Staff

                     Andrew W. Baker, Chief Counsel

                 April Slayton, Communications Director

           William E. O'Conner, Jr., Minority Staff Director

                                 ______

      Subcommittee on General Farm Commodities and Risk Management

                BOB ETHERIDGE, North Carolina, Chairman

DAVID SCOTT, Georgia                 JERRY MORAN, Kansas, Ranking 
JIM MARSHALL, Georgia                Minority Member
JOHN T. SALAZAR, Colorado            TIMOTHY V. JOHNSON, Illinois
NANCY E. BOYDA, Kansas               SAM GRAVES, Missouri
STEPHANIE HERSETH SANDLIN, South     CHARLES W. BOUSTANY, Jr., 
Dakota                               Louisiana
BRAD ELLSWORTH, Indiana              K. MICHAEL CONAWAY, Texas
ZACHARY T. SPACE, Ohio               FRANK D. LUCAS, Oklahoma
TIMOTHY J. WALZ, Minnesota           RANDY NEUGEBAUER, Texas
EARL POMEROY, North Dakota           KEVIN McCARTHY, California

               Clark Ogilvie, Subcommittee Staff Director

                                  (ii)
                             C O N T E N T S

                              ----------                              
                                                                   Page
Etheridge, Hon. Bob, a Representative in Congress from North 
  Carolina, opening statement....................................     1
Graves, Hon. Sam, a Representative in Congress from Missouri, 
  prepared statement.............................................     4
Moran, Hon. Jerry, a Representative in Congress from Kansas, 
  opening statement..............................................     2
    Prepared statement...........................................     2
Peterson, Hon. Collin C., a Representative in Congress from 
  Minnesota, opening statement...................................     3
    Prepared statement...........................................     3

                               Witnesses

Lukken, Hon. Walter, Acting Chairman, Commodity Futures Trading 
  Commission, Washington, D.C....................................     4
    Prepared statement...........................................     7
Williams, Orice M., Director, Financial Markets and Community 
  Investment, U.S. Government Accountability Office, Washington, 
  D.C............................................................    14
    Prepared statement...........................................    16
Newsome, Ph.D., James E., President and CEO, New York Mercantile 
  Exchange, Inc., New York, NY...................................    39
    Prepared statement...........................................    41
Sprecher, Jeffrey C., Founder, Chairman, and CEO, 
  IntercontinentalExchange, Inc., Atlanta, GA....................    47
    Prepared statement...........................................    48
Pickel, Robert G., Executive Director and CEO, International 
  Swaps and Derivatives Association, New York, NY................    53
    Prepared statement...........................................    55
Corbin, Arthur, President and CEO, Municipal Gas Authority of 
  Georgia, Kenesaw, GA; on behalf of American Public Gas 
  Association....................................................    60
    Prepared statement...........................................    62
Cicio, Paul N., President, Industrial Energy Consumers of 
  America, Washington, D.C.......................................    68
    Prepared statement...........................................    69
Eerkes, Craig, President, Sun Pacific Energy; Chairman, Petroleum 
  Marketers Association of America, Kennewick, WA; on behalf of 
  New England Fuel Institute.....................................    71
    Prepared statement...........................................    72

                           Submitted Material

Submitted question...............................................    85


         HEARING TO REVIEW TRADING OF ENERGY-BASED DERIVATIVES

                              ----------                              


                        THURSDAY, JULY 12, 2007

                  House of Representatives,
 Subcommittee on General Farm Commodities and Risk 
                                        Management,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Subcommittee met, pursuant to call, at 10 a.m., in Room 
1300 of the Longworth House Office Building, Hon. Bob Etheridge 
[Chairman of the Subcommittee] presiding.
    Members present: Representatives Etheridge, Scott, 
Marshall, Boyda, Space, Walz, Pomeroy, Peterson (ex officio), 
Barrow, Moran, Graves, Boustany, Conaway, Neugebauer, McCarthy, 
and Goodlatte (ex officio).
    Staff present: Tyler Jameson, Scott Kuschmider, Clark 
Ogilvie, John Riley, Sharon Rusnak, Debbie Smith, Kristin 
Sosanie, Bryan Dierlam, Kevin Kramp, and Jamie Weyer.

 OPENING STATEMENT OF HON. BOB ETHERIDGE, A REPRESENTATIVE IN 
                  CONGRESS FROM NORTH CAROLINA

    The Chairman. This hearing of the Subcommittee on General 
Farm Commodities and Risk Management to review the trading of 
energy-based derivatives will come to order. Let me welcome 
you. After months of working on the farm bill, this 
Subcommittee turns its attention to an area that not only 
impacts our farmers, but every man, woman and child in America, 
the trading of energy-based derivatives.
    The futures industry impacts our lives every single day. 
Derivatives trading provides customers with forms of price 
discovery and price hedging for a wide variety of commodities 
and financial instruments. We are talking about a trillion 
dollar industry that impacts the price of corn, wheat, soybeans 
that go into our food products; the price of meat at the 
grocery store; price of gas we are paying for at the pumps; 
price of energy to heat our homes; the interest rates we pay on 
our credit cards; the interest you pay on your mortgages; the 
price of metals that go into products that we buy and many 
other things that we use every single day.
    In 2000 Congress took a bold step in dramatically amending 
the Commodities Exchange Act and changing our system of 
derivatives markets regulation. As you will recall, it wasn't 
easy. Congress was faced with several different and often 
conflicting paths toward change offered by a wide variety of 
industry participants, but boldness was necessary in the face 
of technological advances within the industry and increased 
foreign competition in derivative business. With the Commodity 
Futures Modernization Act of 2000, Congress delivered.
    And we have seen the results of the work of Congress. The 
volume of derivatives and option contracts traded have more 
than tripled; the number of tradable products have increased by 
almost as much. The number of participants trading in this area 
has likewise skyrocketed, all of which has provided more 
opportunities for price discovery and more opportunities to 
hedge against risk. Now here we are, almost 7 years removed 
from that point and perhaps naturally, people are starting to 
feel the 7 year itch. They are asking questions about whether 
the regulatory regime we created in 2000 is appropriate for 
every commodity; or whether we should increase the Commodity 
Futures Trading Commission's authority in some areas.
    Therefore it is an appropriate time for us to review what 
is happening in the energies derivative market, as well as the 
CFTC's oversight of these markets. Today we hear from the 
regulators of these markets, as well as from the government's 
accounting arm, which has been conducting its own review of 
what has taken place in these markets. We will also hear from a 
variety of players who will bring different perspectives to 
what role the government should play in overseeing these 
markets.
    I hope my colleagues will find this hearing informative. I 
know I am looking forward to hearing today's testimony from our 
witnesses; want to welcome all of you here this morning; and 
thank those of you who are going to testify for being here.
    Now I turn to my colleague, the gentleman from Kansas, Mr. 
Moran, for his opening statement.

  OPENING STATEMENT OF HON. JERRY MORAN, A REPRESENTATIVE IN 
                      CONGRESS FROM KANSAS

    Mr. Moran. Mr. Chairman, I am pleased to join you here this 
morning. I appreciate the opportunity to hear from these 
witnesses. I thank them for their time and their expertise. 
This Committee, the House Committee on Agriculture, takes its 
jurisdiction of the commodities futures industry seriously. 
This hearing is one more example of our efforts to make certain 
that adequate oversight is being provided to an industry that, 
as you described, is very important to the consumers in the 
U.S., as well as the world economy. So I am anxious to hear 
what our witnesses have to say and with that, Mr. Chairman, I 
would ask you to proceed.
    [The prepared statement of Mr. Moran follows:]

 Prepared Statement of Hon. Jerry Moran, a Representative in Congress 
                              From Kansas
    Thank you Mr. Chairman. We are here today to gather information 
regarding energy markets in the United States. We have before us a 
diverse group that includes witnesses from the Commodity Futures 
Trading Commission (CFTC), which is tasked with overseeing the 
commodity futures and options markets; a designated contract market 
(DCM); an exempt commercial market (ECM); and industry users of energy 
products. It is my hope that we can have an open discussion about how 
energy markets function in this country and how oversight levels of 
those markets can be properly established, while at the same time 
maintaining vibrant markets that allow adequate risk management 
mechanisms for all market participants.
    Recently, there has been much discussion about the level of market 
surveillance and position regulation needed in regard to ECM's. This 
Subcommittee has an important role in ensuring that the CFTC has the 
necessary tools it needs to monitor markets and provide enforcement 
against market participants that might choose to manipulate markets. In 
making determinations of whether existing oversight and enforcement 
tools are sufficient, however, Congress must proceed in a deliberate 
and adequately informed manner.
    Issues regarding commodity markets are without doubt complex. In 
crafting market regulations, proper consideration must be given to the 
differences between ECM's and DCM's. For instance, we must recognize 
that DCM's involve commodities of finite supply that are subject to 
delivery upon contract expiration, whereas ECM's typically involve 
contracts where no deliverable commodity is involved. Furthermore, we 
must consider the type of participants that are involved in each 
respective market. The underlying fundamentals of the cash market 
should also be taken into account. Finally, it should be considered 
what affect imposing further limitations on ECM's will have on 
commodity and derivative markets. If position limits are imposed on 
ECM's will participants in these markets shift their business to fully 
exempt over-the-counter bilateral markets and result in less oversight; 
or will these market participants simply shift their transactions to 
foreign exchanges?
    These are all questions that must be answered. Since passage of the 
Commodity Futures Modernization Act (CFMA), commodity markets have 
exponentially increased in size and scope. Arguably, this has helped to 
promote competitive markets and bring new liquidity to traditional 
commodity markets. It is Congress' responsibility to hear from today's 
witnesses and determine what action is needed to ensure that CFTC has 
the necessary authority to carry out its mission to protect the public 
and market users from manipulation and fraud and ensure competitive and 
open commodity markets. I would like to thank all the witnesses for 
appearing today and I look forward to your testimony.

    The Chairman. I thank you and I now recognize the Chairman 
of full Committee, Mr. Peterson, for any comments he might 
have.

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE 
                   IN CONGRESS FROM MINNESOTA

    Mr. Peterson. I thank you, Mr. Chairman, and I want to 
thank you and the Ranking Member for your leadership and 
continuing attention to this issue and others under your 
jurisdiction. And I want to associate myself with your and the 
Ranking Member's remarks. I have a statement I will just make 
part of the record because we all have plenty to do and we 
might as well get on with things.
    [The prepared statement of Mr. Peterson follows:]

  Prepared Statement of Hon. Collin C. Peterson, a Representative in 
                        Congress From Minnesota
    Thank you, Mr. Chairman, for calling this hearing today.
    Today, we will look into trading of energy derivatives, the growth 
of the derivatives industry, and what that growth means in the 
establishment of fuel prices. Since 2000, the last time Congress 
addressed the derivatives markets, the volume of futures and options 
contracts trading on U.S. exchanges have more than tripled. The number 
of tradable products available on these exchanges has also increased 
dramatically.
    We all recognize the importance of derivatives markets and the role 
that producers, hedgers, and yes, even speculators play in them. 
Active, transparent markets provide valuable benefits to the public in 
the form of efficient price discovery and the ability for businesses to 
hedge risks, allowing them to withstand periods of unfavorable or 
volatile prices. Every farmer, food processor and energy consumer 
benefits from open, transparent markets. Consequently, every one of us 
pays the price if the futures markets are manipulated or distorted. 
Farmers are especially affected by volatility and price run-ups in 
these markets and are not able to pass costs along to consumers the way 
other industries can in the form of surcharges. Throughout the farm 
bill debate, for example, I have heard from farmers everywhere that, 
yes, commodity prices are high, but so are input costs like gasoline, 
diesel fuel and fertilizer.
    A major issue confronting futures market regulators is the growth 
of exempt commercial markets and the over-the-counter (OTC) market for 
energy derivatives, which are subject to different levels of oversight 
under the Commodity Futures Modernization Act of 2000. For example, 
trading on exempt commercial markets like IntercontinentalExchange is 
not subject to position limits like its competitor, the New York 
Mercantile Exchange.
    The CFTC believes it has sufficient oversight capabilities through 
existing anti-fraud and anti-manipulation measures to deal with market 
problems. I am sure the members of our second panel will have points of 
view that both agree and disagree with this assessment. I look forward 
to their testimony and for their thoughts with regard to the structure 
of our regulatory system.
    I welcome today's witnesses and I yield back my time.

    The Chairman. I thank the gentleman and the chair would 
request that other Members submit their opening statements for 
the record so the witnesses may begin their testimony and will 
ensure ample time for questions.
    [The prepared statement of Mr. Graves follows:]

  Prepared Statement of Hon. Sam Graves, a Representative in Congress 
                             From Missouri
    The natural gas trade concerns me greatly because of the impacts on 
the end-users including farmers, manufacturers, and seniors on a fixed 
income. Spikes in price that have been created artificially through 
speculation and manipulation should not be tolerated in any venue where 
the commodity is traded, including on exempt commercial markets (ECM) 
(i.e., ICE) and on over-the-counter (OTC) markets. For these reasons, I 
support expanding transparency and oversight to these areas. My 
intention is to eliminate market manipulation.
    Please know that as we move forward in this debate that I plan to 
engage on this issue to see my concerns addressed.
            Thank you,
            
            

    The Chairman. We would like to welcome our first panel to 
the table, the Honorable Walter Lukken, Acting Chairman of the 
Commodity Futures Trading Commission, and Ms. Orice M. 
Williams, Director of Financial Markets and Commodity 
Investments of U.S. Government Accounting Office. Mr. Lukken, 
please begin when you are ready, sir, and your full statements 
will be made a part of the record and if you would, please, try 
to summarize your statement within 5 minutes.

  STATEMENT OF HON. WALTER LUKKEN, ACTING CHAIRMAN, COMMODITY 
                  FUTURES TRADING COMMISSION,
                        WASHINGTON, D.C.

    Mr. Lukken. Thank you, Mr. Chairman, Representative Moran 
and Members of the Subcommittee. I am pleased to testify on 
behalf of the Commodity Futures Trading Commission, and I 
appreciate the opportunity to discuss the CFTC and our role 
with respect to the energy markets. The CFTC pays close 
attention to the futures trading in energy commodities because 
of the importance of energy prices and supplies to our nation's 
consumers, producers and the economy, in general. Our agency is 
well aware of the reliance of the agricultural sector on 
various sources of energy. Based on our surveillance efforts 
today, we believe that energy futures have, over all, been 
reflecting the underlying fundamentals of supply and demand.
    The futures industry plays a critical role in the U.S. and 
global economy. It provides risk management tools that 
producers, distributors and commercial users of commodities use 
to protect themselves from unpredictable price changes. These 
markets also play a price discovery role for commercial 
interests seeking a centralized price reflective of supply and 
demand. Both functions would be harmed by manipulation or the 
perception of foul play. The success of these markets can be 
attributed, in part, to the principles-based approach that 
Congress adopted with the Commodity Futures Modernization Act 
in 2000 under the leadership of this Subcommittee. Trading 
volume on U.S. futures markets has expanded 400 percent in less 
than 10 years due to the flexibility of the CFMA and the 
rejection of the one-size-fits-all prescriptive approach to 
regulation. As we discuss energy derivatives today, we must be 
mindful of how successful the U.S. futures industry has been 
under the current regulatory framework.
    The Commission has exclusive jurisdiction over commodity 
futures and options contracts traded on Designated Contract 
Markets, or DCMs. The CFTC's market surveillance mission 
regarding DCM activity is to ensure that commodity futures and 
options operate in an open and competitive manner, free of 
price distortions. The CFTC fulfills this obligation through a 
comprehensive program that is designed to identify and mitigate 
the potential for manipulation and other market abuses. CFTC's 
staff closely monitors trading on exchanges to detect unusual 
activity or price aberrations that may indicate manipulation.
    The cornerstone of our market surveillance program is a 
large trader reporting system which requires traders to file 
daily reports concerning their positions in a particular 
contract. Through large trader reports, the CFTC becomes aware 
of concentrated positions that might be used to manipulate the 
market. When the CFTC's surveillance staff identifies a 
problematic situation, the CFTC engages in an escalating series 
of communications to work to resolve the situation. The traders 
are advised of the CFTC's concern and reminded that they are 
expected to trade in a responsible manner. This activity by 
CFTC is usually quite effective. Should more action be needed, 
however, the CFTC has the authority to limit, liquidate or halt 
trading through its emergency powers.
    Should a violation of our Act occur, the CFTC aggressively 
pursues any individual that intentionally seeks to disrupt the 
integrity of our markets. The CFTC's Division of Enforcement 
investigates and prosecutes violations of our Act, including 
manipulation, false reporting and trade practice abuses. 
Sanctions and prosecuted cases serve as a powerful deterrent 
for would-be violators and send a clear message that improper 
conduct will not be tolerated.
    In addition to energy futures traded on a regulated 
exchange, Congress included a provision in the CMFA permitting 
a new type of trading facility known as an Exempt Commercial 
Market, or ECM, on which exempt commodities, such as energy 
products, may be traded. Only eligible commercial entities, 
generally, institutional traders, may trade on ECMs, ensuring 
that these markets are open only to sophisticated parties. ECMs 
are exempt from most provisions of the Act, however, the CFTC 
does retain fraud and manipulation authority over ECMs. ECMs 
are subject to certain limited reporting requirements to the 
CFTC. In addition, ECMs must maintain, for 5 years, certain 
records, including audit trail information sufficient to 
reconstruct trading activity. The Commission also has the 
authority to issue what is known as a special call for any 
information that the ECM may have of interest to us.
    The futures markets have changed dramatically since the 
passage of the CFMA and the creation of the ECM category. This 
designation has encouraged tremendous innovation and growth for 
these institutional markets, while attempting to calibrate the 
amount of oversight to the risks associated with them. These 
exempt markets have increased competition, advanced the 
adoption of electronic trading and lowered costs for 
derivatives trading. However, certain contracts on regulated 
futures markets and ECMs have become increasingly linked and as 
a result, the public risks associated with these products may 
have changed.
    The CFTC has recognized this and exercised its existing 
authorities in order to keep pace. For example, through our 
special call authority, the CFTC is now obtaining, daily, 
natural gas trading information from the 
IntercontinentalExchange that is similar to our large trader 
reports, providing a more comprehensive picture of the 
marketplace. More recently, the CFTC proposed to clarify that 
large traders on DCMs are required to keep information 
regarding all their related positions, including over-the-
counter data and to provide that information to the Commission 
upon request.
    These measures have and will improve our oversight of these 
markets. However, the CFTC is nearing the boundaries of its 
authorities in this area. A part of the CFTC's reauthorization 
debate, and the broader energy policy discussion, has been the 
question of increased regulation of ECMs. Several legislative 
ideas have been suggested and all are worthy of thoughtful 
discussion. As this Committee fully understands, this is a 
complicated matter with difficult legal and policy issues. 
However, protecting the integrity of the price discovery 
process should be our utmost priority, given its broad impact 
on consumers and the Commission stands ready to lend its 
expertise in finding the right solutions.
    Lawmakers should be precise when considering additional 
regulation, given these electronic markets can move off-shore 
or into more opaque venues. In our capital markets, 
policymakers are focusing on whether current regulatory 
structures are having a negative effect on U.S. 
competitiveness, as evidenced by three independent bipartisan 
studies on the subject. Fortunately, the U.S. derivatives 
markets enjoy a competitive advantage internationally and have 
grown their market shares since the passage of the CFMA.
    As policy changes are contemplated, Congress should be 
mindful of these global market concerns and should not undo the 
broader benefits that the CMFA has provided this industry. In 
my new role as acting Chairman, I look forward to working with 
this Committee, others in Congress and my fellow regulators to 
ensure that the nation's energy markets remain open and 
competitive, free from price distortions and fraud. The 
Commission will continue to devote all necessary resources and 
expertise to achieve this important national goal. Thank you 
and I look forward to your questions.
    [The prepared statement of Mr. Lukken follows:]

 Prepared Statement of Hon. Walter Lukken, Acting Chairman, Commodity 
              Futures Trading Commission, Washington, D.C.
    Thank you, Mr. Chairman and Members of the Committee. I am pleased 
to testify on behalf of the Commodity Futures Trading Commission (CFTC 
or Commission), and I appreciate the opportunity to discuss the CFTC 
and our role with respect to energy derivatives trading.
    The CFTC continues to pay close attention to futures and options 
trading in energy commodities because of the importance of energy 
prices and supplies to our nation's consumers, producers, and its 
economy in general. Our agency is also well aware of the reliance of 
the agricultural sector on various sources of energy that provide fuel 
for field implements, feedstock for fertilizer and power for grain-
drying equipment, to name a few uses. Based on our surveillance efforts 
to date, we believe that energy futures markets have been reflecting 
the underlying fundamentals of these markets.
    Futures and options 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 and options 
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.
Overview of Energy Trading
    Trading in energy commodities takes place principally in three 
different ways: (1) on designated contract markets (DCMs), such as the 
New York Mercantile Exchange (NYMEX); (2) on exempt commercial markets 
(ECMs), such as the IntercontinentalExchange (ICE); and (3) in over-
the-counter bilateral transactions.
    On-exchange trading of energy commodities takes place on DCMs, 
which operate as price discovery and risk management facilities. Off-
exchange trading of energy commodities can take place on electronic 
trading facilities known as ECMs, which operate without being 
designated as contract markets by the CFTC. Transactions on ECMs are 
entered into on a principal-to-principal basis only between ``eligible 
commercial entities'' as defined by the Commodity Exchange Act (CEA). 
Finally, off-exchange trading of energy commodities among wealthy, 
sophisticated participants, ``eligible contract participants'' as 
defined by the CEA, can also occur in bilateral transactions that do 
not take place on a trading facility. Each of these three ways of 
trading energy commodities is subject to varying levels of CFTC 
regulation under the CEA.
CFTC Mission
    The CFTC's mission is two-fold: to protect the public and market 
users from manipulation, fraud, and abusive practices; and to promote 
open, competitive and financially sound markets for commodity futures 
and options.
    Congress created the CFTC in 1974 as an independent agency with the 
mandate to regulate commodity futures markets, and later option 
markets, in the United States. To do this, the Commission employs a 
highly-skilled and dedicated staff who work within three major 
programs--Market Oversight, Clearing and Intermediary Oversight, and 
Enforcement. These divisions have distinct and separate charges and 
standards to meet, while working in conjunction to ensure market 
integrity and economic opportunity. The three major Commission programs 
are complemented by other offices, including the Office of the Chief 
Economist, Office of the General Counsel, Office of International 
Affairs and Office of Proceedings. The Chairman and Commissioners' 
offices provide agency direction, and stewardship over CFTC's human 
capital, financial management, and information technology resources.
CFTC Division of Market Oversight
    The CEA provides that the Commission has exclusive jurisdiction 
with respect to accounts, agreements, and transactions involving 
commodity futures and options contracts that are required to be traded 
or executed on a designated contract market, also known as a DCM or an 
exchange. One of the purposes of the CEA is ``to serve the public 
interests . . . through a system of effective self-regulation of 
trading facilities . . . under the oversight of the Commission.'' \1\ 
DCMs are regulated entities that are self-regulatory organizations 
(SROs) subject to comprehensive oversight by the CFTC. DCMs can list 
for trading any type of contract, they can permit intermediation, and 
all types of traders (including retail traders) are permitted to 
participate in their markets. The CFTC's Division of Market Oversight 
(DMO) is responsible for monitoring and evaluating a DCM's operations 
and it conducts surveillance of all activity on DCMs, as described 
below.
---------------------------------------------------------------------------
    \1\ CEA Section 3(b), 7 U.S.C.  5(b).
---------------------------------------------------------------------------
    DCMs must comply with a number of designation criteria and core 
principles as a condition for initial CFTC approval and continuing 
operation. Once operational, DCMs, as SROs, must establish and devote 
resources toward an effective oversight program, which includes 
surveillance of all activity on their markets to detect and deter 
manipulation and trading abuses. That responsibility includes, among 
other things, ensuring that listed contracts are not readily 
susceptible to manipulation, addressing conflict of interest 
situations, ensuring fair trading, providing for the financial 
integrity of contracts, utilizing effective rules to deal with market 
emergencies, and complying with comprehensive reporting and record 
keeping requirements. DMO staff review all exchange new product and 
rule filings to ensure that they comply with the core principles set 
forth in the Act and the Commission's regulatory requirements.
    DMO's market surveillance mission regarding DCM activity is to 
ensure market integrity and customer protection in the futures markets. 
Traders establishing positions on DCMs are subject to reporting 
requirements so that DMO staff and the DCM can evaluate position sizes 
to detect and deter manipulation. In addition, trade practice 
surveillance involves compilation and monitoring of transactional-level 
data by the Commission and the DCM to detect and deter abusive trading 
such as wash sales, money laundering and trading ahead of customers 
(trade practice surveillance). The surveillance staff conducts active 
market and trade practice surveillance of all futures and options 
trading activity that occurs on DCMs.
    Under the CEA, the primary mission of market surveillance is to 
identify situations that could pose a threat of manipulation and to 
initiate appropriate preventive actions. Each day, for the estimated 
1,400 active futures and option contracts in the U.S., DMO market 
surveillance staff monitors the activities of large traders, key price 
relationships, and relevant supply and demand factors to ensure market 
integrity.
    The market surveillance staff focuses, for example, on looking for 
large positions, especially in comparison to potential deliverable 
supply of the commodity. Such a dominant position might provide a 
trader an opportunity to cause a price manipulation, such as in a 
``squeeze,'' in which, for example, a single trader might hold a large 
long (buy-side) position and demand delivery of more of a commodity 
than is available for delivery. In such a situation, traders holding 
short (sell-side) positions may have no alternative but to buy back 
their positions at artificially high prices dictated by the dominant 
long trader.
    The market surveillance program uses many sources of daily market 
information. Some of this information is publicly available, including 
data on: the overall supply, demand, and marketing of the underlying 
commodity; futures, option and cash prices; and data on trading volume 
and open contracts. Some of the information is highly confidential, 
including position and trading data that the Commission regularly 
receives from DCMs, intermediaries, and large traders.
    DCMs report to the Commission the daily positions and transactions 
of each of their clearing members. The data are transmitted 
electronically during the morning after the ``as of'' trade date. They 
show separately, for proprietary and customer accounts, the aggregate 
position and trading volume of each clearing member in each futures and 
option contract. The data are useful for quickly identifying the firms 
that clear the largest buy or sell volumes or hold the biggest 
positions in a particular market. The clearing member data, however, do 
not identify the beneficial owners of the positions.
    To address this limitation, DMO uses a large-trader reporting 
system. Under this system, clearing members, futures commission 
merchants (FCMs), and foreign brokers (collectively called ``reporting 
firms'') electronically file daily reports with the Commission. These 
reports contain the futures and option positions of individual traders 
that hold positions above specific reporting levels set by Commission 
regulations, and allow DMO staff to review the beneficial owners of 
futures positions. If, at the daily market close, a reporting firm has 
a trader holding a position at or above the Commission's reporting 
level in any single futures month or option expiration, it reports that 
trader's entire position in all futures and options expiration months 
in that commodity, regardless of size.
    Since traders frequently carry futures positions through more than 
one FCM, and since individuals sometimes control or have a financial 
interest in more than one account, the Commission routinely collects 
information that enables its surveillance staff to aggregate related 
accounts. Reporting firms file information with the CFTC to identify 
each new account that acquires a reportable position. In addition, once 
an account reaches a reportable size, the account owner periodically is 
required to file a more detailed report to further identify accounts 
and reveal any relationships that may exist with other accounts or 
traders.
    Surveillance economists prepare weekly summary reports for futures 
and option contracts that are approaching their expiration periods. 
Regional surveillance supervisors immediately review these reports. 
Surveillance staff advises the Commissioners and senior staff of 
significant market developments at weekly surveillance meetings (which 
are non-public, closed meetings) so they will be prepared to take 
action if necessary.
    Typically, the Commission gives the DCM, as the front-line 
regulator, the first opportunity to resolve any issue arising in its 
markets. If a DCM fails to take actions that the Commission deems 
appropriate, the Commission has broad emergency powers under the CEA to 
order the DCM to take specific actions. Such actions could include 
limiting trading, imposing or reducing limits on positions, requiring 
the liquidation of positions, extending a delivery period, or closing a 
market. Fortunately, most issues are resolved without the need to use 
the Commission's emergency powers. The fact that the Commission has had 
to take emergency action only four times in its history demonstrates 
its commitment to refrain from intervening in the futures markets 
unless all other efforts have been unsuccessful.
    In addition to market surveillance, DMO staff monitors trading 
activity on DCMs in order to detect and prevent possible trading 
violations. To help accomplish this mission, staff engages in various 
analyses to profile trading activity and conducts trade practice 
investigations. These functions require the collection of trade data 
and the ability to process those in various ways for further analysis. 
In this regard, DMO currently operates the Electronic Database System 
(EDBS), a system developed in the mid-1980s, to process and maintain 
information concerning trading activity on DCMs. EDBS is an older 
system with limited capabilities, especially with respect to trading 
data collected from electronically traded markets. The Commission is in 
the process of replacing EDBS with a more robust tool, the Trade 
Surveillance System (TSS). The primary function of TSS is to collect 
and make all trade data accessible to staff so they can retrieve, 
organize, and analyze trade data to assess DCM compliance with the Act 
and Commission regulations. TSS will assist staff in conducting timely, 
customized analyses of all trading activity; examining side-by-side 
trading (same contract trading simultaneously on an exchange floor and 
an electronic trading platform) and cross-market activity (similar or 
identical contracts trading on different exchanges); and detecting 
novel and complex patterns of potential trading violations involving 
electronic trading. TSS also will allow DMO staff to respond to fast-
moving market events, which is crucial to effective trade practice 
surveillance. The identification of potential trading violations 
results in referrals to relevant DCMs and to the Commission's Division 
of Enforcement.
    It should be noted that surveillance of DCM trading is not 
conducted exclusively by the Commission. As SROs, DCMs have significant 
statutory surveillance responsibilities.\2\ Typically, however, 
surveillance issues are handled jointly by Commission staff and the 
relevant DCM. Surveillance information is shared and, when appropriate, 
corrective actions are coordinated. Situations of particular 
surveillance interest are jointly monitored and, if necessary, verbal 
contacts are made with the brokers or traders who are significant 
participants in the market in question. These contacts may be for the 
purpose of asking questions, confirming reported positions, alerting 
the brokers or traders to the regulatory concern regarding the 
situation, or warning them to conduct their trading responsibly. 
Throughout its history, the Commission, together with the DCMs, has 
been quite effective in using these methods to resolve issues at an 
early stage.
---------------------------------------------------------------------------
    \2\ See, e.g., Sections 5(b)(2) and 5(d)(4) of the CEA, 7 U.S.C.  
7(b)(2), 7(d)(4).
---------------------------------------------------------------------------
    Another key DMO oversight role involves staff oversight and 
assessment of the regulatory and oversight activities of DCMs. This 
involves periodic examinations of DCMs' self-regulatory programs on an 
ongoing, routine basis to evaluate their compliance with applicable 
core principles under the Act and the Commission's regulations. These 
examinations, known as ``Rule Enforcement Reviews,'' result in reports 
that evaluate a DCM's compliance and surveillance capabilities. The 
reports set forth recommendations for improvement, where appropriate, 
with respect to a DCM's trade practice surveillance, market 
surveillance, disciplinary, audit trail, and dispute resolution 
programs. These reviews promote and enhance continuing, effective self-
regulation and ensure that exchanges rigorously enforce compliance with 
their rules. The reports are made public and are posted on the 
Commission's website.
    In conclusion, the Commission has a comprehensive market oversight 
program to detect and prevent disruption of the economic functions of 
all the commodity futures and option markets that it regulates.
CFTC Division of Clearing and Intermediary Oversight
    The Commission's Division of Clearing and Intermediary Oversight 
(DCIO) is responsible for and plays an integral role in ensuring the 
financial integrity of all transactions on the markets that the CFTC 
regulates.
    DCIO meets these responsibilities through an oversight program that 
includes the following elements: (1) conducting risk-based oversight 
and examinations of industry SROs responsible for overseeing FCMs, 
commodity trading advisors, commodity pool operators, and introducing 
brokers, to evaluate their compliance programs with respect to 
requirements concerning fitness, net capital, segregation of customer 
funds, disclosure, sales practices, and related reporting and record 
keeping; (2) conducting risk-based oversight and examinations of all 
Commission-registered derivatives clearing organizations (DCOs) to 
evaluate their compliance with core principles, including their 
financial resources, risk management, default procedures, protections 
for customer funds, and system safeguards; (3) conducting financial and 
risk surveillance oversight of market intermediaries to monitor 
compliance with the provisions of the CEA and Commission regulations; 
(4) monitoring market events and conditions to evaluate their potential 
impact on DCOs and the clearing and settlement system and to follow-up 
on indications of financial instability; and (5) developing 
regulations, orders, guidelines, and other regulatory approaches 
applicable to DCOs, market intermediaries, and their SROs. 
Collectively, these functions serve to protect market users, the 
general public and producers, to govern the activities of market 
participants, and to enhance the efficiency and effectiveness of the 
futures markets as risk management mechanisms. DCIO's most important 
function is to prevent systemic risk and ensure the safety of customer 
funds.
    The DCOs that the Commission currently regulates are located in New 
York, Chicago, Kansas City, Minneapolis and London, England. The 
intermediaries overseen by the Commission are located throughout the 
United States and in various other countries.
CFTC Division of Enforcement
    At any one time, the Division of Enforcement (Enforcement) is 
investigating and litigating with approximately 700 to 1,000 
individuals and corporations for alleged fraud, manipulation, and other 
illegal conduct. Working closely with the President's Corporate Fraud 
Task Force, Enforcement is staffed with skilled professionals who 
prosecute cases involving complex over-the-counter and on-exchange 
transactions. Enforcement also routinely assists in related criminal 
prosecutions by domestic and international law enforcement bodies.
    During the last 5 years, Enforcement has maintained a record level 
of investigations and prosecutions in nearly all market areas, 
including attempted manipulation, manipulation, market squeezes and 
corners, false reporting, hedge fund fraud, off-exchange foreign 
currency fraud, brokerage compliance and supervisory violations, wash 
trading, trade practice misconduct, and registration issues.
    In the energy sector alone, Enforcement investigated Enron and 
dozens of national and international energy companies, as well as 
hundreds of energy traders and hedge funds around the country. As a 
result of those efforts, the Commission prosecuted numerous traders and 
corporate entities. At the same time, in other market sectors, 
Enforcement prosecuted more than 50 hedge funds and commodity pool 
operators for various violations, and filed actions against more than 
360 individuals and companies for off-exchange foreign currency fraud 
and misconduct.
    Enforcement receives referrals from several sources: the CFTC's own 
market surveillance staff; the compliance staff at exchanges; market 
participants and members of the public; and other state, Federal, and 
international regulatory authorities. During an investigation, the CFTC 
may grant formal administrative subpoena authority, which enables 
Enforcement to obtain relevant materials (for example, audio 
recordings, e-mail and trade data) and testimony from witnesses.
    If warranted, at the conclusion of its investigation, Enforcement 
will recommend to the Commissioners that the CFTC initiate a civil 
injunctive action in Federal district court or an administrative 
proceeding. The CFTC may obtain temporary statutory restraining orders 
and preliminary and permanent injunctions in Federal court to halt 
ongoing violations, as well as civil monetary penalties, appointment of 
a receiver, the freezing of assets, restitution to customers, and 
disgorgement of unlawfully acquired gains. Administrative sanctions may 
include orders suspending, denying, revoking, or restricting 
registration; prohibiting trading; and imposing civil monetary 
penalties, cease and desist orders, and orders of restitution.
    The CFTC also refers enforcement matters to the Department of 
Justice. Criminal activity involving commodity-related instruments can 
result in prosecution for criminal violations of the CEA and for 
violations of Federal criminal statutes, such as mail fraud or wire 
fraud.
Oversight of Exempt Commercial Markets
    Congress included a provision in the Commodity Futures 
Modernization Act of 2000 (CFMA) to govern a new type of trading 
facility known as an ECM.\3\ As outlined in Section 2(h)(5)(F) of the 
CEA, ECMs are not ``registered with, or designated, recognized, 
licensed or approved by the Commission.'' ECMs, as well as transactions 
executed on ECMs, are statutorily exempt from most provisions of the 
CEA. Trading on an ECM such as ICE is not subject to regular, ongoing 
market surveillance oversight by the Commission. Under current law, the 
Commission does not have the legal authority to limit the size of a 
trader's position on an ECM. Nor are ECMs required to comply with the 
self-regulatory obligations required of DCMs, such as adopting position 
limitations or position accountability rules. The Commission does 
retain fraud and manipulation authority over ECMs. To assist the 
Commission in carrying out its fraud and manipulation authority, ECMs 
are required to maintain a record of allegations or complaints received 
by the trading facility concerning instances of suspected fraud or 
manipulation and to forward them to the Commission.\4\
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    \3\ CEA Sections 2(h)(3)-(5), 7 U.S.C.  2(h)(3)-(5).
    \4\ Commission Regulation 36.3(b)(iii), (iv), 17 C.F.R.  
36.3(b)(iii), (iv).
---------------------------------------------------------------------------
    ECMs are also subject to certain limited reporting requirements 
that are authorized under Section 2(h)(5)(B)(i) of the CEA and spelled 
out in Commission Regulation 36.3(b).\5\ Pursuant to these provisions, 
an ECM is required to identify those transactions conducted on the 
facility with respect to which the ECM intends to rely on the statutory 
Section 2(h)(3) exemption, and which averaged five trades per day or 
more over the most recent calendar quarter. With respect to such 
transactions, the ECM is required to transmit weekly to the Commission 
certain basic trade information, including ``the commodity, the 
[delivery or price-basing] location, the maturity date, whether it is a 
financially settled or physically delivered instrument, the date of 
execution, the time of execution, the price, [and] the quantity.'' \6\ 
The reports filed pursuant to Regulation 36.3(b) can provide Commission 
surveillance staff with information regarding price spikes or unusual 
divergence between the price of a commodity traded on an ECM and the 
price of a related commodity traded on a DCM. The Regulation 36.3(b) 
reports, however, do not require ECMs to identify the individual 
traders holding positions on the ECM.
---------------------------------------------------------------------------
    \5\ 17 C.F.R.  36.3(b).
    \6\ ICE has been submitting such trade data for natural gas 
transactions meeting the regulatory reporting threshold since January 
1, 2005.
---------------------------------------------------------------------------
    In addition, an ECM must maintain for 5 years, and make available 
for inspection upon request by the Commission, records of its 
activities related to its business as an electronic trading facility, 
including audit trail information sufficient to enable the Commission 
to reconstruct trading activity, and the name and address of each 
participant authorized to enter into transactions on the facility.\7\ 
Should the Regulation 36.3(b) reports, or other information obtained by 
surveillance staff (including information from futures market large 
trader reports), indicate a need for further information from an ECM, 
Section 2(h)(5)(B)(iii) of the CEA and Commission Regulation 36.3(b)(3) 
give the Commission authority to issue what is known as a ``special 
call.'' Under the CEA, the Commission can obtain from an ECM ``such 
information related to its business as an electronic trading facility 
exempt under paragraph [2(h)](3) . . . as the Commission may deem 
appropriate.'' The issuance of a special call to an ECM is simply an 
indication that the Commission's staff is seeking additional 
information. A special call, in and of itself, is not evidence of 
improper or illegal market behavior.
---------------------------------------------------------------------------
    \7\ CEA Section 2(h)(5)(B)(ii), 7 U.S.C.  2(h)(5)(B)(ii).
---------------------------------------------------------------------------
    Finally, if the Commission determines that an ECM performs a 
significant price discovery function for transactions in the cash 
market for the commodity underlying any agreement, contract, or 
transaction traded on the facility, the ECM must publicly disseminate, 
on a daily basis, information such as contract terms and conditions, 
trading volume, open interest, opening and closing prices or price 
ranges, or other price information approved by the Commission.\8\ To 
date, the Commission has not made such a determination.
---------------------------------------------------------------------------
    \8\ CEA Section 2(h)(4)(D), 7 U.S.C.  2(h)(4)(D); Commission 
Regulation 36.3(c)(2), 17 C.F.R.  36.3(c)(2).
---------------------------------------------------------------------------
    Since the fall of 2006, the CFTC has been regularly utilizing its 
special call authority to request information from ICE. This 
information assists us in the regulation of activities on DCMs, and we 
believe it helps us to get a more comprehensive picture of the 
marketplace, given the similarity of ICE's natural gas contracts to 
those traded on NYMEX. On September 28 and December 1, 2006, 
respectively, the Commission issued two special calls to ICE that 
required ICE to provide position data to the Commission, on an ongoing 
basis, related to transactions in ICE's most heavily traded natural gas 
swap contracts. Specifically, these separately-issued special calls 
required that ICE provide the Commission with clearing member position 
data and individual trader position data in the various ICE natural gas 
contracts that are cash-settled based on NYMEX natural gas contracts.
    The special call for clearing member position data was issued by 
the Commission on September 28, 2006, and the Commission has been 
receiving responsive data from ICE, on a daily basis, since October 10, 
2006. The individual trader position data special call was issued on 
December 1, 2006. ICE found it necessary to make various technical 
adjustments to its systems in order to produce the requested materials, 
which it has done. Those adjustments are now in place, and the 
Commission received the first batch of individual trader daily position 
data on February 16 (showing positions as of February 15) and continues 
to receive that information on an ongoing basis.
    These two special calls were issued primarily in order to assist 
Commission staff in its surveillance of the related NYMEX natural gas 
contracts. Compliance with special calls is not voluntary, but 
mandatory. The special calls were not issued as part of an 
investigation of any particular market participant or trading activity 
on either ICE or NYMEX. Nor were they issued in order to conduct 
regular market surveillance of ICE contracts themselves. The 
information provided by ICE through the special calls is comprehensive, 
but it does not duplicate the information that the Commission collects 
through its DCM surveillance programs.
    Despite the difference in regulatory authorities over DCMs and 
ECMs, the Commission is aware that when markets trade similar products 
or products that can be arbitraged, information regarding activity in 
one market tends to be incorporated into the other. This is almost 
certainly the case when large numbers of traders operate in both 
markets, as is the case between NYMEX and ICE.
CFTC Coordination With the Federal Energy Regulatory Commission
    The Energy Policy Act of 2005 (EPAct) marked an important milestone 
in the on-going debate over the appropriate policy for regulating 
trading activities in our nation's energy markets. The EPAct 
established the Federal Energy Regulatory Commission's (FERC) anti-
fraud and anti-manipulation authority in the natural gas and 
electricity cash markets. At the same time the EPAct initiated this 
upgrade in FERC's authority, it also maintained the CFTC's longstanding 
anti-manipulation authority in these cash markets. Recognizing the 
CFTC's successes in combating abusive trading practices, the EPAct 
preserved the CFTC's exclusive jurisdiction over commodity futures and 
options transactions, and accordingly its enforcement authority to 
proceed against abusive energy trading and false reporting under the 
CEA.
    As called for by the EPAct, the CFTC and FERC in October 2005 
entered into a Memorandum of Understanding (MOU) to coordinate their 
activities. Accordingly, the respective staffs of the Commission and 
FERC are authorized to efficiently share information concerning various 
issues in the energy markets without the need for cumbersome access 
requests for each particular matter. To that end, designated Commission 
staff remain in regular contact with counterparts at FERC, and FERC 
staff is routinely invited to attend Commission enforcement briefings 
and surveillance meetings. The Commission's Enforcement staff also 
meets with FERC counterparts on a quarterly basis to share information 
on issues and matters of mutual interest.
    While this inter-agency MOU has helped bridge some of the day-to-
day matters that have arisen, certain issues remain. For instance, 
since the EPAct was enacted, the CFTC and FERC now have different legal 
standards required to prove a violation of their respective anti-
manipulation provisions. The FERC anti-manipulation language parallels 
the language in Section 10(b) of the Securities Exchange Act of 1934. 
As a result, the elements of a manipulation case for FERC differ 
significantly from the elements of a manipulation action brought by the 
CFTC pursuant to the CEA and related judicial precedent. Under the FERC 
legal standard, the language contemplates that in order to prove a 
violation, FERC must prove that a defendant intentionally or knowingly 
engaged in the proscribed conduct. It appears that the courts could 
interpret ``reckless conduct'' as an acceptable standard for FERC's 
``intent'' requirement. In contrast, for manipulation cases under the 
CEA, the CFTC must prove specific intent, arguably a higher standard 
than ``recklessness.'' The CFTC must also show that the defendant had 
the ability to influence market prices, that artificial prices existed, 
and that the defendant caused the artificial prices.\9\
---------------------------------------------------------------------------
    \9\ See In re Cox, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. 
(CCH) 23,786 at 34,061 (CFTC July 15, 1987.
---------------------------------------------------------------------------
    We continue to work to resolve how each agency should enforce its 
mandate in the absence of a bright-line delineation of the boundaries 
of the respective agencies' authorities. These issues affect the 
agencies' regulatory efforts in the energy markets, and possibly 
undermine the effectiveness of Congress's intent to end those types of 
trading abuses that hurt energy consumers and undercut public 
confidence in fair and orderly energy markets. The CFTC will continue 
to monitor the ongoing interactions between our agencies in this area 
and will report to Congress as to whether it may be appropriate to 
harmonize FERC's and the CFTC's manipulation authorities.
CFTC Budget
    The current budget that funds the divisions, the technology and 
surveillance operations, and other support staff, is approximately $98 
million for the current Fiscal Year (FY). The FY 2008 President's 
Budget request for the CFTC is for an appropriation of $116 million and 
475 staff--an increase of approximately $18 million and 17 staff over 
the FY 2007 continuing resolution appropriation which supports a level 
of 458 staff.
    We are grateful for the Administration's recognition of the need 
for increased funding for our agency. The FY 2008 Budget request is a 
good down payment in an effort to reverse a recent downward trend in 
resources at the Commission, but it is, in perspective, a small 
recognition of the challenge we face.
    Since the CFMA was enacted, there has been a seven-fold increase in 
the rate of new product listings by U.S. exchanges. Nine new DCMs and 
nine new DCOs have been approved by the CFTC. Electronic trading has 
soared to approximately 60 percent of total volume this year, and that 
percentage is steadily increasing. The competition, product innovation, 
and increasing use of technology fostered by the CFMA meant exponential 
growth in the futures and option markets, especially during the last 
few years. It has also meant continuing evolution of these markets in 
the form of new trading venues, new trading strategies, new risk 
management tools, and new customers.
    The CFMA replaced the prior ``one-size-fits-all'' regulatory model 
with a flexible, practical, principles-based model for exchanges. U.S. 
exchanges also were given the authority to approve new products and 
rules through a self-certification process without prior CFTC approval, 
which encouraged innovation and enabled exchanges to act quickly in 
response to fast-changing market conditions. The CFMA also permitted 
the establishment of non-intermediated trading platforms such as ECMs, 
the growth of which has rapidly matured in recent years.
    During this period of unprecedented growth for the futures 
industry, however, the CFTC's resources have been steadily diminishing. 
The CFTC needs additional staff resources in almost every program area. 
Currently, the Commission operates with a staff of 436--an historic low 
at a time when the industry we regulate is at an all-time high by 
almost any measure: more volume, more trading platforms, more products, 
more complexity and a more global marketplace. Commission employees 
work hard, work smart, and use technology effectively, but given the 
complexity of the markets we oversee, they are stretched. We have the 
resources to carry out the Commission's mission on a daily basis--by 
asking more of staff and putting off some technological needs and other 
programs--but it is clear that the agency can continue at this funding 
level only for the short-term.
    With regard to the adequacy of our surveillance resources, it is 
useful to consider that the number of actively traded contracts trading 
on U.S. exchanges has more than quintupled in the last decade, with 
most of that growth seen in the last 5 years. Staff devoted to 
surveillance today is 46; ten years ago, it was 58.
    As for Enforcement, staff has fallen from 154 to 110 during the 
same ten year period. The CFTC prides itself on its vigorous 
enforcement efforts. However, in derivatives markets that are exploding 
in size and complexity, coupled with its reduced staffing, the CFTC's 
enforcement professionals are struggling to keep up with the volume and 
size of its cases. For comparison purposes, the enforcement division at 
the Securities and Exchange Commission is funded with a budget that is 
more than twenty times larger than that for the CFTC's enforcement 
operations. We are forced to make hard choices every day on how to 
prioritize our investigative and litigation efforts.
    Technology is critical to enable our professional staff to 
adequately oversee the markets. However, budget constraints have 
required the Commission to put new systems development initiatives and 
hardware and software purchases on hold. For example, Commission 
investment in technology, as a percentage of total budget, has fallen 
from approximately 10 percent to around seven percent. This trend is 
unsustainable given that so much of the growth in the futures industry 
is directly attributable to investments in technology. It is important 
that the Commission not be overwhelmed by the technologically 
innovative industry we regulate.
Conclusion
    The CFTC's last reauthorization expired in 2005, and Congress has 
worked hard during the past 2 years to try to reauthorize the CFTC and 
update our statutory mandate. We appreciate the efforts of this 
Subcommittee, the full Committee and your Senate counterparts, as you 
continue those efforts.
    In order to clarify the CFTC's anti-fraud authority with respect to 
transactions in energy commodities, it is important that Congress 
clarify that the CFTC's primary anti-fraud provision in CEA Section 4b 
\10\ applies to principal-to-principal transactions. We appreciate that 
such a clarification was included in H.R. 4473, the CFTC 
reauthorization legislation reported out of the House Agriculture 
Committee and adopted by the House of Representatives in December 2005.
---------------------------------------------------------------------------
    \10\ 7 U.S.C.  6b.
---------------------------------------------------------------------------
    Apart from enforcement, another part of the reauthorization debate 
has been about regulation of energy markets. It is a complicated policy 
decision that encompasses consideration of a number of issues, 
including: economic opportunity and competition at home and abroad; 
ensuring customer protections and market integrity; promoting growth 
and innovation of U.S. exchanges; and ensuring a level playing field 
for competitors. Congress, regulators and industry participants have 
varied opinions on the topic and the debate continues. It is important 
to hear all sides to strike the right balance in this complex economic 
and policy discussion.
    This is truly a dynamic time in the futures markets, given the 
growth in trading volume, product innovation and complexity, and 
globalization--in all commodities, including energy. The Commission 
will continue to work to promote competition and innovation by 
proactively taking down unnecessary barriers to trading in our markets, 
while at the same time, fulfilling our mandate under the CEA to protect 
the public interest and to enhance the integrity of, and public 
confidence in, U.S. futures markets.
    In closing, I appreciate the Committee's inquiries into this 
complex and important area as well as the opportunity to testify. I 
look forward to answering any questions you might have.
    Thank you.

    The Chairman. Thank the gentleman. Before we move to Ms. 
Williams, let me recognize the Ranking Member and welcome him 
and any comments he might have, before we move, if you have 
something.
    Mr. Goodlatte. Thank you, Mr. Chairman. I appreciate your 
holding this hearing.
    The Chairman. And we thank you. And now we recognize Ms. 
Williams for her opening comments.

STATEMENT OF ORICE M. WILLIAMS, DIRECTOR, FINANCIAL MARKETS AND 
                   COMMUNITY INVESTMENT, U.S.
       GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, D.C.

    Ms. Williams. Mr. Chairman and Members of the Subcommittee, 
I am pleased to be here today to discuss our preliminary 
findings on the trading of derivatives for energy commodities. 
As energy prices have increased in recent years, the trading 
volume of exchange traded futures, off-exchange traded swaps 
and other types of derivatives have also experienced 
significant growth. Increased energy prices have generally been 
attributed to normal market forces of supply and demand, but 
trends in energy derivatives markets have increased questions 
about whether this trading activity has placed additional 
upward pressure on the prices of physical energy commodities.
    My remarks today focus on (1) trends in the energy 
derivatives and physical markets and the effect of those trends 
on energy prices; and (2) the regulatory structure of the 
various markets where energy commodities and derivatives are 
traded. The futures and physical markets for crude oil, 
unleaded gasoline, heating oil and natural gas have experienced 
substantial changes in recent years. First, from January 2002 
to July 2006, monthly averaged futures and spot prices for 
crude oil, gasoline and heating oil registered an increase of 
over 200 percent.
    Second, the volatility of energy prices generally remained 
above historic averages for most of the period, but declined 
for most energy commodities during 2006 to levels at or near 
their historical average.
    And third, trading volumes for futures increased, at least 
in part, as a growing number of managed money traders, 
including hedge funds, began to see energy futures as 
attractive investment alternatives. While these changes were 
occurring in the futures market, the physical market was 
experiencing tight supply and increase in global demand, 
ongoing political instability in oil producing regions, limited 
refining capacity and other ongoing supply disruptions.
    Some observers believe that higher energy prices were 
solely the result of supply and demand fundamentals, while 
others believe that increased derivatives trading activity may 
have also contributed to higher prices. Given the changes that 
have occurred in both markets over this period, the extent of 
impact of any one of the changes in either market is unclear.
    Now, turning my attention to CFTC's authority: Energy 
products are traded on futures exchanges, exempt commercial 
markets and over-the-counter, or OTC, markets. Some of these 
markets are subject to CFTC oversight and some are largely 
unregulated. Under the Commodity Exchange Act, CFTC regulatory 
oversight is focused on the surveillance of futures exchanges, 
protecting the public and ensuring market integrity. CFTC does 
not, however, have oversight authority over exempt commercial 
markets, which are electronic trading facilities that trade 
exempt commodities, including energy commodities, on a 
principle-to-principle basis solely between persons that are 
eligible commercial entities.
    Moreover, the volume of off-exchange transactions has 
increased significantly in recent years. Also, certain parties, 
those who qualify as eligible contract participants, can enter 
into contracts directly. Both the exempt commercial market and 
the OTC market are exempt from general CFTC oversight. However, 
both markets are subject to CFTC's enforcement of the CEA's 
anti-manipulation and where appropriate, anti-fraud provisions.
    Given these varying levels of CFTC oversight, some market 
observers question whether CFTC needs additional resources and 
broader authority over all derivatives markets, particularly 
those involving exempt commodities. CFTC generally believes 
that the Commission has sufficient authority over OTC 
derivatives and exempt energy markets, however, CFTC has 
recently taken an important step in clarifying its authority to 
obtain information about pertinent off-exchange transactions.
    In closing, our work to date shows that the derivatives and 
physical markets have both undergone substantial change and 
evolution and warrants ongoing monitoring and analysis to 
protect the public and ensure the integrity of the markets. Mr. 
Chairman, this concludes my prepared statement. I would be 
happy to respond to any questions that you or other Members of 
the Subcommittee may have. Thank you.
    [The prepared statement of Ms. Williams follows:]

 Prepared Statement of Orice M. Williams, Director, Financial Markets 
    and Community Investment, U.S. Government Accountability Office,
                            Washington, D.C.
Energy Derivatives
Preliminary Views on Energy Derivatives Trading and CFTC Oversight
What GAO Found
    Rising energy prices have been attributed to a variety of factors, 
and recent trends in the futures and physical markets highlight the 
changes that have occurred in both markets from 2002 through 2006. 
Specifically:

   Inflation-adjusted energy prices in both the futures and 
        physical markets increased by over 200 percent during this 
        period for three of the four commodities we reviewed.
   Volatility (a measurement of the degree to which prices 
        fluctuate over time) in energy futures prices generally 
        remained above historic averages during the beginning of the 
        time period but declined through 2006 for three of the four 
        commodities we reviewed.
   The number of noncommercial participants in the futures 
        markets including hedge funds, has grown; along with the volume 
        of energy futures contracts traded; and the volume of energy 
        derivatives traded outside traditional futures exchanges.

    At the same time these changes were occurring in the futures 
markets for energy commodities, tight supply and rising demand in the 
physical markets pushed prices higher. For example, while global demand 
for oil has risen at high rates, spare oil production capacity has 
fallen since 2002, and increased political instability in some of the 
major oil-producing countries has threatened the supply of oil. 
Refining capacity also has not expanded at the same pace as the demand 
for gasoline. The individual effect of these collective changes on 
energy prices is unclear, as many factors have combined to affect 
energy prices. Monitoring these changes will be important to protect 
the public and ensure market integrity.
    Based on its authority under the Commodity Exchange Act (CEA), CFTC 
primarily focuses its oversight on the operations of traditional 
futures exchanges, such as NYMEX, where energy futures are traded. 
However, energy derivatives are also traded on other markets, namely 
exempt commercial markets and over-the-counter (OTC) markets--both of 
which have experienced increased volumes in recent years. Exempt 
commercial markets are electronic trading facilities that trade exempt 
commodities between eligible participants, and OTC markets involve 
eligible parties that can enter into contracts directly off-exchange. 
Both of these markets are exempt from general CFTC oversight, but they 
are subject to the CEA's anti-manipulation and anti-fraud provisions 
and CFTC enforcement of those provisions. Because of these varying 
levels of CFTC oversight, some market observers question whether CFTC 
needs broader authority over all derivative markets. CFTC generally 
believes that the Commission has sufficient authority over OTC 
derivatives and exempt energy markets. However, CFTC has recently taken 
additional actions to clarify its authority to obtain information about 
pertinent off-exchange transactions.
          * * * * *
    Mr. Chairman and Members of the Subcommittee:

    I am pleased to be here today to discuss our preliminary views on 
the trading of derivatives for energy commodities such as natural gas 
and crude oil. As energy prices have increased in recent years, the 
trading volume of exchange-traded futures, off-exchange traded swaps, 
and other types of derivatives have also experienced significant 
growth.\1\ Increased energy prices generally have been attributed to 
normal market forces of supply and demand, but these trends in energy 
derivatives markets have raised questions about whether this trading 
activity has placed additional upward pressure on the prices of 
physical energy commodities. The prices of futures contracts, like 
those of all derivatives, are in large part based on prices in the 
physical spot (cash) market where commodities are sold. At the same 
time, buyers and sellers of natural gas, crude oil, gasoline, and other 
energy products use exchange-traded futures prices, which are published 
daily, when determining prices in the physical markets. The extent to 
which off-exchange prices are used for determining prices of the 
underlying commodity, however, is unclear. The growth in energy futures 
trading since 2001 has in part been fueled by new market participants 
such as hedge funds and by increased investment in commodity index 
funds, which are funds whose prices are tied to the price of a basket 
of various commodity futures.
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    \1\ Our analysis of energy prices and energy financial markets is 
generally limited to the time period from January 2002 to December 
2006.
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    My testimony today is based on an ongoing engagement on trading 
activity in energy derivatives markets--primarily the futures market--
and the oversight role of the Commodity Futures Trading Commission 
(CFTC). Because of the broad interest in this subject, our ongoing work 
has been initiated under the authority of the Comptroller General. My 
remarks today present our preliminary views on (1) trends in the energy 
derivatives and physical markets and the effect of those trends on 
energy prices, and (2) the regulatory structure of the various markets 
where energy commodities and derivatives are traded.
    In conducting this work, we obtained and analyzed energy futures 
prices and trading volumes from the New York Mercantile Exchange, Inc. 
(NYMEX). Specifically, we collected data for crude oil, heating oil, 
natural gas, and unleaded gas for the period January 2002 through 
December 2006. We also obtained and analyzed data on market 
participants and the outstanding trading positions of different 
categories of traders from CFTC. In addition, we reviewed publicly 
available information, including academic studies and reports and 
market data. Finally, we interviewed a broad range of market 
participants and observers, representatives of energy trading markets, 
and government regulators and agencies involved with the energy 
markets. This work is being done in accordance with generally accepted 
government auditing standards.
    In summary, derivatives and physical markets for crude oil, 
unleaded gasoline, heating oil, and natural gas have experienced 
substantial changes in recent years. From January 2002 to July 2006, 
monthly average futures and spot prices for crude oil, gasoline, and 
heating oil registered increases of over 200 percent.\2\ The volatility 
of energy prices also generally remained above historic averages for 
most of the period but declined during 2006 to levels at or near the 
historical average. At the same time, trading volumes for futures 
increased, at least in part because a growing number of managed-money 
traders (including hedge funds) began to see energy futures as 
attractive investment alternatives. While these changes were occurring, 
the physical market was experiencing tight supply and rising demand 
from increasing global demand, ongoing political instability in oil-
producing regions, limited refining capacity, and other ongoing supply 
disruptions. Some observers believe that higher energy prices were 
solely the result of supply and demand fundamentals while others 
believe that increased futures trading activity may also have 
contributed to higher prices. But the effect on energy prices of 
individual changes in these markets is unclear, as many factors have 
combined to affect energy prices. Monitoring these changes in the 
future will be important in protecting the public and ensuring market 
integrity.
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    \2\ To account for the effects of inflation on prices, prices are 
adjusted to reflect prices in the base year of 2006.
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    Energy derivatives are traded on futures exchanges, exempt 
commercial markets, and over-the-counter (OTC). Some of these markets 
are subject to CFTC oversight and some are largely unregulated. Under 
the Commodity Exchange Act (CEA), CFTC regulatory oversight is focused 
on the surveillance of futures exchanges, protecting the public, and 
ensuring market integrity. CFTC does not, however, have oversight 
authority over exempt commercial markets--electronic trading facilities 
that trade exempt commodities, including energy commodities, on a 
principal-to-principal basis solely between persons that are eligible 
commercial entities--and the volume of off-exchange transactions has 
increased significantly in recent years. Also, certain parties--those 
who qualify as eligible contract participants--can enter into contracts 
directly (over-the-counter). Both the exempt commercial market and the 
OTC market are exempt from general CFTC oversight. However, both 
markets are subject to CFTC's enforcement of the CEA's anti-
manipulation and, where applicable, anti-fraud provisions. Because of 
these varying levels of CFTC oversight, some market observers question 
whether CFTC needs broader authority over all derivative markets, 
particularly those involving exempt commodities. CFTC generally 
believes that the Commission has sufficient authority over OTC 
derivatives and exempt energy markets. However, CFTC has recently taken 
additional actions to clarify its authority to obtain information about 
pertinent off-exchange transactions.
Background
    Energy commodities are bought and sold on both the physical and 
financial markets. The physical market includes the spot market where 
products such as crude oil or gasoline are bought and sold for 
immediate or near-term delivery by producers, wholesalers, and 
retailers. Spot transactions take place between commercial participants 
for a particular energy product for immediate delivery at a specific 
location. For example, the U.S. spot market for West Texas Intermediate 
(WTI) crude oil is the pipeline hub near Cushing, Oklahoma, while a 
major spot market for natural gas operates at the Henry Hub near Erath, 
Louisiana. The prices set in the specific spot markets provide a 
reference point that buyers and sellers use to set the price for other 
types of the commodity traded at other locations.
    In addition to the cash markets, derivatives based on energy 
commodities are traded in financial markets. The value of the 
derivative contract depends on the performance of the underlying 
asset--for example, crude oil or natural gas. Derivatives include 
futures, options, and swaps. Energy futures include standardized 
exchange-traded contracts for future delivery of a specific crude oil, 
heating oil, natural gas, or gasoline product at a particular spot 
market location. An exchange designated by CFTC as a contract market 
standardizes the contracts, which participants cannot modify. The owner 
of an energy futures contract is obligated to buy or sell the commodity 
at a specified price and future date. However, the contractual 
obligation may be removed at any time before the contract expiration 
date if the owner sells or purchases other contracts with terms that 
offset the original contract. In practice, most futures contracts on 
NYMEX are liquidated via offset, so that physical delivery of the 
underlying commodity is relatively rare.
    Options give the purchaser the right, but not the obligation, to 
buy or sell a specific quantity of a commodity or financial asset at a 
designated price. Swaps are privately negotiated contracts that involve 
an ongoing exchange of one or more assets, liabilities, or payments for 
a specified time period. Like futures, options can be traded on an 
exchange designated by CFTC as a contract market. Both swaps and 
options can be traded off-exchange if the transactions involve 
qualifying commodities and the participants satisfy statutory 
requirements. Options and futures are used to buy and sell a wide range 
of energy, agricultural, financial, and other commodities for future 
delivery.
    Market participants use futures markets to offset the risk caused 
by changes in prices, to discover commodity prices, and to speculate on 
price changes. Some buyers and sellers of energy commodities in the 
physical markets trade in futures contracts to offset, or ``hedge,'' 
the risks they face from price changes in the physical market. Exempt 
commercial markets and OTC derivatives can serve the same function. 
Price risk is an important concern for buyers and sellers of energy 
commodities, because wide fluctuations in cash market prices introduce 
uncertainty for producers, distributors, and consumers of commodities 
and make investment planning, budgeting, and forecasting more 
difficult. To manage price risk, market participants may shift it to 
others more willing to assume the risk or to those having different 
risk situations. For example, if a petroleum refiner wants to lower its 
risk of losing money because of price volatility, it could lock in a 
price by selling futures contracts to deliver the gasoline in 6 months 
at a guaranteed price. Without futures contracts to manage risk, 
producers, refiners, and others would likely face greater uncertainty.
    The futures market also helps buyers and sellers determine, or 
``discover,'' the price of commodities in the physical markets, thus 
linking the two markets together. Price discovery is facilitated when 
(1) participants have current information about the fundamental market 
forces of supply and demand, (2) large numbers of participants are 
active in the market, and (3) the market is transparent. Market 
participants monitor and analyze a myriad of information on the factors 
that currently affect and that they expect to affect the supply of and 
demand for energy commodities. With that information, participants buy 
or sell an energy commodity contract at the price they believe the 
commodity will sell for on the delivery date. The futures market, in 
effect, distills the diverse views of market participants into a single 
price. In turn, buyers and sellers of physical commodities may consider 
those predictions about future prices, among other factors, when 
setting prices on the spot and retail markets.
    Other participants, such as investment banks and hedge funds, which 
do not have a commercial interest in the underlying commodities, use 
the futures market strictly for profit. These speculators provide 
liquidity to the market but also take on risks that other participants, 
such as hedgers, seek to avoid. In addition, arbitrageurs attempt to 
make a profit by simultaneously entering into several transactions in 
multiple markets in an effort to benefit from price discrepancies 
across these markets.
Multiple Factors in the Derivatives and Physical Markets Have Impacted 
        Energy Prices
    Both derivatives and physical markets experienced a substantial 
amount of change from 2002 through 2006. These changes have been 
occurring simultaneously, and the specific effect of any one of these 
changes on energy prices is unclear.
The Energy Futures Markets Experienced Rising Prices, High Volatility, 
        Increased Trading Volume, and Growth in Some Types of Traders
    Several recent trends in the futures markets have raised concerns 
among some market observers that these conditions may have contributed 
to higher physical energy prices. Specifically from January 2002 to 
July 2006, the futures markets experienced higher prices, relatively 
higher volatility, increased trading volume, and growth in some types 
of traders. During this period, monthly average spot prices for crude 
oil, gasoline, and heating oil increased by over 200 percent, and 
natural gas spot prices increased by over 140 percent.\3\ At the same 
time that spot prices were increasing, the futures prices for these 
commodities showed a similar pattern, with a sharp and sustained 
increase. For example, the price of crude oil futures increased from an 
average of $22 per barrel in January 2002 to $74 in July 2006. At the 
same time, the annual historical volatilities--measured using the 
relative change in daily prices of energy futures--between 2000 and 
2006 generally were above or near their long-term averages, although 
crude oil and heating oil declined below the average and gasoline 
declined slightly at the end of that period. We also found that the 
annual volatility of natural gas fluctuated more widely than that of 
the other three commodities and increased in 2006 even though prices 
largely declined from the levels reached in 2005. Although higher 
volatility is often equated with higher prices, this pattern 
illustrates that an increase in volatility does not necessarily mean 
that price levels will increase. In other words, price volatility 
measures the variability of prices rather than the direction of the 
price changes.
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    \3\ To account for the effects of inflation on prices, prices are 
adjusted to reflect prices in the base year of 2006.
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    We also observed that at the same time that prices were rising and 
that volatility was generally above or near long-term averages, futures 
markets saw an increase in the number of noncommercial traders such as 
managed money traders, including hedge funds.\4\ The trends in prices 
and volatility made the energy derivatives markets attractive for the 
growing number of traders that were looking to either hedge against 
those changes or profit from them. Using CFTC's large trader data, we 
found that from July 2003 to December 2006 crude oil futures and 
options contracts experienced the most dramatic increase, with the 
average number of noncommercial traders more than doubling from about 
125 to about 286. As shown in Figure 1, while the growth was less 
dramatic in the other commodities, the average number of noncommercial 
traders also showed an upward trend for unleaded gasoline, heating oil, 
and natural gas.
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    \4\ CFTC collects data on traders holding positions at or above 
specific reporting levels set by the Commission. This information is 
collected as part of CFTC's Large Trader Reporting System.


    Another notable trend, but one that is much more difficult to 
quantify, was the apparently significant increase in the amount of 
energy derivatives traded outside exchanges. Trading in these markets 
is much less transparent, and comprehensive data are not available 
because these energy markets are not regulated. While the Bank for 
International Settlements publishes data on worldwide OTC derivative 
trading volume for broad groupings of commodities, this format can be 
used only as a rough proxy for trends in the trading volume of OTC 
energy derivatives.\5\ According to these data, the notional amounts 
outstanding of OTC commodity derivatives excluding precious metals, 
such as gold, grew by over 850 percent from December 2001 to December 
2005.\6\ In the year from December 2004 to December 2005 alone, the 
notional amount outstanding increased by more than 200 percent to over 
$3.2 trillion. Despite the lack of comprehensive energy-specific data 
on OTC derivatives, the recent experience of individual trading 
facilities further reveals the growth of energy derivatives trading 
outside of futures exchanges. For example, according to its annual 
financial statements, the volume of non-futures energy contracts traded 
on the IntercontinentalExchange, also known as ICE, including 
financially settled derivatives and physical contracts, increased by 
over 400 percent to over 130 million contracts in 2006.
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    \5\ The Bank for International Settlements (BIS) is an 
international organization that fosters international monetary and 
financial cooperation and serves as a bank for central banks.
    \6\ The notional amount is the amount upon which payments between 
parties to certain types of derivatives contracts are based. The 
notional amount is not exchanged between the parties but instead 
represents a hypothetical underlying quantity upon which payment 
obligations are computed. The BIS data on OTC derivatives includes 
forwards, swaps, and options.
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    Further, while some market observers believe that managed money 
traders were exerting upward pressure on prices by predominantly buying 
futures contracts, CFTC data we analyzed revealed that from the middle 
of 2003 through the end of 2006, the trading activity of managed money 
participants became increasingly balanced between buying (those that 
expect prices to go up) and selling (those that expect prices to go 
down). That is, our preliminary view of these data suggests that 
managed money traders as a whole were more or less evenly divided in 
their expectations about future prices than they had been in the past.
    We found that views were mixed about whether these trends had any 
upward pressure on prices. Some market participants and observers have 
concluded that large purchases of oil futures contracts by speculators 
could have created an additional demand for oil that could lead to 
higher prices. Contrary to this viewpoint, some Federal agencies and 
other market observers took the position that speculative trading 
activity did not have a significant impact on prices. For example, an 
April 2005 CFTC study of the markets concluded that increased trading 
by speculative traders, including hedge funds, did not lead to higher 
energy prices or volatility. This study also argued that hedge funds 
provided increased liquidity to the market and dampened volatility. 
Still others told us that while speculative trading in the futures 
market could contribute to short-term price movements in the physical 
markets, they did not believe it was possible to sustain a speculative 
``bubble'' over time, because the two markets were linked and both 
responded to information about changes in supply and demand caused by 
such factors as the weather or geographical events. In the view of 
these observers and market participants, speculation could not lead to 
artificially high or low prices over a long period of time.
Various Patterns in the Physical Markets Also Explain Rising Energy 
        Prices
    The developments in the derivatives markets in recent years have 
not occurred in isolation. Conditions in the physical markets were also 
undergoing changes that could help explain increases in both derivative 
and physical commodity prices. As we have reported, futures prices 
typically reflect the effects of world events on the price of the 
underlying commodity such as crude oil.\7\ For example, political 
instability and terrorist acts in countries that supply oil create 
uncertainties about future supplies that are reflected in futures 
prices in anticipation of an oil shortage and expected higher prices in 
the future. Conversely, news about a new oil discovery that would 
increase world oil supply could result in lower futures prices. In 
other words, futures traders' expectations of what may happen to world 
oil supply and demand influence their price bids.
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    \7\ See GAO, Motor Fuels: Understanding the Factors that Influence 
the Retail Prices of Gasoline, GAO-05-525SP (Washington, D.C.: May 
2005).
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    According to the Energy Information Administration (EIA), world oil 
demand has grown from about 59 million barrels per day in 1983 to more 
than 85 million barrels per day in 2006 (Fig. 2). While the United 
States accounts for about a quarter of this demand, rapid economic 
growth in Asia has also stimulated a strong demand for energy 
commodities. For example, EIA data shows that from 1983 to 2004, 
China's average daily demand for crude oil increased almost fourfold.



    The growth in demand does not, by itself, lead to higher prices for 
crude oil or any other energy commodity. For example, if the growth in 
demand were exceeded by a growth in supply, prices would fall, other 
things remaining constant. However, according to EIA, the growth in 
demand outpaced the growth in supply, even with spare production 
capacity included in supply. Spare production capacity is surplus oil 
that can be produced and brought to the market relatively quickly to 
rebalance the market if there is a supply disruption anywhere in the 
world oil market. As shown in Figure 3, EIA estimates that global spare 
production capacity in 2006 was about 1.3 million barrels per day, 
compared with spare capability of about 10 million barrels per day in 
the mid-1980s and 5.6 million barrels a day as recently as 2002.



    Major weather and political events can also lead to supply 
disruptions and higher prices. In its analysis, EIA has cited the 
following examples:

   Hurricanes Katrina and Rita removed about 450,000 barrels 
        per day from the world oil market from June 2005 to June 2006.

   Instability in major oil-producing countries of the 
        Organization of Petroleum Exporting Countries (OPEC), such as 
        Iraq and Nigeria, have lowered production in some cases and 
        increased the risk of future production shortfalls in others.

   Oil production in Russia, a major driver of non-OPEC supply 
        growth during the early 2000s, was adversely affected by a 
        worsened investment climate as the government raised export and 
        extraction taxes.

    The supply of crude oil affects the supply of gasoline and heating 
oil, and just as production capacity affects the supply of crude oil, 
refining capacity affects the supply of those products distilled from 
crude oil. As we have reported, refining capacity in the United States 
has not expanded at the same pace as the demand for gasoline.\8\ 
Inventory, another factor affecting supplies and therefore prices, is 
particularly crucial to the supply and demand balance, because it can 
provide a cushion against price spikes if, for example, production is 
temporarily disrupted by a refinery outage or other event. Trends 
toward lower levels of inventory may reduce the costs of producing 
gasoline, but such trends may also cause prices to be more volatile. 
That is, when a supply disruption occurs or there is an increase in 
demand, there are fewer stocks of readily available gasoline to draw 
on, putting upward pressure on prices. However, others noted a 
different trend for crude oil inventories. That is, prices have 
remained high despite patterns of higher levels of oil in inventory.
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    \8\ See GAO, Energy Markets: Factors Contributing to Higher 
Gasoline Prices, GAO-06-412T (Washington, D.C.: Feb. 1, 2006) and GAO-
05-525SP.
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    In addition to the supply and demand factors that generally apply 
to all energy commodities, specific developments can affect particular 
commodities. For instance, the growth of special gasoline blends--so-
called ``boutique fuels''--can affect the price of gasoline. As we have 
reported, it is generally agreed that the higher costs associated with 
supplying special gasoline blends contributed to higher gasoline 
prices, either because of more frequent or more severe supply 
disruptions or because the costs were likely passed on, at least in 
part, to consumers.\9\
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    \9\ GAO, Gasoline Markets: Special Gasoline Blends Reduce Emissions 
and Improve Air Quality, but Complicate Supply and Contribute to Higher 
Prices, GAO-05-421 (Washington, D.C.: June 17, 2005).
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    Like the futures market, the physical market has undergone 
substantial changes that could affect prices. But market participants 
and other observers disagree about the impact of these changes on 
increasing energy prices. Some observers believe that higher energy 
prices were solely the result of supply and demand fundamentals, while 
others believe that increased futures trading activity contributed to 
higher prices. Another consideration is that the value of the U.S. 
dollar on open currency markets could also affect crude oil prices. For 
example, because crude oil is typically denominated in U.S. dollars, 
the payments that oil-producing countries receive for their oil are 
also denominated in U.S. dollars. As a result, a weak U.S. dollar 
decreases the value of the oil sold at a given price, and oil-producing 
countries may wish to increase prices for their crude oil in order to 
maintain the purchasing power in the face of a weakening U.S. dollar. 
The relative effect of each of these changes remains unclear, however, 
because all of the changes were occurring simultaneously. Monitoring 
these trends and patterns in the future will be important in order to 
better understand their effects, protect the public, and ensure market 
integrity.
CFTC Oversees Exchanges and Has Some Authority Over Other Derivatives 
        Markets
    Energy products are traded on multiple markets, some of which are 
subject to varying levels of CFTC oversight and some of which are not. 
This difference in oversight has caused some market observers to 
question whether CFTC needs broader oversight authority. As we have 
seen, under the CEA CFTC's regulatory authority is focused on 
overseeing futures exchanges, protecting the public, and ensuring 
market integrity. But in recent years two additional venues for trading 
energy futures contracts that are not subject to direct CFTC oversight 
have grown and become increasingly important--exempt commercial markets 
and OTC markets. However, traders in these markets are subject to the 
CEA's anti-manipulation and anti-fraud provisions, which CFTC has the 
authority to enforce. Also, exempt commercial markets must provide CFTC 
with data for certain contracts.\10\
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    \10\ 17 C.F.R.  36.3; see 7 U.S.C.  2(h)(4)(D).
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    Futures exchanges such as NYMEX are subject to direct CFTC 
regulation and oversight. CFTC generally focuses on fulfilling three 
strategic goals related to these exchanges. First, to ensure the 
economic vitality of the commodity futures and options markets, CFTC 
conducts its own direct market surveillance and also reviews the 
surveillance efforts of the exchanges. Second, to protect market users 
and the public, CFTC promotes sales practice and other customer 
protection rules that apply to futures commission merchants and other 
registered intermediaries.\11\ Finally, to ensure the market's 
financial integrity, CFTC reviews the audit and financial surveillance 
activities of self-regulatory organizations.
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    \11\ See 17 C.F.R. Parts 155, 166.
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    CFTC conducts regular market surveillance and oversight of energy 
trading on NYMEX and other futures exchanges.\12\ Oversight activities 
include:
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    \12\ NYMEX conducts its own surveillance activities and may bring 
enforcement actions when violations are found.

   detecting and preventing disruptive practices before they 
        occur and keeping the CFTC Commissioners informed of possible 
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        manipulation or abuse;

   monitoring NYMEX's compliance with CFTC reporting 
        requirements and its enforcement of speculative position 
        limits;

   investigating traders with large open positions; and

   documenting cases of improper trading.

    In contrast to the direct oversight it provides to futures 
exchanges, CFTC does not have general oversight authority over exempt 
commercial markets, where qualified entities may trade through an 
electronic trading facility. According to CFTC officials, these markets 
have grown in prominence in recent years. Some market observers have 
questioned their role in the energy markets and the lack of 
transparency about their trading activities. Trading energy derivatives 
on exempt commercial markets is permissible only for eligible 
commercial entities--a category of traders broadly defined in the CEA 
to include firms with a commercial interest in the underlying 
commodity--as well as other sophisticated investors such as hedge 
funds. These markets are not subject to CFTC's general direct oversight 
but are required to maintain communication with CFTC. Among other 
things, an exempt commercial market must notify CFTC that it is 
operating as an exempt commercial market and must comply with certain 
CFTC informational, record-keeping, and other requirements.
    Energy derivatives also may be traded OTC rather than via an 
electronic trading facility. OTC derivatives are private transactions 
between sophisticated counterparties, and there is no requirement for 
parties involved in these transactions to disclose information about 
their transactions. Derivatives transactions in both exempt commercial 
markets and OTC markets are bilateral contractual agreements in which 
each party is subject to and assumes the risk of nonperformance by its 
counterparty. These agreements differ from derivatives traded on an 
exchange where a central clearinghouse stands behind every trade.
    While some observers have called for more oversight of OTC 
derivatives, most notably for CFTC to be given greater oversight 
authority over this market, others consider such action unnecessary. 
Supporters of more CFTC oversight authority believe that more 
transparency and accountability would better protect the regulated 
markets and consumers from potential abuse and possible manipulation. 
Some question how CFTC can be assured that trading on the OTC market is 
not adversely affecting the regulated markets and ultimately consumers, 
given the lack of information about OTC trading. However, in 1999 the 
President's Working Group on Financial Markets concluded that OTC 
derivatives generally were not subject to manipulation because 
contracts were settled in cash based on a rate or price determined in a 
separate highly liquid market and did not serve a significant price 
discovery function.\13\ Moreover, the market is limited to professional 
counterparties that do not need the protections against manipulation 
that CEA provides to retail investors. Finally, the group has recently 
noted that if there are concerns about CFTC's authority, CFTC's 
enforcement actions against energy companies are evidence that the CFTC 
has adequate tools to combat fraud and manipulation when it is 
detected.\14\
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    \13\ The President's Working Group was established by executive 
order in 1988 following the 1987 stock market crash. Its purpose was to 
enhance the continued integrity, competitiveness, and efficiency of 
U.S. financial markets and maintain the public's confidence in those 
markets. See the Report of the President's Working Group on Financial 
Markets, Over-the-Counter Derivatives Markets and the Commodity 
Exchange Act (Washington, D.C.: 1999).
    \14\ June 11, 2003, letter signed by the members of the President's 
Working Group to the Honorable Senator Michael D. Crapo and the 
Honorable Zell B. Miller.
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    The lack of reported data about off-exchange markets makes 
addressing concerns about the function and effect of these markets on 
regulated markets and entities challenging. CFTC officials have said 
that while they have reason to believe these off-exchange activities 
can affect prices determined on a regulated exchange, they also 
generally believe that the Commission has sufficient authority over OTC 
derivatives and exempt energy markets. However, CFTC has recently begun 
to take steps to clarify its authority to obtain information about 
pertinent off-exchange transactions. In a June 2007 proposed 
rulemaking, CFTC noted that having data about the off-exchange 
positions of traders with large positions on regulated futures 
exchanges could enhance the Commission's ability to deter and prevent 
price manipulation or any other disruptions to the integrity of the 
regulated futures markets.\15\ According to CFTC officials, the 
Commission has also proposed amendments to clarify its authority under 
the CEA to collect information and to bring fraud actions in principal-
to-principal transactions in these markets, enhancing CFTC's ability to 
enforce anti-fraud provisions of CEA.
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    \15\ According to CFTC, the purpose of the proposed regulation is 
to make explicit that persons holding or controlling reportable 
positions on a reporting market must retain books and records and make 
available to the Commission upon request any pertinent information with 
respect to all other positions and transactions in the commodity in 
which the trader has a reportable position, including positions held or 
controlled or transactions executed over-the-counter and/or pursuant to 
Sections 2(d), 2(g) or 2(h)(1)-(2) of the Commodity Exchange Act (Act) 
or Part 35 of the Commission's regulations, on exempt commercial 
markets operating pursuant to Sections 2(h)(3)-(5) of the Act, on 
exempt boards of trade operating pursuant to Section 5d of the Act, and 
on foreign boards of trade; and to make the regulation clearer and more 
complete with respect to hedging activity. 72 Fed. Reg. at 34413.
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    In closing, our work to date shows that the derivatives and 
physical markets have both undergone substantial change and evolution. 
Given the changes in both markets, causality is unclear, and the 
situation warrants ongoing review and analysis. We commend the 
Subcommittee's efforts in this area. Along with the overall concern 
about rising prices, questions have also been raised about CFTC's 
authority to protect investors from fraudulent, manipulative, and 
abusive practices. CFTC generally believes that the Commission has 
sufficient authority over OTC derivatives and exempt energy markets. 
However, CFTC has taken an important step by clarifying its authority 
to obtain information about pertinent off-exchange transactions.
GAO Contacts
    For further information about this testimony, please contact Orice 
M. Williams on (202) 512-8678 or at [email protected].
Staff Acknowledgments
    Contact points for our Offices of Congressional Relations and 
Public Affairs may be found on the last page of this statement. 
Individuals making key contributions include John Wanska (Assistant 
Director), Kevin Averyt, Ross Campbell, Emily Chalmers, John Forrester, 
and Paul Thompson.

    The Chairman. Thank you, Ms. Williams, and the chair will 
recognize Members, those who were present at the fall of the 
gavel and others as they came to the meeting, but before we 
begin the questions, I would ask unanimous consent that the 
gentleman from Georgia may sit with the panel during this 
hearing. No objection, so ordered. I will now recognize myself 
for 5 minutes.
    Commissioner Lukken, during your appearance before the 
Senate Permanent Investigations Subcommittee, you said that the 
CFTC decided that the markets on New York Merc and ICE were 
linked with respect to certain types of traded energy-based 
derivatives, that one affected the other. Wouldn't such linkage 
call for a review by the Commission as to whether ICE is 
performing a significant price discovery function with regard 
to the affected derivatives?
    Mr. Lukken. Mr. Chairman, absolutely. We do have a rule on 
the books dealing with whether the statute requires that if 
there is a significant price discovery function being performed 
by one of these ECMs, that that could trigger reporting of 
volume, open interest, high and low closing ranges, so forth. 
We need to review that rulemaking to make sure. When this was 
put on the books, this was prior to the phenomena of these 
linked contracts between regulated exchanges and exempt 
exchanges. Obviously, now that the two interplay with each 
other, there is a relationship there, an important 
relationship. This is one of our rules that we need to review 
to make sure that it encompasses that type of relationship that 
has developed rather recently over the last couple years.
    The Chairman. Let me follow that up a bit because I would 
appreciate you talking with us about the process the Commission 
uses to evaluate ECMs for that function. Also, what is the 
standard that the Commission uses to determine it?
    Mr. Lukken. The rulemaking, itself, looks to whether 
outside entities are utilizing, on a regular basis, prices on 
an exempt commercial market. So if a utility or somebody is 
quoting those prices or basing contracts on those prices, on an 
ongoing basis, that is evidence that somebody is discovering 
prices from that marketplace. Again, that was not thought 
through with this linkage idea, however. This was looking only 
at ICE and whether people were discovering products off of ICE 
and now that the two interact with each other in some ways, we 
didn't consider this link sufficiently and weren't aware of it 
when we put together this rulemaking. So, I think this might be 
an area we might need to clarify in this rule and they may be, 
after review, serving as a significant price discovery market.
    The Chairman. I think this Committee would be very 
interested in that information as you develop it.
    Mr. Lukken. Well, we are going to make this a priority.
    The Chairman. All right. Thank you, sir. Ms. Williams, I 
understand that GAO will be issuing a report looking at trading 
of energy derivatives in the near future. Can you give us a 
timeline as to when we can expect the report, and will it 
include recommendations? Can you give us any sense of what 
those could be so we might get a glimpse of what the future is 
going to look like?
    Ms. Williams. We do hope to issue a report later this year 
in terms of the areas that we focused on in addition to the two 
areas that I discussed today in my prepared statement.
    The Chairman. I hate to interrupt you. When you say later 
this year, can you give me a little bit better window?
    Ms. Williams. In the next several months.
    The Chairman. I agree with the Ranking Member, you are 
good. And that could be 3 to 6 months.
    Ms. Williams. That is a safe range. Hopefully, closer to 
the 3.
    The Chairman. That is close. Any thoughts of what kind of--
--
    Ms. Williams. Well, in addition to looking at trends in the 
futures and physical market that I briefly discussed, we also 
are looking at, kind of, the CFTC's authority and also their 
surveillance and enforcement activities. So to the extent that 
we do have any recommendations, it would be focused on those 
last two areas.
    The Chairman. Well, certainly this Committee would be quite 
interested in that.
    Ms. Williams. Absolutely.
    The Chairman. And sooner rather than later.
    Ms. Williams. We understand.
    The Chairman. Even with the preliminary report, it would be 
quite helpful, given that we operate on a timeline here.
    Ms. Williams. Okay. Right.
    The Chairman. It is pretty tight now and the days of the 
legislative calendar are drawing nigh, they are running out.
    Ms. Williams. We understand.
    The Chairman. Thank you. With that, I yield to the Ranking 
Member.
    Mr. Moran. Mr. Chairman, thank you very much. Commissioner 
Lukken, welcome back to the House Agriculture Committee. My 
thought would be this is your debut appearance as the acting 
Chairman and so welcome. First of all, I would like for you 
just to describe for me, for the Committee, the function, the 
manner in which the Commission is currently functioning. I 
would be happy to have your reassurance, but the Commission has 
been short of Commissioners. There has been change and turnover 
in regard to its Chairman and there are constant concerns about 
the level of the budget and appropriations for the CFTC. And so 
as we look at your capabilities, the CFTC's capabilities, I 
would like to have your report on the current status of how the 
Commission is functioning given the lack of Commissioners, 
perhaps lack of money and an acting Chairman.
    Mr. Lukken. Thank you, Congressman. Obviously, that was 
mentioned by the Chairman's opening statement and your 
statement. Our industry has experienced significant growth 
since the passage of the CFMA. Markets were experiencing really 
flat growth coming into the CFMA. Since then, they have taken 
off; 343 percent since 2000 through 2006. We have gained market 
share globally; 34 percent in 2000. We are now at 43 percent, 
globally, the U.S. So we are gaining on the world in futures 
volume and that is great.
    You know, we are also seeing more contracts than ever 
before. Where 250 contracts may have been listed at any one 
time, we are experiencing over 1,400 actively traded futures 
contracts. As an industry, we should applaud that growth. But 
that has to be juxtaposed with what we are doing, as a 
Commission, which we are struggling with the resources we have. 
We are at historically low levels. In the 1970s, when this 
industry was much smaller, we were over 500 individuals, as an 
agency. Now we are at historical lows of 450 or so individuals 
at the CFTC.
    Budgets have been flat recently, as has ours. It is almost 
a demographic phenomenon, but our agency, as it approaches 35 
or so years of service, people who are in the agency are 
starting to retire and that institutional knowledge is walking 
out the door when we have been under a hiring freeze. So we are 
struggling to keep pace and we are keeping pace because we have 
talented individuals, but we are stretched. And so thankfully, 
the Senate, yesterday, gave us an appropriations mark of $116 
million for our annual budget, which is the same as what the 
President had asked for. I am hopeful today that the House does 
the same.
    You also mentioned what the Commission is doing as a 
Commission, itself. The Commissioners, and we are down to two, 
in fact, Commissioner Mike Dunn is in the audience supporting 
me today and it is just the two of us. And the Sunshine laws 
prevent us from talking to each other, which is problematic. 
You know, we want to, just as the House and Senate want to, 
collaborate and discuss. These are serious issues that we need 
important discussions about and we are not able to do that. We 
have to relay messages through staff. It is difficult. The 
President has nominated two individuals. I hope that the Senate 
is able to move on those individuals quickly so that we have a 
full or nearly full complement of Commissioners and we are able 
to do the serious business before the Commission.
    Mr. Moran. I am confused as to how you can speak for the 
Commission when you and Mr. Dunn can't communicate with each 
other, but there was some, at least in the press, criticism may 
be too strong of a word, but there was some exception taken to 
your testimony recently in the Senate. It was as if you were 
close minded to, at least this is my impression, close minded 
to additional regulation of the energy markets.
    My impression of what you said today is that that is not 
the case, and my impression is also that you are saying 
something that every Commission Chairman that has testified 
before this Committee in past years has said something very 
similar. So I wanted to give you the opportunity to clarify 
your thoughts or your statement about this topic, but also to 
tell me whether you are deviating in your remarks or testimony 
today from past testimony of the Commission and whether you and 
Commissioner Dunn, as Commissioners are generally in agreement, 
to your testimony today.
    Mr. Lukken. My written testimony is the testimony of the 
Commission in its entirety, Mike and myself. But I think a good 
mark of a regulator is somebody who is open to ideas, that can 
adapt with change. And certainly, this market is evolving and 
we have to keep pace with that change. We have tried to do 
things within our existing authority to keep pace with that 
change. However, as I note, we are nearing the outer edges of 
that authority. So I think the ideas that are being discussed 
are important ideas, but as this Committee knows, and you have 
the battle scars from 2000, these are complex matters.
    If we start to wade into this, there are questions of 
whether that provides additional uncertainty to the swaps 
markets. Do we only go after this one market we are talking 
about and limited products within that market? Are we only 
talking natural gas or are we talking energy products? Are we 
talking metals, which are also an exempt commodity? A lot of 
these smaller ECMs are incubator exchanges. They are 
innovative, they are growing. We want to encourage that. 
Additional regulation on these exchanges might shut them down.
    There is a potential that a regulation could drive markets 
overseas or maybe into the more opaque over-the-counter 
markets. So this shouldn't deter us from trying to ask these 
questions and trying to find solutions. But I am just saying 
that this is complex and we just have to be cautious and 
precise as we approach these things. I am open to all ideas, 
including the ideas that were suggested in the PSI report on 
Monday, but it is going to take some precision and some caution 
and a lot of discussion before we can reach the right solution.
    Mr. Moran. Commissioner, thank you very much for your 
testimony and for your leadership at the CFTC.
    The Chairman. I thank the gentleman and the chair would now 
be happy to yield 5 minutes to the gentleman from Virginia, Mr. 
Goodlatte.
    Mr. Goodlatte. Mr. Chairman, thank you very much. 
Commissioner, Ms. Williams, welcome. Let me start with you, 
Commissioner Lukken. I would like to follow up on the gentleman 
from Kansas' questions. What would be the impact on your budget 
and staffing if you are required to regulate more markets?
    Mr. Lukken. It depends on what the breadth of the new 
authority might be, but it would be significant. Currently, we 
had looked at maybe, if extended to ECMs and other over-the-
counter products, of having to hire 30 or 40 new surveillance 
economists. Some of the legislation covers products not even 
traded on futures exchanges, so this would be a significant 
amount of new resources that would have to be devoted to this. 
As we approach this, I think these two have to go hand-in-hand, 
that if new authority is given, there has to be assurance that 
resources come along with that authority.
    Certainly, we don't want to have to choose between what we 
do, as an agency, because all of our mission is important. I 
would hate to pursue energy manipulations but allow fraud on 
forex markets, allow that to occur. So right now our plate is 
full and we are approaching having to make those decisions 
currently, given our budget situation. I think the new budget 
number is appropriate and will help with that. But new 
authority will again task us and this is going to be difficult, 
but it is something I think we can do.
    Mr. Goodlatte. The CFTC has previously testified that you 
do continual oversight of market conduct. Have you stepped up 
that oversight and surveillance efforts in response to the 
increase in energy prices?
    Mr. Lukken. Absolutely. More economists are now being 
devoted to the energy complex than ever before. We have 
developed software to allow better analytical tools when 
looking at the energy complex. The data we see is being 
analyzed differently and more in-depth by our economists, 
looking at different types of information that may interact 
into these markets. Our chief economist office is now doing 
more studies, primarily in the energy area, so that we know 
trends, understand price relationships better, understand the 
role of speculation volatility. And certainly, with energy, we 
should also mention our enforcement section because they are 
complementary to any of our regulatory functions, as well. We 
have taken significant steps to take enforcement actions; over 
55 individuals and entities have been prosecuted over the last 
several years.
    Mr. Goodlatte. Let me interrupt you. You mentioned the 
types of evidence you look at. What kind of market anomaly 
would trigger greater oversight attention?
    Mr. Lukken. Well, typically, an expiration month of a 
futures contract, it is a large position going into that with 
tight, deliverable supply. Also there are trading ranges, when 
prices are being set. If we see anomalies in trading activity, 
that will raise the eyebrows of our surveillance economists and 
we will look further into that, that type of an issue.
    Mr. Goodlatte. And have you found any evidence of 
manipulation in the trading of gasoline or oil contracts?
    Mr. Lukken. Absolutely. We have taken several actions at 
any one time. Currently, in fact, we have over a hundred 
individuals and entities under investigation for attempting to 
manipulate the energy markets. Not all of those turn into an 
actual case, but we are turning over the rocks to make sure 
that manipulation is not occurring and if it does, we are ready 
to take real-time enforcement action against that.
    Mr. Goodlatte. Ms. Williams, your testimony describes how 
the CFTC conducts market oversight. Do you think that they do 
it effectively?
    Ms. Williams. At this point, given that our work is ongoing 
in the area, we will be in a position, in our final report, to 
discuss CFTC's oversight program and get into greater detail 
exactly what they do in terms of oversight, surveillance and 
enforcement.
    Mr. Goodlatte. And Mr. Lukken, we have heard, in fact, you 
mention in your testimony the success that we have had with 
U.S. markets in trading futures, generally. How do these 
futures markets compete internationally with other markets and 
what could help or hinder that?
    Mr. Lukken. Well, part of it is the success of the 
principles-based system that this Committee helped to 
implement. We need flexibility when going into other markets. 
Part of my charge, as Chairman of the Global Markets Advisory 
Committee, is to seek out markets overseas that our futures 
markets can enter into. Again, we are gaining on the world in 
this area, so that is important. But some of it is just making 
sure you understand regulatory frameworks around the world so 
that they are compatible, that we are engaged with the 
International Organization of Securities Commissions so that we 
are setting high global standards for regulation in these 
areas.
    It is interesting because, 10 years ago, when we looked at 
whether to allow foreign competitors to come into the United 
States and compete with domestic exchanges, there was a lot of 
resistance from domestic exchanges to allow that to occur. When 
we recently reviewed this, they were in full support of 
allowing global competition because they knew that they were at 
a competitive advantage. They didn't want foreign markets to 
raise barriers for them getting into their marketplace. So the 
fear was if we raised our barriers that others would do the 
same and the right call was made, that competition, whether it 
is domestic or global, is important and really lets our markets 
grow.
    Mr. Goodlatte. Thank you, Mr. Chairman.
    The Chairman. Thank the gentleman. The gentleman from 
Georgia, Mr. Scott, for 5 minutes.
    Mr. Scott. Thank you very much, Mr. Chairman, and welcome, 
Mr. Lukken and Ms. Williams. I would like to talk a minute 
about these recent calls for additional regulation and it seems 
that these calls for more regulation of the over-the-counter 
markets have risen out of two specific situations, namely, 
Enron and the Amaranth situation. Let me first talk about the 
Enron situation, Mr. Lukken. Is there anyone operating, to your 
knowledge, under what is referred to as the ``Enron Loophole'' 
at this time?
    Mr. Lukken. I am a little unclear of what the ``Enron 
Loophole'' is. It was discussed, actually, on Monday. There is 
some uncertainty of what people term the Enron Loophole. But I 
think what Enron was performing in 2000, in 2001, was a one-to-
many market, where they were dealer and everybody was 
transacting with them as sort of the hub of the spoked wheel 
system. I am unaware, most of the trading has moved to a multi-
lateral type system, which is like what exchanges currently 
perform where anybody can hit a bid or an offer in order to 
make a contract. So I am unaware of anybody performing a 
dealer-like market in energy similar to Enron was doing in 
2000.
    Mr. Scott. On that line, do you believe that you have the 
authority necessary to monitor the activities that brought 
about the Enron situation in an effort to prevent another Enron 
disaster from happening? Do you think that you have sufficient 
tools and authority to make sure that this kind of disaster 
does not happen again?
    Mr. Lukken. Well, we have, in that area, broad fraud and 
manipulation authority to take action. In fact, against Enron 
we took action and over $35 million of civil monetary 
penalties. The markets, as they exist today, as we have talked 
about, ECMs, where most of this trading is occurring, we have 
limited authorities where we do see trading positions every 
day. We see where large traders might be, both on the regulated 
market and the ECMs. But as I mentioned, we are nearing the 
outer limits of that authority. That is something that is 
worthy of discussion.
    Mr. Scott. A more recent situation with Amaranth presents 
some interesting situations. I am not so sure that that there 
was an attempt to have market manipulation, but rather, the 
situation at Amaranth might have been simply created by a fund 
manager who was not very good at his job and bet wrong. Am I 
off on that analysis?
    Mr. Lukken. I think you point out correctly that market 
discipline worked in this area, especially, we are talking 
about more market surveillance issues today. But from a 
financial integrity side, Enron made the wrong decision. We 
like speculators in our markets because they provide liquidity 
to our markets and allow commercials to get in and out of the 
markets when they need to. However, Amaranth made the wrong 
decision and the market disciplined it in a brutal fashion.
    Mr. Scott. Let me ask you this. Would additional regulation 
of the over-the-counter market have helped prevent this sort of 
situation with Amaranth?
    Mr. Lukken. I think with Amaranth, a lot of this was 
occurring on the regulated exchanges. Prices were moving 
against them regardless of whether it was on-exchange or off-
exchange. I think, by the time they did shift to ICE in the 
latter parts of August and September, that the market was 
already moving against them. It is still important to point 
out, that there was this shift which we weren't able to see at 
the time and now we see it. But I don't think it would've 
changed the Amaranth situation at all.
    Mr. Scott. Would an additional regulation push investors to 
an even less regulated or transparent overseas market?
    Mr. Lukken. Possibly.
    Mr. Scott. And so in essence, it seems that if someone 
wants to act foolishly investing other people's money, there 
will always be a way to do so. No amount of regulation can 
prevent this.
    Mr. Lukken. Absolutely.
    Mr. Scott. Okay. Thank you, Mr. Chairman.
    The Chairman. Thank the gentleman. The gentleman from 
Texas, Mr. Conaway, for 5 minutes.
    Mr. Conaway. Thank you, Mr. Chairman. Mr. Lukken, you made 
a startling statement a second ago. What I heard was a 
startling statement that the crude oil and gasoline markets 
have been manipulated?
    Mr. Lukken. Correct.
    Mr. Conaway. There have been people who tried to manipulate 
it and you are looking into whether or not they----
    Mr. Lukken. I have just been informed by my enforcement 
director that we have evidence of manipulation in these 
markets, but we are still building cases in this area.
    Mr. Conaway. Okay.
    Mr. Lukken. You know, this is a very legal and evidence 
intensive process and something that we are looking into.
    Mr. Conaway. Okay. What is the average length of time it 
takes you to open a case and close a case on these 
manipulations?
    Mr. Lukken. It is significant. If not months, years.
    Mr. Conaway. And are there ways to shorten that time?
    Mr. Lukken. Well, we have tried to through different 
methods, to make it more real-time, as I have said, to try to 
make sure that the crime and the punishment were more timely 
together. We try by devoting significant staff resources to 
certain cases that we find, our public policy interest, and 
other methods to try to move up those time-frames.
    Mr. Conaway. But you do acknowledge a keen interest in 
shortening that length of time that those cases are open? I 
mean, that doesn't do anybody any good, particularly the 
markets, themselves. What is your relationship with the 
exchanges, themselves? Do you have an ongoing relationship with 
them? And how do you assess their self-disciplinary actions?
    Mr. Lukken. We have a very close relationship with the 
exchanges and this is built over the 150 years of self-
regulation that the exchanges have had in place. We check our 
surveillance economists, talk to exchanges daily about what 
they are seeing. A lot of our eyes and ears are the exchanges, 
themselves. We do duplicate certain things, such as the 
surveillance of the markets, themselves; also, trade practice 
abuses, whether traders are trading ahead of other traders with 
certain information, because that is very important to our 
mission. However, a lot of things we defer to the exchanges and 
talk to them on a regular basis.
    Mr. Conaway. But you would characterize your relationship 
as generally positive and appropriate at this stage?
    Mr. Lukken. Yes, and it has to be. We have to work hand-in-
hand with the exchanges in order to police these markets.
    Mr. Conaway. Okay. Ms. Williams, you used the phrase ``some 
observers'' and then you would follow that phrase by some 
negative information. Is that just open source information that 
you are conveying to this or ``some observers,'' is that code 
for GAO?
    Ms. Williams. No. We actually, as we have conducted our 
work in the area, we have talked to a broad cross-section of 
market observers. We have talked to investment banks, we have 
talked to energy companies, we have talked to various Federal 
regulators, academics, so it is a cross-section.
    Mr. Conaway. All right. And then, I am assuming that you 
will follow up, in your report that is coming, within 3 to 6 
months, as to your findings or your evaluation of the validity 
of those observations of these outsiders.
    Ms. Williams. We hope to be able to speak to the trends and 
patterns that we have observed.
    Mr. Conaway. All right. Back to Mr. Lukken again. Back to 
the enforcement. My background is with regulating CPAs and so 
you mentioned 55 cases that have actually gone completely 
through the process. Is that since 2000?
    Mr. Lukken. I think it is since 2002, actually.
    Mr. Conaway. 2002?
    Mr. Lukken. Roughly, the time of the California energy 
crisis, when a lot of this was going on.
    Mr. Conaway. Okay. Can you give us some sense, a little 
more detail? You said evidence of manipulation in the markets. 
Can you give us some sort of a range as to what the impact of 
that manipulation was that you are looking at?
    Mr. Lukken. Well, this is 55 individuals and entities, so 
there may have been fewer----
    Mr. Conaway. No, no. I am talking about the cases that are 
currently under investigation, the evidence of manipulation. 
Can you give us some sense of what impact, unproven at this 
point, but what impact it had on the markets dollar-wise? Did 
it move crude oil $10 a barrel? What did the manipulation do 
that you think happened?
    Mr. Lukken. Well, the policy of the Commission is not to 
openly discuss, in public----
    Mr. Conaway. No, I am not asking for any names.
    Mr. Lukken. Right.
    Mr. Conaway. We have a hundred cases out there. I don't 
know that anything you could tell us right now would link back 
to that hundred, but can you give us some sense of what the 
range of the impact on the market was for the manipulations 
that you are investigating?
    Mr. Lukken. I will be honest. I am not aware of the ranges 
of some of these manipulations, but what I can do is I can 
certainly brief you privately with our enforcement director on 
what is going on and we can get into details of some of these 
investigations.
    Mr. Conaway. Okay. That is fair. Thank you. I yield back.
    The Chairman. I thank the gentleman. The gentleman from 
Georgia, Mr. Marshall, for 5 minutes.
    Mr. Marshall. Thank you, Mr. Chairman. Ms. Williams, did 
you testify before the Senate the other day?
    Ms. Williams. No.
    Mr. Marshall. Okay. So are you familiar with the testimony 
that was given to the Senate?
    Ms. Williams. Generally.
    Mr. Marshall. Later this morning, Arthur Corbin, who is 
with the Municipal Gas Authority of Georgia, is going to be 
testifying and he will testify, and he has already testified, 
that he believes that gas consumers in Georgia were 
essentially, I don't know whether it would be defrauded or 
what, but essentially, they had to pay about an additional $18 
million as a result of the Amaranth speculation. And what would 
be helpful, perhaps, to GAO, but certainly, to me and to many 
others, is if in the course of GAO completing its 
investigations into this entire area, you spoke specifically to 
Mr. Corbin and specifically took him to account what he 
believes occurred in Georgia.
    Ms. Williams. Okay.
    Mr. Marshall. And whether it is in your report or it is 
somewhere else, if you would specifically comment upon not only 
what happened, but also the suggested fixes that Mr. Corbin is 
offering so that this sort of thing does not happen again, if, 
in fact, something inappropriate did occur. The argument, 
effectively, is that somebody who has a legitimate need for 
natural gas, the Municipal Gas Authority of Georgia is just one 
of many, is almost a pawn sort of caught and tossed by these 
much larger forces that are speculating upon the future where 
natural gas is concerned.
    And if you have one large, very large trader heading in a 
very bad direction, just making a big mistake, that big mistake 
made by that trader not only affects the trader, but it affects 
an awful lot of legitimate hedgers, entities that actually 
consume and actually take delivery as opposed to just playing 
the financial end of it. And so if you would specifically work 
with him, I would appreciate that.
    Ms. Williams. Absolutely. We will contact him.
    Mr. Marshall. Mr. Lukken, I guess, congratulations on your 
chairmanship. I will call you Mr. Chairman. The questions I had 
for you have already been asked by Mr. Moran and Mr. Goodlatte. 
I would like to elaborate a little bit, though, on the problem 
that you identified in your Senate testimony. I took it to be 
your view that perhaps some additional regulation should be 
considered, but that we should go slow in trying to figure out 
what that regulation might be and in response to Mr. Goodlatte, 
you specifically said, ``We have to be very cautious and 
precise,'' and it is not just the Commission, it is also the 
lawmakers here.
    And being cautious and precise requires that we understand 
the possible impacts, very sophisticated possible impacts, that 
any move that we make might have that could be detrimental to a 
wide range of individuals, including consumers. And you have 
already listed, for our benefit, in your testimony, in response 
to questions from Mr. Moran and Mr. Goodlatte, the various 
things that need to be taken into account. And I guess, as I 
listened to that and I think about our current status, it seems 
to me we ought not to be trying to do these things piecemeal, a 
little dabble here, a little dabble there, let us do something 
with energy over here with a little piece of legislation maybe 
in another Committee, et cetera. Maybe we ought to be trying to 
consider this as a whole cloth when we do CEA reauthorization.
    And among the things we have to take into account is if we 
give you additional responsibilities or requirements, what your 
additional needs will be. What do you think? Should this be CEA 
reauthorization and all folded into that or should we be doing 
it piecemeal?
    Mr. Lukken. I think that is logical, to try to do this as 
part of CEA reauthorization. This is the Committee of 
jurisdiction and expertise in this area. Many of you worked in 
2000 on this bill and understand the participants, the players 
and the concerns of this industry, so I think that that would 
make perfect sense to try to do, along with GAO's 
recommendations. Certainly, the Commission, hopefully, if we 
have a full complement of Commissioners, can provide some 
expertise and views on this, as well, to make sure that we 
avoid these pitfalls in trying to find the right solution.
    Mr. Marshall. I appreciate that. Back to Ms. Williams very 
briefly. In addition, could GAO, assuming that the Georgia 
Municipal Gas Authority and consumers in Georgia were 
specifically hurt by Amaranth, could you make suggestions for 
how to avoid that kind of thing in the future? I yield back.
    The Chairman. I thank the gentleman. Let us see. Mr. Graves 
for 5 minutes.
    Mr. Graves. Thank you, Mr. Chairman. I have to tell you, I 
appreciate you having this hearing. I just got a call. My 
daughter got a Reserve Grand Champion Marking Guild at the fair 
and I would much rather be there than here, but regardless, I 
do appreciate this hearing and I don't know if I have so much a 
question as a statement. Mr. Barrow and I introduced a bill 
last year and he has introduced it again this year, with me on 
there, that increased transparency considerably and oversight, 
and I hope you take a good close look at that.
    Your lack of staff or shortage of staff is well noted and 
we understand that and you talk, too, about the prosecutions 
being up. The only thing that concerns me about that is once it 
gets to, at least the majority, to prosecutions, the impact on 
the market has already been felt. We would much rather see this 
prevented rather than it getting that far and that is the 
reason for the oversight and more surveillance, and that is 
what this bill specifically deals with. But I would very much 
like to keep moving in that direction and improve that 
considerably and I hope you will do that. Thank you, Mr. 
Chairman.
    The Chairman. The gentleman yields back?
    Mr. Graves. Yes.
    The Chairman. I thank the gentleman. Mr. Boustany.
    Mr. Boustany. Thank you, Mr. Chairman. Ms. Williams, on 
page 12 of your testimony, you talk about, in addition to 
supply and demand factors that generally apply to energy 
commodities, specific developments can affect particular 
commodities, and you talk about special gasoline blends, the 
so-called boutique fuels. We all know that the presence of a 
number of boutique fuels does run up the cost because you have 
a segmented market and so forth. Can you talk a little bit 
about how does this complicate the work of the CFTC in terms of 
looking for price manipulation?
    Ms. Williams. Well, I think the bottom line in our 
statement is that it complicates the analysis and it makes 
establishing causality unclear because in the futures market, 
as well as the physical market, you have a number of dynamics 
going on and you have a lot of changes going on in each 
marketplace, so it does complicate the analysis.
    Mr. Boustany. Thank you. Commissioner Lukken, do you want 
to comment on that?
    Mr. Lukken. Well, traditionally, our job was much easier. 
There was number two corn, there was wheat, these products. But 
as these niche products have developed and the 
interconnectedness between those products has increased, it 
makes our surveillance economists' job much more difficult. 
They have to look at much more information, trying to find out 
where correlations might occur, so it is difficult. Technology 
helps. We are able to, hopefully, bring some analytical tools, 
with computers, to help bring some of these issues to bear, but 
it is definitely a difficult job.
    Mr. Boustany. Thank you. Since we last had you before the 
Committee, we have seen the advent of ethanol futures. Can you 
give us some observations, any ongoing issues with your work 
with regard to monitoring ethanol futures?
    Mr. Lukken. I think they were listed on the Chicago Board 
of Trade, was it a year and a half ago or so? Yes, it is not 
currently a very active contract on the Board of Trade, but I 
think the thinking is that if there is a product there for risk 
management, that those are involved in either the purchasing or 
production of ethanol, have a risk mitigation device in the 
futures markets that they can develop and be a part of. We 
think it is a product that maybe hasn't reached its day, but 
certainly will as ethanol production increases.
    Mr. Boustany. Thank you. Given that most oil transactions, 
I guess all oil transactions have been conducted in dollars, 
but Iran recently made the announcement that they were going to 
switch to Euros. Do you see this broadening on international 
markets and how will this complicate what you do?
    Mr. Lukken. Well, there are Middle East futures exchanges 
now being developed. NYMEX is in partnership with the Dubai 
Mercantile Exchange and there is now a Middle East crude oil 
contract being traded there and these are all linked and 
cleared through the United States. So it is bringing money and 
dollars back into the United States as a result of that. So 
this again, as you noted earlier, makes our job more difficult 
because the more products, the more interconnectedness of these 
products, the more difficult it is to surveil them. But we 
have, hopefully, the analytical tools in place to keep an eye 
on these markets.
    Mr. Boustany. Thank you. Mr. Chairman, I yield back.
    The Chairman. I thank the gentleman. Mr. Pomeroy for 5 
minutes.
    Mr. Pomeroy. Pass.
    The Chairman. Wow. Thank you. Mr. Neugebauer for 5 minutes.
    Mr. Neugebauer. Mr. Pomeroy's response has left me 
speechless, Mr. Chairman.
    The Chairman. But he did not yield his 5 minutes to you.
    Mr. Neugebauer. I really just have one question, Mr. 
Lukken. Of the cases of manipulation that you are currently 
investigating, how many of those were brought to you by the 
exchanges themselves or are those cases you originated on your 
own?
    Mr. Lukken. About 35 percent come from the exchanges or the 
ECMs and the rest are developed either on our own or from tips.
    Mr. Neugebauer. And since 100 is a good number to work with 
percentages on, so on cases where you have manipulation alleged 
or you open up a case on that, what would you say the 
percentage of cases that you close and say, ``Well, in fact, 
after further investigation, there was no manipulation.'' What 
are the percentage of the cases where you said there was 
manipulation?
    Mr. Lukken. I would say a majority we end up closing. I 
don't know percentage-wise what that might be, but it is 
significant. It is more than 50 percent that we don't have the 
evidence to prove that manipulation or attempted manipulation 
occurred.
    Mr. Neugebauer. And you may now have this number and you 
could get it to me, I would be interested to know of the, say, 
30 percent of the cases that the exchanges bring you, what the 
closure rate is on that, also. I do have a second question. Are 
you in any way alarmed right now that there is not currently a 
system in place with the industry regulating itself? Obviously, 
they have a vested interest in protecting the integrity of 
their marketplaces or their exchanges because if it is 
perceived that on a certain exchange that there is not 
appropriate protection, would cause folks maybe not want to 
trade with that exchange, but are you concerned? Obviously, we 
would like to see nobody trying to manipulate markets and in 
many cases, 50 percent of the people really aren't, but it 
appears, because of their trading patterns, that they might be 
doing something, so are you concerned?
    Mr. Lukken. Well, we do the best we can. Our mission is to 
detect and deter and try to prevent manipulations from ever 
occurring. Oftentimes our surveillance, itself, deters this 
from occurring. We talk people off the ledge and we call them 
up and ask them what are they doing. Why are you doing it. So 
oftentimes we never get to that hundred that I mentioned 
earlier.
    But once they get to that, there is evidence that something 
occurred. We have to take strong enforcement action and look 
into it vigorously and that is the complement of trying to 
prevent it while also going after it once it does occur. And 
oftentimes, this is coming from things outside the marketplace, 
information or activities outside the marketplace that we 
weren't able to surveil. We have to go after that vigorously 
and we have done so, so I am very confident in our staff and 
what we are doing in this area.
    Mr. Neugebauer. That was a good answer, but that wasn't the 
question. The question was are you concerned, currently? I mean 
in other words, at the level of activity going on right now, do 
you see any trend that makes you believe that we are out of 
control, that we aren't policing the markets appropriately. Or 
do you think that there is adequate protection and transparency 
in the system today?
    Mr. Lukken. I think we are adequately protecting the 
regulated futures marketplace, yes.
    Mr. Neugebauer. Thank you.
    The Chairman. The gentleman yields back? I thank you. The 
gentleman from Georgia, Mr. Barrow, for 5 minutes.
    Mr. Barrow. Thank you, Mr. Chairman. I want to thank you, 
Mr. Chairman, and the Ranking Member and all the other Members 
of this Committee for the courtesy you extended me today of 
allowing me to participate in your proceedings, knowing, as you 
do, of mine and Mr. Graves' keen interest in this subject. 
Thank you for your thoughtfulness.
    The Chairman. With that, we would just remind you, we are 
not going to extend more than 5 minutes.
    Mr. Barrow. I am not going to take more than 5 minutes. And 
I appreciate that reminder, too. I need that.
    Mr. Commissioner, I just want to take the Amaranth 
situation as a starting point, just to make sure I understand 
at least part of what is going on here. Am I correct in 
understanding that they had an over-the-counter position that 
was a whole lot bigger than their market position, their 
exchange position?
    Mr. Lukken. Well, over time, Amaranth first began 
exchanging on NYMEX and had a position on NYMEX and that 
position, over time, shifted.
    Mr. Barrow. My point is at the time of its collapse, their 
over-the-counter position was a whole lot bigger than their 
position in any regulated exchange?
    Mr. Lukken. That is correct.
    Mr. Barrow. And what kind of real-time notice did you all 
have of that?
    Mr. Lukken. We were not aware of the shift to ICE at the 
time.
    Mr. Barrow. Now, Mr. Graves and I are introducing a bill 
today which really doesn't do very much, but I would like your 
assessment of it. All it does is give you guys the direction to 
go out there and pass a rule that defines what a ``large 
position trade'' is or a ``large position trader.'' It gives 
you all the discretion to say how big is enough to be reported 
and how small is small enough not to be reported. It gives you 
all the flexibility and the discretion to do that, but then it 
tells you to go forth and do that and imposes a record keeping 
requirement on folks.
    Now, it seems to me just to be common sense that if folks 
who had been trading without your notice and occupying much 
larger positions in a completely unregulated marketplace, just 
to know that someone has the opportunity to know what their 
position is, if it is growing. But if someone obtains a legal 
right to demand a whole lot more than any existing supply, or 
any real world demand is, that someone is going to be able to 
notice that as it is going on. It seems to me that would deter 
a lot of misbehavior at the front end. What is wrong with that? 
Can't you all handle that?
    Mr. Lukken. I think the concept that you mention of 
additional transparency in record keeping is a good one. Since 
Amaranth, we have started to receive additional data from ICE.
    Mr. Barrow. And I want to commend the representatives of 
ICE, who will be testifying on the next panel, for their 
initiative in this. My point is, they are only dealing with the 
next level of lack of transparency outside the regulated 
exchange. Beyond that are the bilaterals and the folks who want 
any kind of regular exchange, regulated or otherwise. And my 
question to you is, is it important to know, since the game is 
now pretty much out there--isn't it important to know what kind 
of position folks have so we can monitor or at least measure 
the gap between the legal right to demand something and the 
real demand for the commodity?
    Mr. Lukken. Obviously, we have identified a similar risk 
here with trying to get more information from ICE on the 
regulated exchanges. As I mentioned earlier, and I am not sure 
if you were here at the time, but by extending it more broadly 
to the over-the-counter market raises concerns about us only 
having jurisdiction over futures contracts and there had been, 
in 2000, this debate over swaps versus futures. By trying to 
pull them into our jurisdiction, that might have the reaction 
of sending these markets overseas or to London or anywhere 
where those markets can exist. And so I understand what you are 
trying to do to bring greater transparency and record keeping 
in this area. All I would ask is that this Committee, when it 
considers these things, be precise, that there are difficult 
legal questions here. But we would certainly welcome, our staff 
would welcome, an opportunity to look at your legislation, give 
views on what might be necessary to improve it.
    Mr. Barrow. If it would put you all in the driver's seat in 
deciding what has to be reported and what doesn't, can you 
handle that?
    Mr. Lukken. Again, within our current legal authorities, 
yes. We are stretched to our legal bounds at the moment.
    Mr. Barrow. Thank you, and thank you, Mr. Chairman. I yield 
back.
    The Chairman. I thank the gentleman. Commissioner Lukken, 
Ms. Williams, thank you both for your testimony. We appreciate 
you being with us and my guess is, as this is ongoing, you will 
be together again in the not-too-distant future. Thank you.
    Now we will welcome our second panel, if they get set up, 
et cetera. Just so Members will know and you will know, we are 
anticipating a vote somewhere around 11:30 plus. We are not 
real sure exactly what time, depending on the action on the 
floor. So hopefully, we will get through the opening statements 
before we have to take a break.
    Okay, I think we got everybody seated. Thank you and we 
welcome the second panel to the table. Our first panelist is 
Dr. James Newsome, President and CEO of the New York Mercantile 
Exchange, New York. We welcome you here. And the next two I am 
going to ask Mr. Scott, if he will, to introduce those since 
they are from his home district in the State of Georgia.
    Mr. Scott. Thank you very much, Mr. Chairman, and it 
certainly is a great pleasure to welcome a couple of very fine 
Georgians to this Committee; first of all, Mr. Jeff Sprecher, 
who is the Chairman and CEO of IntercontinentalExchange. 
Welcome and we are delighted to have you. And also, Mr. Arthur 
Corbin of the Municipal Gas Authority of Georgia. We are 
delighted to have you before this Committee and we look forward 
to your testimony and thank you for coming.
    The Chairman. Thank you. Mr. Robert Pickel, Executive 
Director and CEO of the International Swaps and Derivatives 
Association of New York. Welcome. We are glad to have you. Mr. 
Paul Cicio, Industrial Energy Consumers of America in 
Washington. And Mr. Craig Eerkes, President of Sun Pacific 
Energy on behalf of the Petroleum Marketers Association of 
America. Thank you for coming and Dr. Newsome, please begin 
when you are ready. And please try to limit your testimony, as 
much as you can, to 5 minutes. Your testimony and your full 
statement will be included in the record. Thank you. Dr. 
Newsome.

 STATEMENT OF JAMES E. NEWSOME, Ph.D., PRESIDENT AND CEO, NEW 
          YORK MERCANTILE EXCHANGE, INC., NEW YORK, NY

    Dr. Newsome. Thank you, Mr. Chairman and Members of the 
Committee. I am Jim Newsome and I have the honor of serving as 
President and the Chief Executive Officer of the New York 
Mercantile Exchange, which is the world's largest forum for 
trading, clearing physical commodity-based futures contracts, 
including both energy and metals. NYMEX is fully regulated by 
the CFTC under the Commodity Exchange Act, both as a clearing 
organization and as a designated contract market, or DCM, which 
is the highest and most comprehensive of regulatory oversight 
to which a derivatives trading facility may be subject under 
current law and regulation.
    Mr. Chairman, I thank you and the Members of the Committee 
for the opportunity to participate in today's hearing on energy 
derivatives trading. Prior to joining NYMEX, I served as CFTC 
Chairman. Mr. Chairman, I led the CFTC's implementation of the 
Commodity Futures Modernization Act of 2000 and worked very 
closely with this Committee in doing so. I tend to agree 
completely with acting Chairman Lukken that the vast majority 
of the CFMA has been very, very successful.
    The CFMA streamlined and modernized the regulatory 
structure of the derivatives industry and also permitted 
bilateral trading of energy on electronic platforms. Under CFTC 
rules, these electronic trading platforms are called ECMs, or 
exempt commercial markets, and are subject only to the CFTC's 
anti-fraud, anti-manipulation authority. Unlike the designated 
contract market, the ECM is exempted from some statutory CFTC 
regulation and also has no self-regulatory obligations to 
monitor its own markets.
    A series of significant changes has occurred in the natural 
gas market since the passage of the CFMA, including 
advancements in trading technology, such that NYMEX, the 
regulated DCM, and the IntercontinentalExchange, ICE, an 
unregulated ECM, have become highly linked trading venues. As a 
result, which could not have been reasonably predicted just a 
few short years ago, the current statutory structure, in my 
opinion, no longer works for certain markets now operating as 
ECMs. Specifically, the regulatory disparity between NYMEX and 
ICE, which are functional equivalents, has created serious 
challenges for the CFTC, as well as for the NYMEX in its 
capacity as an SRO.
    In August of 2006, NYMEX proactively took steps to maintain 
the integrity of its markets by ordering Amaranth to reduce its 
positions in the natural gas futures contract. However, 
Amaranth then increased its positions on the unregulated and 
non-transparent ICE electronic trading platform. Because the 
ICE and NYMEX trading venues for natural gas are tightly linked 
and highly interactive with each other, they are, in essence, 
components of a broader natural gas derivatives market. 
Therefore Amaranth's response to NYMEX's regulatory directive 
did not reduce Amaranth's overall market risk. Furthermore, the 
integrity of NYMEX markets continued to be affected by, and 
exposed, to Amaranth's positions in the natural gas market.
    Finally, NYMEX had no means to monitor Amaranth's positions 
on ICE, or to take steps to have Amaranth reduce its 
participation on that trading venue. Based upon these 
experiences, I believe that ECMs such as ICE, that function 
more like a traditional exchange, and that trade products that 
are linked to an established exchange, should be subject to 
regulation of the CFTC. Consequently, legislative change may be 
necessary to address the real public interest concerns created 
by the current structure of the natural gas market and the 
potential for systemic risk.
    Mr. Chairman, I would like to address two additional things 
that were brought out with the previous panel. One, there was 
quite a bit of discussion about the special call authority and 
that is the authority that I used when I was Chairman of the 
CFTC. It is very effective authority, particularly from an 
enforcement standpoint, that allows the enforcement agency to 
collect information and to use that information to build an 
enforcement case. But the role of the Market Oversight Division 
of the CFTC is to prevent that manipulation or that systemic 
risk from occurring in the first place, and it is impossible to 
do so when you only collect information after the fact. So that 
was a point that I wanted to bring out.
    The second point is with regard to the fear of flight to 
offshore markets. Certainly, that is a potential risk and it is 
a risk in a number of markets and situations that we talked 
about. But I think here today we are specifically talking about 
natural gas and the way that natural gas has evolved related to 
other markets. In natural gas, I think one of the things that 
is really different is the fact that even in the over-the-
counter space, 90 percent of the natural gas markets are now 
cleared. They are cleared either at NYMEX or they are cleared 
on Jeff's exchange at ICE. Because of that you are aggregating 
that risk in an exchange type manner, but customers want to 
clear those contracts. So I think because of the high 
percentage of cleared contracts in natural gas, the fear of 
that offshore risk is much decreased as compared to other 
markets.
    Thank you, Mr. Chairman.
    [The prepared statement of Dr. Newsome follows:]

 Prepared Statement of James E. Newsome, Ph.D., President and CEO, New 
              York Mercantile Exchange, Inc., New York, NY
Introduction
    Mr. Chairman and Members of the Subcommittee, my name is Jim 
Newsome and I am the President and Chief Executive Officer of the New 
York Mercantile Exchange, Inc. (NYMEX or Exchange). NYMEX is the 
world's largest forum for trading and clearing physical-commodity based 
futures contracts, including energy and metals products. NYMEX has been 
in the business for more than 135 years and is a federally chartered 
marketplace, fully regulated by the Commodity Futures Trading 
Commission (CFTC) both as a ``derivatives clearing organization'' and 
as a ``designated contract market'' (DCM), which is the highest and 
most comprehensive level of regulatory oversight to which a derivatives 
trading facility may be subject under current law and regulation.
    Prior to joining NYMEX, I served as a CFTC Commissioner and, 
subsequently, from 2001 to 2004, as the Chairman. As Chairman, I led 
the CFTC's implementation of the Commodity Futures Modernization Act of 
2000 (CFMA). The CFMA streamlined and modernized the regulatory 
structure of the derivatives industry and provided legal certainty for 
over-the-counter (OTC) swap transactions by creating new exclusions and 
exemptions from substantive CFTC regulation for bilateral transactions 
between institutions and/or high net-worth participants in financial 
derivatives and exempt commodity derivatives, such as energy and 
metals.
    On behalf of the Exchange, its Board of Directors and shareholders, 
I thank you and the Members of the General Farm Commodities and Risk 
Management Subcommittee for the opportunity to participate in today's 
hearing on energy-related derivatives trading.
Statutory Background
    In order to better understand the situation regarding energy-based 
derivatives, it is useful to review a bit of history leading up to the 
CFMA. For many years, the CFTC has had exclusive jurisdiction over the 
regulation of contracts for a commodity for future delivery, i.e., 
futures contracts. Moreover, a longstanding requirement was that 
futures contracts could only be traded on a futures exchange that was 
directly regulated by the CFTC. A contract deemed by the CFTC to be a 
futures contract that was not executed on a regulated futures exchange 
was viewed as an illegal off-exchange transaction and would be subject 
to CFTC enforcement action. Additionally, there was legal uncertainly 
concerning the execution of swaps, including energy swaps, on an 
electronic trading facility. During the 1990s, the OTC swap market 
began to increase substantially in size, and swap agreements began to 
be more standardized and strikingly similar to futures contracts. This 
transition created additional legal uncertainty around the trading of 
OTC swaps.
    Because of the growing legal uncertainty regarding whether such 
products were or were not futures contracts, Congress directed the 
President's Working Group on Financial Markets (PWG) to conduct a study 
of OTC derivatives markets and to provide legislative recommendations 
to Congress. The PWG Report entitled ``Over-the-Counter Derivatives 
Markets and the Commodity Exchange Act,'' was issued in 1999 and 
focused primarily on swap and other OTC derivatives transactions 
executed between eligible participants. Among other things, the PWG 
Report recommended exclusion from the Commodity Exchange Act (CEA) for 
swap transactions in financial products between eligible swap 
participants. However, the PWG Report explicitly noted that ``[t]he 
exclusion should not extend to any swap agreement that involved a non-
financial commodity with a finite supply.'' (Report of the PWG, ``Over-
the-Counter Derivatives Markets and the Commodity Exchange Act'' 
(November 1999) at p. 17.) The collective view at the CFTC at that time 
was that the jury was still out as to whether or not energy commodities 
were susceptible to manipulation and, therefore, energy commodities 
should not be excluded from the Act.
    In December 2000, Congress enacted the CFMA, which is widely 
credited for the phenomenal growth and innovation of the futures 
industry. The CFMA provided greater legal certainty for derivatives 
executed in OTC markets; established a number of new statutory 
categories for trading facilities; and shifted away from a ``one-size-
fits-all'' prescriptive approach to futures exchange regulation to a 
more flexible approach that included use of core principles for DCMs.
    The Congress included provisions in the CFMA which exempted energy 
commodities from CFTC regulation and allowed the trading of energy 
swaps on an electronic trading platform. Under CFTC rules, these 
trading facilities are known as ``Exempt Commercial Markets'' (ECM). 
While transactions executed on an ECM generally are subject to anti-
fraud and anti-manipulation authority, the ECM itself is essentially 
exempt from all substantive CFTC regulation and oversight and has no 
self-regulatory responsibilities.
NYMEX's Role and Responsibilities as a DCM
    NYMEX is fully regulated by the CFTC as a DCM, which is the highest 
level of regulation for a trading platform under the CEA. As a DCM, 
NYMEX has an affirmative responsibility to act as a self-regulatory 
organization (SRO) and to monitor and to police activity in its own 
markets. The CFMA established a number of ``Core Principles'' for DCM 
regulation. The CFMA also permitted bilateral trading of energy on 
electronic platforms. Under CFTC rules, ECMs are subject only to the 
CFTC's anti-fraud and anti-manipulation authority. Unlike the DCM, the 
ECM is completely unregulated by the CFTC and thus has no self-
regulatory obligations to monitor its own markets or otherwise to 
prevent market abuses. The IntercontinentalExchange (ICE) is an ECM.
    As the benchmark for energy prices around the world, trading on 
NYMEX is transparent, open and competitive and fully regulated by the 
CFTC. NYMEX does not trade in the market or otherwise hold any market 
positions in any of its listed contracts and, being price neutral, does 
not influence price movement. Instead, NYMEX provides trading fora that 
are structured as pure auction markets for traders to come together and 
to execute trades at competitively determined prices that best reflect 
what market participants think prices will be in the future, given 
today's information. Transactions can also be executed off-Exchange, 
i.e., in the traditional bilateral OTC arena, and submitted to NYMEX 
for clearing via the NYMEX ClearPort' Clearing website 
through procedures that will substitute or exchange a position in a 
regulated futures or options contract for the original OTC product.
    Unlike securities markets, which serve an essential role in capital 
formation, organized derivatives venues such as NYMEX provide a very 
different, but equally important economic benefit to the public by 
serving two key functions: (1) competitive price discovery and (2) 
hedging by market participants.
    The public benefits of commodity markets, including increased 
market efficiencies, price discovery and risk management, are enjoyed 
by the full range of entities operating in the U.S. economy, whether or 
not they trade directly in the futures markets. Everyone in our economy 
is a public beneficiary of vibrant, efficient commodity markets, from 
the U.S. Treasury, which saves substantially on its debt financing 
costs, to every food processor or farmer, every consumer and company 
that uses energy products for their daily transportation, heating and 
manufacturing needs, and anyone who relies on publicly available 
futures prices as an accurate benchmark.
    Under the CFMA, NYMEX must comply with a number of broad, 
performance-based Core Principles applicable to DCMs that are fully 
subject to the CFTC's regulation and oversight. These include eight 
Core Principles that constitute initial designation criteria, as well 
as 18 other ongoing Core Principles for DCMs.
    NYMEX has an affirmative obligation to act as a SRO. As such, NYMEX 
must police its own markets and maintain a program that establishes and 
enforces rules related to detecting and deterring abusive practices. Of 
particular note is the series of Core Principles that pertain to 
markets and to market surveillance. A DCM can list for trading only 
those contracts that are not readily susceptible to manipulation. In 
addition, a DCM must monitor trading to prevent manipulation, price 
distortion and disruptions of the delivery or cash-settlement process. 
Furthermore, to reduce the potential threat of market manipulation or 
congestion, the DCM must adopt position limits or position 
accountability for a listed contract, where necessary or appropriate.
    NYMEX has numerous surveillance tools that are used routinely to 
ensure fair and orderly trading on our markets. The large trader 
reporting system is the principal tool that is used by DCMs to monitor 
trading for purposes of ensuring market integrity. For energy 
contracts, the reportable position levels are distinct for each 
contract listed by the Exchange for trading. The levels are set by 
NYMEX and are specified by rule amendments that are submitted to the 
CFTC, typically following consultation and coordination with the CFTC 
staff.
    The NYMEX Market Surveillance staff routinely reviews price 
activity in both futures and cash markets, focusing, among other 
things, on whether the futures markets are converging with the spot 
physical market as the NYMEX contract nears expiration. Large trader 
data are reviewed daily to monitor customer positions in the market. On 
a daily basis, NYMEX collects the identities of all participants who 
maintain open positions that exceed set reporting levels as of the 
close of business the prior day. These data are used to identify 
position concentrations requiring further review and focus by Exchange 
staff. These data are also published in aggregate form for public 
display by the CFTC on its website in a weekly report referenced as the 
Commitments of Traders (COT) report. Historically at NYMEX, the open 
interest data included in large trader reports reflects approximately 
80% of total open interest in the applicable contracts.
    Any questionable market activity results in an inquiry or formal 
investigation. NYMEX closely monitors its futures market at all times 
in order to enforce orderly trading and liquidations. NYMEX staff 
additionally increases its market surveillance reviews during periods 
of heightened price volatility.
    By rule, NYMEX also maintains and enforces limits on the size of 
positions that any one market participant may hold in a listed 
contract. These limits are set at a level that greatly restricts the 
opportunity to engage in possible manipulative activity on NYMEX. It is 
the tradition in futures markets that futures and options contracts 
generally are listed as a series of calendar contract months. When 
position accountability levels are exceeded, exchange staff conducts 
heightened review and inquiry, which may result in NYMEX staff 
directing the market participant to reduce its positions. Breaching the 
position limit can result in disciplinary action being taken by the 
Exchange. Finally, NYMEX also maintains a program that allows for 
certain market participants to apply for targeted exemptions from the 
position limits in place on expiring contracts. Such hedge exemptions 
are granted on a case-by-case basis following adequate demonstration of 
bona fide hedging activity involving the underlying physical cash 
commodity or involving related swap agreements.
    Beyond the formal regulatory requirements, NYMEX staff works 
cooperatively and constructively with CFTC staff to assist them in 
carrying out their market surveillance responsibilities. NYMEX staff 
and CFTC staff regularly engage in the informal sharing of information 
about market developments. In addition to the Exchange's self-
regulatory program, the CFTC conducts ongoing surveillance of NYMEX 
markets, including monitoring positions of large traders, deliverable 
supplies and contract expirations. The CFTC also conducts routine 
``rule enforcement'' reviews of our self-regulatory programs. NYMEX 
consistently has been deemed by the CFTC to maintain adequate 
regulatory programs and oversight, in compliance with its self-
regulatory obligations under the Commodity Exchange Act.
    Moreover, NYMEX staff can and do make referrals to CFTC staff for 
possible investigation, such as with respect to activity by a market 
participant that is not a NYMEX member or member firm. Thus, for 
example, in an investigation of a non-member market participant, the 
Exchange would lack direct disciplinary jurisdiction and the consequent 
ability to issue effective sanctions (other than denial of future 
access to the trading of our products). In that situation, NYMEX staff 
could and has in the past turned over the work files and related 
information to CFTC staff. All such referrals are made on a strictly 
confidential basis. Similarly, CFTC staff on occasion makes 
confidential referrals to NYMEX staff as well.
    Overall, there is a strong overlap between the CFTC's regulatory 
mission and NYMEX's SRO role in ensuring the integrity of trading in 
NYMEX's contracts. NYMEX itself has a strong historic and ongoing 
commitment to its SRO responsibilities. As noted in the Report, the 
NYMEX regulatory program has a current annual budget of approximately 
$6.2 million, which reflects a significant commitment of both staff and 
technology.
Linked Trading Venues
    At the time that the CFMA was being formulated in Congress, there 
may have been a notion that the public interest was not implicated by 
trading on markets such as ICE because larger market participants did 
not need a regulatory agency to protect them from trading with each 
other. Yet, what has become clear in the last several years is that the 
changing nature and role of ECM venues such as ICE do now trigger 
public interest concerns in several ways, including with respect to the 
multiple impacts on other trading venues that are regulated as well as 
through the exchange-like aggregation of financial risk.
    A series of profound changes have occurred in the energy markets 
since the passage of the CFMA, including technological advances in 
trading, such that the regulated DCM, NYMEX, and the unregulated ECM, 
ICE, have become highly linked trading venues. As a result of this 
phenomenon, which could not have been reasonably predicted only a few 
short years ago, the current statutory structure no longer works for 
certain markets now operating as ECMs. Specifically, the regulatory 
disparity between the NYMEX and the ICE, which are functionally 
equivalent, has created serious challenges for the CFTC as well as for 
NYMEX in its capacity as an SRO.
    We do not believe that the case has been made and, thus, we do not 
support any new regulation of derivatives transactions that are 
individually negotiated and executed off-exchange i.e., not on a 
trading facility, between eligible participants in the traditional 
bilateral OTC market. On the other hand, we do believe that ECMs such 
as ICE that function more like a traditional exchange and that are 
linked to an established exchange should be subject to the full 
regulation of the CFTC. In addition, the continuing exchange-like 
aggregation and mutualization of risk at the clearinghouse level from 
trading on active ECMs such as ICE, where large positions are not 
monitored, raise concerns about spill-over or ripple effects for other 
clearing members and for various clearing organizations that share 
common clearing members. Consequently, legislative change may be 
necessary to address the real public interest concerns created by the 
current structure of the natural gas market and the potential for 
systemic financial risk from a market crisis involving significant 
activity occurring on the unregulated trading venue.
    In 2001, when the CFTC was proposing and finalizing implementing 
regulations and interpretations for the CFMA, and shortly following the 
Enron meltdown in late 2001, the natural gas market continued to be 
largely focused upon open outcry trading executed on the regulated 
NYMEX trading venue. At that time, NYMEX offered electronic trading on 
an ``after-hours'' basis, which contributed only approximately 7-10% of 
overall trading volume at the Exchange. Electronic trading (of 
standardized products based upon NYMEX's natural gas contracts) was at 
best a modest proportion of the overall market. Moreover, it was more 
than 6 months following the Enron meltdown before the industry began to 
offer clearing services for OTC natural gas transactions.
    In determining to compete with NYMEX, ICE copied all of the 
relevant product terms of NYMEX's core or flagship natural gas futures 
contract, and also misappropriated the NYMEX settlement price for daily 
and final settlement of its own contracts. ICE's misappropriation of 
NYMEX's intellectual property remains a matter of dispute in ongoing 
litigation between the two exchanges that is now under judicial appeal. 
However, as things stand today, natural gas market participants have 
the assurance that they can receive the benefits of obtaining NYMEX's 
settlement price, which is now the established industry pricing 
benchmark, by engaging in trading either on NYMEX or on ICE.
    For some period of time following the launch of ICE as a market, 
ICE was the only trading platform that offered active electronic 
trading during daytime trading hours. In September 2006, NYMEX began 
providing ``side-by-side'' trading of its products--listing products 
for trading simultaneously on the trading floor and on the electronic 
screen. Since that time, there has been active daytime electronic 
trading of natural gas on both NYMEX and ICE. The share of electronic 
trading at NYMEX as a percentage of overall transaction volume has 
shifted dramatically to the extent that electronic trading now accounts 
for 80-85% of overall trading volume at the Exchange. The existence of 
daytime electronic trading on both NYMEX and ICE has fueled the growth 
of arbitrage trading between the two markets. Thus, for example, a 
number of market participants that specialize in arbitrage activity 
have established computer programs for electronic trading that 
automatically transmit orders to one market when there is an apparent 
price imbalance with the other market or where one market is perceived 
to offer a better price than the other market. As a result, there is 
now a relatively consistent and tight spread in the prices of the 
competing natural gas products. Hence, the two competing trading venues 
are now tightly linked and highly interactive and in essence are simply 
two components of a broader derivatives market. No one could have 
predicted in 2000, when the exemption was crafted for energy swaps, how 
this market would have evolved.
    When the price of a product trading on one venue (ICE) is linked to 
the final settlement price of a product trading on another venue 
(NYMEX), trading on one venue contributes or influences the price of 
that product trading on the other venue. The CFTC acknowledged in its 
recent proposed rule-making that there is ``a close relationship among 
transactions conducted on reporting markets and non-reporting 
transactions.'' (72 Fed. Reg. 34413, at 34414 (2007) (proposed June 22, 
2007.) It is also relevant to consider the recent statement issued on 
June 14, 2007 by the Department of Justice (DOJ) Antitrust Division 
announcing the closure of its review of the proposed acquisition by 
Chicago Mercantile Exchange Holdings Inc. of CBOT Holdings Inc. based 
upon the DOJ's determination that neither that acquisition nor the 
clearing agreement between the two exchanges was likely to reduce 
competition substantially. NYMEX believes that this announcement is 
based upon a tacit recognition by the Antitrust Division that, with 
regard to analysis of the relevant market, at a minimum, regulated 
futures trading and over-the-counter trading are simply components of a 
broader market (that also might be defined to include some cash market 
activity as well).
    In addition to the misappropriation of NYMEX's settlement price, 
the ICE market now has a significant market share of natural gas 
trading, and a number of observers have suggested that most of the 
natural gas trading in the ICE Henry Hub swap is subsequently cleared 
by the London Clearing House, the clearing organization contracted by 
ICE to provide clearing services. Thus, there is now a concentration of 
market activity and positions occurring on the ICE market as well as 
the exchange-like concentration and mutualization of financial risk at 
the clearing house level from that activity.
    A clear illustration of the negative implications of unregulated 
ECMs linked to regulated DCMs can be seen in the demise of Amaranth, a 
hedge fund that actively traded natural gas on both NYMEX and ICE. In 
August 2006, NYMEX proactively took steps to maintain the integrity of 
its markets by ordering Amaranth to reduce its open positions in the 
Natural Gas futures contract. However, Amaranth then sharply increased 
its positions on the unregulated and nontransparent ICE electronic 
trading platform. Because the ICE and NYMEX trading venues for natural 
gas are tightly linked and highly interactive with each other and 
essentially are components of a broader natural gas derivatives market, 
Amaranth's response to NYMEX's regulatory directive admittedly reduced 
its positions on NYMEX but did not reduce Amaranth's overall market 
risk nor the risk of Amaranth's guaranteeing clearing member. 
Furthermore, the integrity of NYMEX markets continued to be affected by 
and exposed to Amaranth's outsize positions in the natural gas market. 
Moreover, NYMEX had no efficient means to monitor Amaranth's positions 
on ICE or to take steps to have Amaranth reduce its participation in 
that trading venue.
    Because ICE price data are available only to market participants, 
NYMEX does not have the means to establish conclusively the extent to 
which trading of ICE natural gas swaps contributes to or influences or 
affects the price of the related natural gas contracts on NYMEX. 
However, what is clear is that, as a consequence of the extensive 
arbitrage activity between the two platforms and ICE's use of NYMEX's 
settlement price as well as other factors, the two natural gas trading 
venues are now tightly linked and highly interactive. These two trading 
venues serve the same economic functions and are now functionally 
equivalent to each other. NYMEX staff has been advised that, during 
most of the trading cycle of a listed futures contract month, there is 
a range of perhaps only five to twelve ticks separating the competing 
NYMEX and ICE products. (The NYMEX NG contract has a minimum price 
fluctuation or trading tick of $.001, or .01 cents per mmBtu.) NYMEX 
staff has also been advised by market participants who trade on both 
markets that a rise (fall) in price on one trading venue will be 
followed almost immediately by a rise (fall) in price on the other 
trading venue. This may occur because prices rise first on ICE and then 
follow on NYMEX, or because prices rise first on NYMEX and then follow 
on ICE. These observations of real-world market activity support the 
conclusion that trading of ICE natural gas swaps do in fact contribute 
to, influence and affect the price of the related natural gas contracts 
on NYMEX.
    Aside from a lawsuit brought by NYMEX against ICE for the use of 
NYMEX's settlement prices, which as noted is a matter that remains 
under appeal in a Federal court of appeals, NYMEX does not otherwise 
have any other ongoing formal relationship with ICE. In particular, as 
ICE and NYMEX are in competition with each other, there are currently 
no arrangements in place, such as information-sharing, to address 
market integrity issues. As stated previously, NYMEX as a DCM does have 
affirmative self-regulatory obligations; ICE as an ECM has no such 
duties. Yet, from a markets perspective, the ICE and NYMEX trading 
venues for natural gas are tightly linked and highly interactive; 
trading activity and price movement on one venue can quickly affect and 
influence price movement on the other venue.
    In a recent report by the Senate Committee on Homeland Security and 
Government Affairs' Permanent Subcommittee on Investigations regarding 
``Excessive Speculation in the Natural Gas Market'', the Subcommittee 
made a number of findings concerning the demise of Amaranth. Among 
other things, the Subcommittee report concluded that 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. The report also concluded that ICE and NYMEX affect each 
other's prices in natural gas trading. Furthermore, the report found 
that the CFTC lacked effective statutory authority to establish or 
enforce speculative position limits for the trading of natural gas on 
ICE or on other exempt commercial markets. The report then called for 
the CFTC to receive such additional authority.
    The lack of effective position limits is of broader significance 
because the issue also arises with respect to energy products other 
than natural gas. Specifically, ICE Futures (a subsidiary of ICE and a 
foreign board of trade regulated by the UK Financial Services 
Authority) lists for trading a crude oil contract that replicates the 
terms of the NYMEX West Texas Intermediate Crude Oil (WTI) contract, 
including the daily and final settlement prices. ICE Futures has no 
direct regulatory relationship with the CFTC, and continues to rely on 
a ``no action'' letter that the CFTC issued to its predecessor back in 
1998. ICE Futures now has a market share of approximately 40 percent of 
the WTI crude oil futures volume, but none of that volume is subject to 
U.S. regulation. Under the U.K. Financial Services Authority regulatory 
structure, trading of the WTI contract on ICE Futures is not subject to 
any position limit requirements. Thus, there is also a regulatory 
imbalance in crude oil trading that provides a clear incentive for 
market participants to shift trading in order to be able to trade 
without any effective restrictions on the size of their positions.
NYMEX Natural Gas Expiration Advisory
    On February 16, 2007, in an effort to cooperate with the Federal 
Energy Regulatory Commission and following consultation with CFTC 
staff, NYMEX issued a compliance advisory in the form of a policy 
statement related to exemptions from position limits in NYMEX Natural 
Gas (NG) futures contracts NYMEX adopted this new policy on an interim 
basis in a good faith effort to carry out its self-regulatory 
responsibilities and to address on an individual exchange level the 
market reality demonstrated by Amaranth's trading on both regulated and 
unregulated markets. However, as detailed below, this experience has 
had an adverse impact on NYMEX's trading venues and is seemingly 
creating the result of shifting trading volume (during the critically 
important NG closing range period at NYMEX on the final day of trading) 
from our regulated trading venue to unregulated trading venues.
    Pursuant to that advisory, NYMEX instituted new uniform 
verification procedures to document market participants' exposure 
justifying the use of an approved hedge exemption in the NG contract. 
These procedures apply to all market participants who carry positions 
above the standard expiration position limit of 1,000 contracts going 
into the final day of trading for the expiring contract. Specifically, 
prior to the market open of the last trading day of each expiration, 
NYMEX now requires all market participants with positions above the 
expiration position limit of 1,000 contracts to supply information on 
their complete trading ``book'' of all natural gas positions linked to 
the settlement price of the expiring NG contract. Positions in excess 
of 1,000 contracts must offset a demonstrated risk in the trading book, 
and the net exposure of the entire book must be no more than 1,000 
contracts on the side of the market that could benefit by trading by 
that market participant during the closing range.
    NYMEX has now experienced five expirations of a terminating 
contract month in the NG futures contract since this new compliance 
advisory went into effect. To date, only two market participants have 
participated in this advisory and supplied information to the Exchange 
on their complete trading book. By comparison, NYMEX staff has observed 
a number of instances where market participants have reduced their 
positions before the open of the final day of trading rather than share 
sensitive trading information about proprietary trading with Exchange 
staff. As a result, NYMEX has observed reduced trading volume on the 
final day of trading in an expiring contract month relative to the 
final day of trading for the same calendar contract month in the prior 
year. The average volume on the final day of trading for the March, 
April, May, June and July 2007 NG contracts was 30,400 versus 37,122 
for the corresponding contract month in the prior year, or an 18% 
reduction
    Even more significantly, the closing range volume for the 30 minute 
closing period on the final day of trading is sharply lower than for 
volume during the final day closing range for the same calendar 
contract month in the prior year. In most instances, the volume in the 
closing range is less than half of the volume in the closing range for 
the same calendar contract month in the prior year. The average closing 
range volume on the final day of trading for the March, April, May, 
June and July 2007 NG contracts was 14,048 versus 23,165 for the 
corresponding contract month in the prior year, or a 39% reduction.
    Overall market volatility in the natural gas market is somewhat 
lower this spring and summer than from comparable periods a year ago. 
This lower volatility stems from a lack of price volatility in the 
underlying physical cash commodity and in our opinion not from our 
implementation of this advisory. That stated, the lower volumes seen 
during the recent 30 minute closing ranges on the final day of trading 
since the implementation of the new policy actually create the 
potential for even greater volatility in the event of any significant 
market move. Thus, the new interim policy implemented by NYMEX on a 
good-faith basis has not only led to reduced volume on NYMEX during the 
critical 30 minute closing range period, which presumably has shifted 
to the unregulated trading venues, but has also failed to solve the 
structural imbalances brought to light by Amaranth's trading. In 
addition, this policy could create new problems by diminishing the 
vitality of the natural gas industry's pricing benchmark. Consequently, 
NYMEX believes that legislative change may be necessary and 
appropriate.
Conclusion
    A series of profound changes have occurred in energy-related 
derivatives markets since the passage of the CFMA, including 
technological advances in trading, such that the regulated DCM, NYMEX, 
and the IntercontinentalExchange, an unregulated ECM, have become 
highly linked trading venues. As a result of this phenomenon, the 
regulatory disparity between NYMEX and ICE, which are functionally 
equivalent to each other, has created serious challenges for the CFTC 
as well as for NYMEX in its capacity as an SRO.
    We do not support any new regulation of derivatives transactions 
that are individually negotiated and executed off-exchange between 
eligible participants in the traditional bilateral OTC market. On the 
other hand, we do believe that ECMs such as ICE that function more like 
a traditional exchange and that are linked to an established exchange 
should be subject to the full regulation of the CFTC. In addition, the 
aggregation and mutualization of risk at the clearinghouse level from 
trading on active ECMs such as ICE, where large positions are not 
monitored, raise concerns about spill-over or ripple implications for 
other clearing members and for various clearing organizations that 
share common clearing members. Consequently, legislative change may be 
necessary to address the real public interest concerns created by the 
current structure of the natural gas market and the potential for 
systemic financial risk from a market crisis involving significant 
activity occurring on the unregulated trading venue.
    I thank you for the opportunity to share the viewpoint of the New 
York Mercantile Exchange with you today. I will be happy to answer any 
questions Members of the Subcommittee may have.

    The Chairman. Thank you, sir. Mr. Sprecher.

           STATEMENT OF JEFFREY C. SPRECHER, FOUNDER,
       CHAIRMAN, AND CEO, IntercontinentalExchange, INC.,
                          ATLANTA, GA

    Mr. Sprecher. Thank you, Mr. Chairman, Subcommittee Members 
and staff members. My name is Jeff Sprecher and I am the 
Chairman/Chief Executive Officer of IntercontinentalExchange, 
which is also called ICE. We very much appreciate the 
opportunity to appear before you today to discuss the 
operations of ICE, and to share with you our views on the 
regulation of the energy derivatives markets. ICE operates a 
leading global commodity marketplace comprising of both futures 
and over-the-counter markets across a wide variety of product 
classes, including agriculture and energy commodities, foreign 
exchange and equity indices.
    ICE owns and operates two regulated futures exchanges. ICE 
Futures, which is a London-based energy futures exchange, and 
it is overseen by the UK Financial Services Authority, and we 
own the Board of Trade of the City of New York, which is an 
agricultural commodity and financial futures exchange regulated 
by the CFTC. ICE's electronic marketplace for OTC energy 
contracts is now serving customers in Asia, Europe and the U.S. 
and it is operated under the Commodity Exchange Act as a 
category of marketplace known as the ECM. As an ECM, these 
markets are subject to the jurisdiction of the CFTC and to 
regulations of the CFTC which impose record keeping, reporting 
and other requirements on us.
    In addition, ICE has established an automated, daily 
position reporting system to the CFTC in our cleared natural 
gas markets, which we continue to work with them to enhance and 
support. ICE has always been, and we continue to be, a strong 
proponent of open and competitive markets in energy commodities 
and their related derivatives, and of regulatory oversight of 
these markets. As an operator of global futures and over-the-
counter markets and as a publicly traded company, we strive to 
ensure the utmost confidence in the integrity of the markets 
and the soundness of our business mode. So to that end, we have 
consistently worked with the CFTC and regulatory agencies in 
the U.S. and abroad to make sure that they have access to all 
relevant information that is available to ICE regarding the 
trading activity in our markets. And we are going to continue 
to work with all relevant agencies in the future.
    We strongly support legislative and regulatory changes that 
will enhance the quality of oversight and available information 
with respect to natural gas in the United States. For example, 
we are in favor of increases to the CFTC's budget and the 
enhancement of its access to trading information. However, we 
do not believe that a complete overhaul of the current 
regulatory structure is either warranted, or is it advisable. 
Moreover, any regulatory changes that are made need to reflect 
the nature of ICE and its markets and the significant 
differences that exist between the many venues for over-the-
counter trading of swaps and derivatives that exist today.
    We also believe that any consideration of possible changes 
to the current regulatory structure must be based on an 
understanding of the operations of an ECM market such as ICE 
and the balance that was struck by Congress and the CFTC 
between overseeing these markets, while still allowing them to 
function in the context of OTC trading by commercial and 
institutional participants. We welcome the opportunity to work 
with the Subcommittee and its staff on these important issues 
and thank you.
    [The prepared statement of Mr. Sprecher follows:]

Prepared Statement of Jeffrey C. Sprecher, Founder, Chairman, and CEO, 
              IntercontinentalExchange, Inc., Atlanta, GA
    Mr. Chairman, Subcommittee Members and Staff Members, my name is 
Jeff Sprecher and I am the Chairman and Chief Executive Officer of 
IntercontinentalExchange, Inc., or ``ICE.'' We very much appreciate the 
opportunity to appear before you today to discuss the operations of ICE 
and to share with you our views on the regulation of the energy 
derivatives markets.
    ICE operates a leading global commodity marketplace, comprising 
both futures and over-the-counter (``OTC'') markets, across a variety 
of product classes, including agricultural and energy commodities, 
foreign exchange and equity indexes. ICE owns and operates two 
regulated futures exchanges--ICE Futures, a London-based energy futures 
exchange overseen by the U.K. Financial Services Authority, and the 
Board of Trade of the City of New York, or ``NYBOT,'' an agricultural 
commodity and financial futures exchange regulated by the Commodity 
Futures Trading Commission (``CFTC''). ICE's electronic marketplace for 
OTC energy contracts serves customers in Asia, Europe and the U.S. and 
is operated under the Commodity Exchange Act (``CEA'') as a category of 
marketplace known as an ``exempt commercial market,'' or ECM. As an 
ECM, these markets are subject to the jurisdiction of the CFTC and to 
regulations of the CFTC imposing record keeping, reporting and other 
requirements. In addition, and as I will discuss later, ICE has 
established a daily position reporting program to the CFTC in its 
cleared natural gas markets that we continue to enhance and support.
    ICE has always been and continues to be a strong proponent of open 
and competitive markets in energy commodities and related derivatives, 
and of regulatory oversight of those markets. As an operator of global 
futures and OTC markets and as a publicly-held company, we strive to 
ensure the utmost confidence in the integrity of our markets and in the 
soundness of our business model. To that end, we have continuously 
worked with the CFTC and other regulatory agencies in the U.S. and 
abroad in order to ensure that they have access to all relevant 
information available to ICE regarding trading activity on our markets 
and we will continue to work with all relevant agencies in the future. 
ICE strongly supports legislative and regulatory changes that will 
enhance the quality of oversight and available information with respect 
to the natural gas markets. For example, we are in favor of increases 
to the CFTC's budget and the enhancement of its access to trading 
information.
    However, we do not believe that a complete overhaul of the current 
regulatory structure is either warranted or advisable. Moreover, any 
legislative or regulatory changes that are made need to reflect the 
nature of ICE and its markets and the significant differences between 
ICE and the many other venues for OTC trading that exist today. In 
particular, as I will discuss, while the New York Mercantile Exchange 
(``NYMEX'') natural gas futures contract is subject to position limits 
in the last 3 days of trading, such limits are neither appropriate nor 
necessary in connection with ICE's OTC natural gas swap. Indeed, the 
NYMEX natural gas swap, like ICE's contract, is not subject to position 
limits. We also believe that any consideration of possible changes to 
the current regulatory structure must be based upon an understanding of 
the operations of ``exempt commercial markets,'' such as ICE, and of 
the balance struck by Congress and the CFTC between overseeing these 
markets while still allowing them to function in the context of OTC 
trading by commercial and institutional participants. We welcome the 
opportunity to work with the Subcommittee and its staff on these 
important issues.
ICE Operates Its Over-the-Counter Platform as an ECM and Is Not 
        ``Unregulated''
    Broadly, because OTC markets tend to be global in nature, most OTC 
markets are now conducted electronically across asset classes, 
including OTC markets for U.S. interest rate instruments, foreign 
exchange and debt securities. ICE responded to the transparency and 
speed enjoyed in other OTC markets by establishing its many-to-many 
electronic marketplace for trading physical energy commodities and 
financially-settled over-the-counter derivatives, primarily swaps, on 
energy commodities. ICE in effect performs the same function as a 
``voice broker'' in the OTC market, but does so through an electronic 
platform that provides full market transparency to market participants, 
timely market information, greater speed of trade execution, record 
keeping efficiency and a more reliable and complete audit trail with 
respect to orders entered, and transactions executed, on our platform 
than exists with respect to traditional, non-electronic OTC venues. The 
introduction and development of ICE's platform have promoted 
competition and innovation in the energy derivatives market, to the 
benefit of all market participants and consumers generally. The 
reliability of ICE's markets has also resulted in an increasing 
preference for electronic trading in these markets. NYMEX itself, in 
its recent testimony before the Senate Permanent Subcommittee on 
Investigations (the ``Senate PSI''), noted that 80-85% of its volume is 
now traded electronically, a development driven largely by competition 
from ICE. The CFTC also pointed out, in its Senate PSI testimony, that 
``the ability to manipulate prices on either [NYMEX or ICE] has likely 
been reduced, given that ICE has broadened participation in contracts 
for natural gas.''
    Participants on ICE enter bids and offers electronically and are 
matched in accordance with an algorithm that executes transactions on 
the basis of time and price priority. Participants executing a 
transaction on our platform may settle the transaction in one of two 
ways--on a bilateral basis, settling the transaction directly between 
the two parties, or on a cleared basis through LCH.Clearnet using the 
services of a futures commission merchant that is a member of 
LCH.Clearnet. In addition to providing the clearing house with daily 
settlement prices, ICE is also responsible for maintaining data 
connectivity to the clearing house.
    It is important to note that there are substantial differences 
between ICE's OTC market, other portions of the OTC market, and the 
NYMEX futures market, and that these differences necessarily inform and 
guide the appropriate level of oversight and regulation of our markets. 
First, ICE is only one of many global venues on which market 
participants can execute OTC trades. A significant portion of OTC 
trading in natural gas is executed through voice brokers or direct 
bilateral negotiation between market counterparties. Of the available 
fora, only ICE (and any other similarly-situated ECMs) is subject to 
CFTC jurisdiction and the CFTC's regulations, or to limitations on the 
nature of its participants. ICE also provides far greater transparency, 
efficiency and data reliability for the benefit of market participants 
and regulators alike than voice brokers or other OTC market mechanisms. 
Second, participants in the futures markets must either become members 
of the relevant exchange or trade through a futures commission merchant 
that is a member. In contrast, ICE's OTC market, by law, is a 
``principals only'' market in which participants must have trades 
executed in their own names on the system, providing greater 
transparency with respect to trader-level transaction data due to the 
absence of a ``middle man.'' Third, the OTC market offers a 
substantially wider range of products than the futures markets, 
including, for example, hundreds of derivatives contracts on natural 
gas and pricing against a large number of delivery points, of which 
there are approximately 100 in North America.
    Fourth, the financially-settled swaps traded on ICE's OTC market 
require one party to pay to the other a cash amount determined by 
reference to settlement prices in the corresponding futures contracts 
but do not, and cannot, result in the physical delivery or transfer of 
energy commodities. Our natural gas contract, for example, constitutes 
an important commercial hedging vehicle and has served as an important 
complement to and a hedge for the NYMEX natural gas futures contract. 
However, our contract cannot affect physical delivery in the market and 
it therefore ultimately has limited ability to drive the pricing of 
natural gas, particularly as the relevant futures contract approaches 
delivery. An understanding of the differences between the NYMEX and ICE 
markets and contracts is critical to any determination of the 
appropriate regulation of these markets, as I will explain more fully 
later.
    ICE operates its OTC platform as an ``exempt commercial market,'' 
or ``ECM,'' under the CEA. The ECM category was adopted as part of the 
Commodity Futures Modernization Act of 2000 (``CFMA''). The creation of 
the ECM category reflected Congress's recognition that ``electronic 
voice brokers,'' such as ICE, occupy a middle ground between completely 
unregulated OTC brokers and market participants and fully regulated 
exchanges. Congress therefore sought to strike a balance between 
providing for oversight and regulation of these electronic markets, due 
to the more extensive participation in their markets by commercial and 
institutional entities, while still allowing them to function as OTC 
markets, which hold a vital place in commodity market structure, rather 
than as futures markets, which would alter their role as a hedging 
mechanism. The ECM category accomplished this objective. Pursuant to 
the CFMA, an electronic market can operate as an ECM if it limits its 
participants to ``eligible commercial entities,'' or ``ECEs.'' 
Transactions and participants on ECMs are fully subject to the anti-
fraud and anti-manipulation provisions of the CEA and the CFTC has 
jurisdiction over such transactions and participants.
    As an ECM, ICE is itself subject to a certain level of regulation 
by the CFTC. In particular, ICE is required, pursuant to the CEA and 
CFTC regulations specifically addressed to ECMs, to:

   prepare and maintain for 5 years records of all transactions 
        executed on its markets;

   report to the CFTC certain information regarding 
        transactions in products that are subject to the CFTC's 
        jurisdiction and that meet specified trading volume levels;

   report to the CFTC certain trader information on the 
        execution of transactions in ICE's cleared natural gas market, 
        pursuant to a special call for information from the CFTC;

   record and report to the CFTC complaints of alleged fraud or 
        manipulative trading activity related to certain of ICE's 
        products; and

   if it is determined by the CFTC that any of ICE's markets 
        for products that are subject to CFTC jurisdiction serve a 
        significant price discovery function (that is, they are a 
        source for determining the best price available in the market 
        for a particular contract at any given moment), publicly 
        disseminate certain market and pricing information free of 
        charge on a daily basis.

    The information that ICE reports to the CFTC on a daily basis 
regarding natural gas contract positions for transactions executed on 
our platform is particularly instructive. This information is being 
provided pursuant to a special call from the CFTC for this data, which 
illustrates the CFTC's statutory and regulatory authority to obtain 
available information regarding transactions executed on ICE. It also 
illustrates ICE's commitment to ensuring that the CFTC has access to 
the information it needs, to the extent available to ICE, to conduct 
appropriate market surveillance or to take appropriate actions. ICE has 
worked extensively with the CFTC, and has expended substantial 
resources, to develop and provide position reporting information to the 
CFTC notwithstanding the fact that ICE does not have this information 
readily available due to the fact that, unlike NYMEX, it is not the 
party that actually clears such transactions (this is done by 
LCH.Clearnet). This information can be used by the CFTC alongside the 
information that NYMEX provides for a more comprehensive, but not 
complete, view of the market. The fact that ICE does not itself clear 
transactions executed on its platform, and does not control the 
clearing house through which transactions are cleared, means that there 
are certain limitations on the position information that ICE can 
provide in that positions can be moved within a clearing house. In 
addition, the fact that ICE represents only a small portion of the much 
larger OTC marketplace means that the CFTC's view will necessarily be 
incomplete. However, we will continue to work with the CFTC to enhance 
the nature and quality of the information that we provide and we are 
committed to furnishing any information needed by the CFTC that is 
available to ICE.
The CFTC and NYMEX Have Access to Information Regarding Trading on ICE
    As noted above, the CFTC has the authority to make special calls to 
ICE for any information that it requires, and the CFTC has in fact 
exercised this authority to require additional information from ICE 
both before and since the events related to Amaranth in 2006. In 
addition, the CFTC recently proposed amendments to its regulations 
clarifying its existing requirement that large traders on DCMs maintain 
books and records of their transactions and to make such books and 
records available to the CFTC. In proposing these amendments, the CFTC 
noted that ``The Act [the CEA] provides ample authority to require 
keeping books and records and providing pertinent information with 
respect to non-reporting transactions [i.e., those not executed on a 
futures exchange].'' 72 Fed. Reg. 34413 (June 22, 2007). It also 
pointed out that the CFTC previously interpreted its rules ``to include 
position and transaction data for non-reporting transactions'' and that 
it ``has received such information in response to requests made 
pursuant to the Regulation.'' While the CFTC believed it appropriate to 
clarify the obligations of participants in the futures markets, 
therefore, it also made it clear that the CFTC currently has the power 
to obtain the information.
    In a recent speech, CFTC Commissioner Walter Lukken noted that:

        ICE is prominent in the trading of natural gas swaps that are 
        pegged to regulated NYMEX futures contracts. This competition 
        has led to significant innovation over the last several years 
        both in the OTC and regulated marketplaces. From a risk 
        perspective, this competition raises the possibility that 
        traders could take positions on one market in order to profit 
        off positions on the other. To address this concern, the CFTC 
        has recently utilized its authorit[y] to request information 
        from ICE regarding trader position data for these pegged 
        contracts on an ongoing basis similar to what we receive from 
        large traders on regulated exchanges. This has allowed our 
        surveillance staff a more comprehensive view of this 
        marketplace. These tailored actions developed from risk 
        considerations--primarily protecting the financial integrity of 
        the regulated marketplace and the price discovery process for 
        energy products.

        Speech by Commissioner Walter Lukken, May 3, 2007.

    As a self-regulatory organization, or ``SRO,'' NYMEX similarly has 
the power under its rules to request information from its members 
regarding their trading on other markets, including ICE, and to compel 
its members to produce such information, in connection with assessing 
positions held in its portfolio. Specifically, even prior to the events 
related to Amaranth, NYMEX rules required its members to disclose to 
NYMEX, upon its request, their trading strategies, including those on 
other markets, in connection with positions exceeding NYMEX 
accountability levels. Moreover, if NYMEX believes that its current 
rules are inadequate to permit it to view members' positions on other 
markets, including ICE, it clearly has the power to amend its rules or 
adopt new rules to compel members to provide this information. NYMEX, 
in its testimony before the Senate PSI, noted that it now requires its 
members to provide information about their trading on other markets 
under certain circumstances. The CFTC noted in its testimony that it 
has been receiving daily position reports from the CFTC ``on an ongoing 
basis.'' These statements reflect the authority of NYMEX and the CFTC 
under current law to obtain the relevant information. To the extent 
that they require additional information about trading on ICE, it is 
clear that they are able similarly to obtain that information as well.
Position Limits or Accountability Requirements on ICE's Markets Are Not 
        Necessary and Are Inappropriate
    Because of the fundamental and important differences between ICE's 
OTC market and NYMEX's futures market, we do not believe that the type 
of position limits applied to NYMEX's futures contract are necessary or 
appropriate in the context of trading on ICE. ICE's natural gas swap, 
as noted, is a cash-settled contract, with settlement priced against 
the physical NYMEX natural gas futures contract. The CFTC itself has 
acknowledged that there is less of a need for market surveillance in 
connection with cash settled contracts. Specifically, the CFTC has 
stated that ``[t]he size of a trader's position at the expiration of a 
cash-settled futures contract cannot affect the price of that contract 
because the trader cannot demand or make delivery of the underlying 
commodity. The surveillance emphasis in cash-settled contracts, 
therefore, focuses on the integrity of the cash price series used to 
settle the futures contract.'' (CFTC website, www.cftc.gov/opa/
backgrounder/opasurveill.htm; emphasis added.) For this reason, the ICE 
cash-settled swap--like the NYMEX cash-settled swap--is not subject to 
position limits.
    As previously stated, NYMEX offers a cash-settled natural gas swap, 
through its ``Clearport'' facility. Because the NYMEX swap is cash-
settled, there are no position limits on this contract, which is 
subject only to position accountability. As an article in ``The Desk'' 
recently reported, ``NYMEX puts limits on NG [the natural gas futures 
contract] but not NN [the cash-settled natural gas swap]. NN has no 
limits. The [June 25 Senate PSI] Report never mentions this. Yet for 
some reason, financial contracts on ICE should be limited. Where is the 
logic there? NYMEX lifted the NN limits earlier in the year and clamped 
down on NG, which is the true pricing mechanism. NN reporting is still 
there but not the limits. It was a brilliant and appropriate 
maneuver.'' The Desk, June 29, 2007. We believe that there are 
compelling reasons for different treatment of the NYMEX natural gas 
futures contract and ICE's cash-settled swap; there is no clear reason 
whatsoever to treat the ICE contract differently from NYMEX's identical 
cash-settled swap. If Congress seeks to implement a ``level playing 
field,'' it should be between substantively similar contracts and, if 
ICE's natural gas swap is to be compared to any other product, it 
should be the NYMEX natural gas swap and all other OTC swaps offered by 
voice brokers, not the NYMEX futures contract. Otherwise, the impact 
would be commercially-oriented rulemaking that codifies preference for 
one venue despite identical products and reporting structures.
    Moreover, we note that NYMEX (not the CFTC) imposes position limits 
on its physical natural gas futures contract only during the final 3 
days of trading in its natural gas futures contract and, at all other 
times, requires only accountability reports from certain participants. 
In addition, during the events related to Amaranth's trading, NYMEX 
took no action over the course of several months as Amaranth 
consistently exceeded its accountability levels; in fact, NYMEX 
increased the limits applicable to Amaranth, apparently based solely on 
Amaranth's unsubstantiated requests and without seeking information 
about Amaranth's trading on ICE or other markets, despite its ability 
to request and obtain such information from market participants.
    As noted previously, ICE currently provides the CFTC with reports 
of all transactions executed by participants in its Henry Hub cleared 
natural gas swaps, pursuant to a special call from the CFTC issued 
after the trading losses experienced by Amaranth. Because ICE is a 
principals-only market, this information is provided at the trader 
level and therefore gives the CFTC information on the activity of 
participants in our markets and facilitates the ability of the CFTC to 
take appropriate action in connection with potentially problematic or 
illegal conduct. Further, the CFTC has ample authority under current 
law to require ICE to obtain or provide to the CFTC additional 
information regarding its participants' trading activities if the CFTC 
believes such action to be necessary or appropriate.
    The balance created under the CFMA was designed to allow ECMs to 
function effectively in the OTC market while providing the CFTC with 
ample authority to oversee their activities and trading by their 
participants. ECMs like ICE operate in an environment that is 
qualitatively distinct in a number of fundamental respects from that of 
the futures markets, despite the surface similarities. Congress and the 
CFTC recognized these distinctions and have sought to create a 
regulatory environment that allows OTC markets to perform their 
important role in the markets while still ensuring market integrity and 
the protection of participants, as well as using technology, 
transparency and innovation to promote the advancement of these goals. 
The judgments made by Congress and the CFTC are fair, appropriate and 
effective and have promoted competition and transparency in the OTC 
markets and in the broader derivative markets as well. Indeed, the 
development of markets, such as ICE, has benefited users of the energy 
markets by tightening market spreads centralizing liquidity and 
attracting participants by bringing more transparency to the markets. 
This evolution has also forced member-dominated exchanges, such as 
NYMEX, to overcome their traditional hostility to electronic trading 
and preference for floor-based markets to provide a more efficient, 
accessible and transparent means of trading to end-users of the 
markets. As Senator Coleman noted in his statement in the Hearings on 
the Senate Permanent Subcommittee Report, ``If we extend CFTC oversight 
and regulation to electronic, over-the-counter exchanges, we must avoid 
unintended consequences. These exchanges have brought vital liquidity 
and increased transparency to our energy markets. Therefore, we cannot 
create incentives for traders to shift their business from over-the-
counter electronic exchanges like ICE, to far less transparent and 
unregulated markets.''
ICE Supports Legislative and Regulatory Changes
    Notwithstanding the issues raised above, we believe that there are 
a number of steps that Congress and the CFTC can take that will result 
in further enhancements to the current regulatory structure. First, we 
believe that the funding of the CFTC should be increased and its 
staffing and resources significantly expanded. The CFTC is obviously a 
critical component in the system of market controls and oversight and 
its role is critical in ensuring the continued integrity of all markets 
within its jurisdiction. With the growth of these markets and the 
introduction of new types of market participants, it is essential that 
the CFTC have the tools it needs to oversee the markets and to perform 
its vital functions. In addition, we fully endorse enhancements to the 
quality and quantity of information currently available to the CFTC 
and, in particular, its ability to integrate data from ICE and NYMEX.
    We understand the surface appeal of the so-called ``level playing 
field'' argument for treating and regulating ICE and NYMEX's futures 
market similarly. However, these markets are fundamentally different in 
significant respects, and any regulatory approach must take those 
differences into account. Also, this argument ignores the much larger 
OTC market outside of both ICE and NYMEX. Indeed, as we have noted, if 
there is a comparison between ICE and NYMEX products to be made, it is 
the comparison between ICE's OTC market and NYMEX's cash-settled swap, 
not its futures market. While we support the maintenance of a ``level 
playing field,'' we do not believe that this can or should result in 
regulating cash-settled OTC contracts in the same manner as physically-
settled futures contracts because they are fundamentally different 
products.
    Thank you for the opportunity to share our views with you on these 
important issues. I would be happy to answer any questions you may 
have.

    The Chairman. Thank you, sir. Mr. Pickel.

  STATEMENT OF ROBERT G. PICKEL, EXECUTIVE DIRECTOR AND CEO, 
              INTERNATIONAL SWAPS AND DERIVATIVES
                   ASSOCIATION, NEW YORK, NY

    Mr. Pickel. Thank you, Mr. Chairman and Members of the 
Committee. I very much appreciate the opportunity to have ISDA 
testify this morning. The work which this Committee has done in 
the past and which it continues to do today plays a critical 
role in creating active markets for risk management. ISDA 
represents participants in the privately negotiated derivatives 
industry. Since its inception, ISDA has pioneered efforts to 
identify and reduce the sources of risk in the derivatives and 
risk management business.
    Energy derivatives are used by a wide range of market 
participants, including energy companies, financial 
institutions such as banks and hedge funds, and traditional 
end-users of energy. The motivations of these market 
participants differ and can include those looking to hedge 
price risk, as well as those looking to take a view on, or 
speculate on, the movement of energy prices. The growth of 
these markets has coincided with volatility in energy prices, 
leading some to question whether the growth in derivatives 
markets and the influx of new market participants has led to 
this volatility. Even more sinister, some have alleged that 
volatility is the result of attempts to manipulate the prices 
of energy commodities.
    Fortunately, there is little evidence that markets of 
energy commodities are subject to widespread manipulation. As 
noted by the Bank for International Settlements, in a recent 
quarterly update, several recent studies which explore the 
relationship between investor activity and commodity prices 
indicate that price changes have led to change in investor 
interest rather than the other way around. The BIS cites 
studies conducted by the CFTC and the International Monetary 
Fund. In addition to these studies, the Government 
Accountability Office, the Federal Trade Commission, the 
Department of Energy and numerous academics likewise have 
examined the question of whether manipulation of energy prices 
exists and is having an adverse effect on consumers.
    All have reached the same conclusion. Energy prices are 
caused by the external forces of supply and demand influenced 
by factors such as refinery capacity and hurricane activity, 
and not by the derivatives markets. Both exchange traded and 
privately negotiated derivatives contribute to more stable and 
more efficient commodity markets.
    The CFMA greatly increased American competitiveness in both 
the exchange traded and OTC derivatives industries. For futures 
exchanges, the law created a principles-based regulatory regime 
that greatly increased the flexibility and efficiency of those 
markets. For OTC derivatives, the law removed legal 
uncertainty, protected the right of sophisticated 
counterparties to engage in individually negotiated swap 
transactions, and retained anti-fraud and anti-manipulation 
authority over the OTC commodity markets.
    OTC derivatives remain subject to a broad range of 
regulation. OTC market participants, themselves, such as 
commercial banks and broker/dealers are subject to regulation 
by their respective regulators. In addition to the regulations 
of the counterparties, themselves, certain OTC energy 
derivative transactions are subject to CFTC oversight.
    Oversight of the energy markets in the United States is 
thorough and effective. Enforcement efforts by Federal 
regulators have been very successful in detecting, deterring 
and punishing misbehavior. The CFTC has brought numerous 
actions against defendants accused of wrongdoing in the energy 
markets. Among ISDA member firms, there is no doubt that there 
is strong oversight of these markets. They report regular 
visits and requests for information from Federal regulatory 
officials as part of the routine operation of their businesses.
    Almost immediately after Congress passed the CFMA, there 
were calls in some quarters to repeal parts of that law. 
Fortunately, Congress has time and again rejected efforts to 
repeal the balance between legal certainty for sophisticated 
institutional market participants and the need for Federal 
oversight provided by the CFMA. For the most part, calls to 
revisit the CFMA rest upon claims of a lack of transparency in 
the markets, as well as suggestions of impropriety. However, as 
I described before, there are no studies which demonstrate a 
cause and effect relationship between activities in the 
derivatives markets and consumer energy prices.
    More to the point, as the members of the President's 
working group have repeatedly noted, there is no change in 
Federal law as applied to derivatives that could alleviate the 
volatility in energy prices which have existed over the last 
several years. Energy prices respond to a variety of supply and 
demand factors which have in recent years been aggravated by 
events such as: active hurricane seasons; lack of refinery 
capacity; unusual weather patterns; and military and political 
crises in major oil producing regions.
    Changing the CFMA will not address those factors nor will 
it do anything to alleviate consumer concerns about high energy 
prices. You can't amend the law of supply and demand. Instead, 
amending the legal certainty for OTC energy derivatives 
provisions of the CEA will serve only to make business less 
attractive in the United States. As acting Chairman Lukken 
noted, American competitiveness in the financial service arena 
is under assault from foreign markets which are eager to 
attract lucrative U.S. financial services activity. There is 
simply no reason that energy transactions which do not call for 
the actual physical delivery of a commodity need be done in the 
United States. Therefore Congress should tread carefully if 
considering legislation in this area.
    Mr. Chairman and Members of the Committee, thank you very 
much for your time today. This is an important issue and 
leadership which this Committee has shown on this topic over 
the last several years has greatly improved the legal and 
regulatory environment in the United States. Going forward, we 
are confident that you will continue to play a leading role in 
promoting the healthy growth of these markets. Thank you again 
and I would be privileged to answer any questions that you may 
have.
    [The prepared statement of Mr. Pickel follows:]

  Prepared Statement of Robert G. Pickel, Executive Director and CEO, 
     International Swaps and Derivatives Association, New York, NY
    Mr. Chairman and Members of the Committee:

    Thank you very much for inviting ISDA to testify this morning. The 
work which this Committee has done in the past, and which it continues 
to do today, plays a critical role in creating healthy, active markets 
for risk management. Thank you very much for your leadership in this 
important area.
About ISDA
    ISDA, which represents participants in the privately negotiated 
derivatives industry, is the largest global financial trade 
association, by number of member firms. ISDA was chartered in 1985, and 
today has over 800 member institutions from 54 countries on six 
continents. These members include most of the world's major 
institutions that deal in privately negotiated derivatives, as well as 
many of the businesses, governmental entities and other end-users that 
rely on over-the-counter derivatives to manage efficiently the 
financial market risks inherent in their core economic activities.
    Since its inception, ISDA has pioneered efforts to identify and 
reduce the sources of risk in the derivatives and risk management 
business. Among its most notable accomplishments are: developing the 
ISDA Master Agreement; publishing a wide range of related documentation 
materials and instruments covering a variety of transaction types; 
producing legal opinions on the enforceability of netting and 
collateral arrangements (available only to ISDA members); securing 
recognition of the risk-reducing effects of netting in determining 
capital requirements; promoting sound risk management practices, and 
advancing the understanding and treatment of derivatives and risk 
management from public policy and regulatory capital perspectives.
Overview of Derivatives
    Derivatives are critical risk management tools which allow 
producers and end-users of commodities to hedge the risk of adverse 
price movements. In the most basic type of derivative, an option, the 
option writer will sell to the buyer the right (but not the obligation) 
to purchase or sell a fixed quantity of a good, at a fixed price, in 
some future period. Options provide the basic building block of 
derivatives, and other types of derivatives can be seen as a 
combination of options. For instance, a long futures contract can be 
seen as the purchase of an option to purchase a commodity combined with 
the simultaneous sale of an option to sell that same commodity. Futures 
contracts are traded on organized exchanges regulated in the United 
States by the Commodity Futures Trading Commission. Privately 
negotiated derivatives, such as swap agreements, are a type of 
derivative subject to negotiation between the parties as to the 
fundamental material economic terms of the transaction. Privately 
negotiated derivatives differ from exchange traded futures contracts in 
that they are not fungible nor by their terms subject to offset through 
the purchase of a contract with the opposite characteristics (e.g., a 
counterparty cannot cancel out its contractual obligations under a swap 
agreement to sell a fixed interest rate by simply purchasing a swap 
agreement to buy the same fixed rate). Another important 
differentiation is that OTC derivatives are typically transacted 
between counterparties that meet certain standards for wealth and 
sophistication.


Allegations of Market Manipulation
    The growth of these markets has coincided with volatility in energy 
prices, leading some to question whether the growth in derivatives 
markets and the influx of new market participants has led to this 
volatility. Even more sinister, some have alleged that volatility is 
the result of attempts to manipulate the prices of energy commodities. 
For instance, on June 25, 2007 the Senate Permanent Subcommittee on 
Investigations claimed 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.'' These very serious charges are of concern to 
everyone involved in these markets, as no one, be they consumers, end-
users or market participants themselves, would benefit from the 
intentional manipulation of prices.



        Intuitively, one might expect large inflows of funds into 
        commodity markets to cause prices to rise sharply, possibly to 
        higher levels than are justified by economic fundamentals. The 
        prima facie evidence seems to support this view, as financial 
        activity has broadly increased in parallel with prices during 
        the past 4 years. However, the results of empirical work on the 
        impact of the growing presence of financial investors on 
        commodity prices are less clear-cut. Several recent studies, 
        which explore the relationship between investor activity and 
        commodity prices, indicate that price changes have led to 
        changes in investor interest rather than the other way around.

    The BIS cites in support of this thesis studies conducted by James 
Overdahl, Chief Economist of the Commodity Futures Trading Commission, 
as well as a report by the International Monetary Fund. In addition to 
these studies the Government Accountability Office, the Federal Trade 
Commission, the Department of Energy and numerous academics likewise 
have examined the question of whether manipulation of energy prices 
exists and is having an adverse effect on consumers. All have reached 
the same conclusion: energy prices are caused by the external forces of 
supply and demand, influenced by factors such as refinery capacity and 
hurricane activity, and not by the derivatives markets. As succinctly 
stated in testimony before the House Energy and Commerce Committee by 
W. David Montgomery, Vice President for CRA International, regarding 
gasoline prices: ``There has never been a finding that . . . price 
increases were caused by any manipulation of the markets.''
    Given the overwhelming evidence that derivatives do not lead to 
manipulation of energy markets, it makes sense to ask what role these 
instruments do play. In addition to serving as risk management tools, 
the experience of market participants and academic research alike 
confirms that on a macro level energy derivatives increase market 
liquidity and depth and stabilize commodity markets. Both exchange 
traded and privately negotiated derivatives contribute to more stable, 
more efficient commodity markets.
The Evolution of the Commodity Exchange Act
    Given the tremendous growth of the energy derivatives industry and 
the role these products play in helping manage risk and stabilize 
markets, it is worth considering how government policy in the United 
States helped promote such a beneficial result. Even before the passage 
of the Commodity Futures Modernization Act of 2000 the CFTC realized 
the inappropriateness of applying a ``one-size-fits-all'' standard to 
derivatives. Beginning in 1990 the Commission began creating 
protections for energy transactions, such as the ``Statutory 
Interpretation Concerning Forward Transactions'' and the 1993 Exemptive 
Order. These administrative decisions provided some comfort to market 
participants that their individually negotiated contracts would be 
protected from unwarranted regulatory intervention, while at the same 
time ensuring that market participants would be subject to the anti-
manipulation provisions of the Commodity Exchange Act (CEA).
    Nevertheless, market participants were still exposed to the risk 
that their contracts would be held legally unenforceable because of the 
inappropriate application of the CEA to their private contracts. 
Because the CEA was originally written to address exchange traded 
agricultural commodities the law contained a provision making any off-
exchange future-like contract illegal (and thus unenforceable). This 
``legal uncertainty,'' which threatened to undermine an important and 
growing market, caused this Committee and its Senate counterpart, the 
House and Senate Banking Committees, the House Commerce Committee and 
the President's Working Group on Financial Markets to jointly undertake 
an historic effort to improve and reform the CEA.
    The Commodity Futures Modernization Act of 2000 greatly increased 
American competitiveness in both the exchange traded and OTC 
derivatives industries. For futures exchanges, the law created a 
principles-based regulatory regime that greatly increased the 
flexibility and efficiency of those markets. For OTC derivatives the 
law removed legal uncertainty, protected the right of sophisticated 
counterparties to engage in individually negotiated swap transactions 
and retained anti-fraud and anti-manipulation authority over the OTC 
commodity markets.
Regulation of OTC Derivatives
    It is important to recognize that OTC derivatives are subject to a 
broad range of regulation. OTC market participants themselves, such as 
commercial banks and broker dealers, are subject to plenary regulation 
by their respective front line regulatory agencies (for example, the 
Federal Reserve and the SEC; the CFTC likewise retains regulatory 
authority over the operations of registered commodity trading advisors 
and commodity pool operators.) This is important, since these OTC 
dealers are the counterparty on the overwhelming majority of 
transactions conducted in the over-the-counter markets. In addition to 
the regulation of the counterparties themselves OTC energy derivative 
transactions are subject to CFTC oversight under section 2(h) \1\ of 
the Commodity Exchange Act.
---------------------------------------------------------------------------
    \1\ Section 2(h) is sometimes derogatorily called the ``Enron 
Loophole,'' because of allegations that the provision was ``snuck in at 
the last minute'' in H.R. 5660, the legislation which contained the 
CFMA. In fact, numerous hearings were held on H.R. 4541, the original 
version of the CFMA. H.R. 4541 contained a similar provision to current 
2(h) entitled ``Exempt Commodities''; the bill was the subject of 
numerous hearings in the House, including four hearings in the House 
Agriculture Committee. In addition to H.R. 4541 the companion Senate 
legislation, S. 2697, likewise contained a provision regarding energy 
commodities; S. 2697 was also the subject of legislative hearings.
---------------------------------------------------------------------------
    Section 2(h) deals with exempt commodities. These are commodities 
which are neither financial nor agricultural, and include oil, natural 
gas, coal and precious metals. Under 2(h) contracts between eligible 
contract participants which are not traded on a trading facility are 
exempt from most provisions of the CEA except for the Act's anti-fraud 
and anti-manipulation provisions. Section 2(h) also exempts trades 
between eligible commercial entities \2\ done on a principal-to-
principal basis when transacted on an electronic trading facility. In 
addition to being subject to the anti-fraud and anti-manipulation 
provisions of the CEA, exempt electronic trading facilities are subject 
to record keeping requirements and must provide price, trading volume 
and such other trading information as the CFTC determines is 
appropriate if the Commission determines the entity serves as a price 
discovery market for the underlying exempt commodity.
---------------------------------------------------------------------------
    \2\ Eligible commercial entities are a narrower subset of eligible 
contract participants that, in general, are in the business of dealing 
in the underlying exempt commodity as a routine part of their 
operations.
---------------------------------------------------------------------------
    In addition to the Commodity Exchange Act, Federal oversight of 
energy products is also provided by the Federal Energy Regulatory 
Commission (FERC). Amendments passed by Congress as part of the Energy 
Policy Act of 2005 provided FERC with anti-fraud and anti-manipulation 
authority over transactions in electricity and natural gas. These 
amendments to the Federal Power Act and the Natural Gas Act are modeled 
after the Securities and Exchange Commission's authority under section 
10(b) of the 1934 Securities and Exchange Act. The FERC's authority 
applies to physical transactions in a commodity, as opposed to 
derivative transactions which are under the exclusive jurisdiction of 
the CFTC. Nevertheless, the two agencies' authorities in this area 
provide an overarching web of regulation of both the physical and 
derivative energy markets, giving a holistic view of these interlinked 
areas. CFTC and FERC likewise have a Memorandum of Understanding 
allowing for information sharing between the two agencies.
    Oversight of the energy markets in the United States is thorough 
and effective. Enforcement efforts by Federal regulators have been very 
successful in detecting, deterring and punishing misbehavior. Between 
December 2002 and May 2007 the CFTC has collected over $307 million in 
civil penalties from defendants accused of wrongdoing in the energy 
markets. Among ISDA member firms there is no doubt that these agencies 
are providing strong oversight of these markets; they report regular 
visits and requests for information from Federal regulatory officials, 
as part of the routine operations of their businesses.
Calls for Greater Regulation Are Unwarranted
    Almost immediately after Congress passed the CFMA there have been 
calls in some quarters to repeal parts of that law. Nowhere have these 
calls come more loudly than with regard to energy commodities. 
Fortunately Congress has time and again rejected efforts to repeal the 
balance between legal certainty for sophisticated institutional market 
participants and the need for Federal oversight provided by the CFMA.
    For the most part, calls to revisit the CFMA rest upon claims of a 
lack of transparency in the markets as well as insinuations of 
impropriety. However, as discussed earlier in this testimony, there are 
no credible studies which demonstrate a cause and effect relationship 
between activities in the derivatives markets and consumer energy 
prices. More to the point, as the Members of the President's Working 
Group have repeatedly noted, there is no change in Federal law as 
applied to derivatives which could alleviate the volatility in energy 
prices which have existed over the last several years. As Federal 
Reserve Chairman Ben Bernanke noted in response to questioning in the 
Senate last Congress: ``I am unaware of any evidence that supports the 
view that additional reporting requirements or other new regulations 
would reduce energy prices or energy price volatility.''
    Energy prices respond to a variety of supply and demand related 
factors, which have in recent years been aggravated by events such as 
an active hurricane season, lack of refinery capacity, unusual weather 
patterns and military and political crises in major oil producing 
regions. Changing the CFMA will not address those factors, nor will it 
do anything to alleviate consumer concerns about high energy prices.
Consequences of Rewriting the CFMA
    Instead, amending the legal certainty for OTC energy derivatives 
provisions of the Commodity Exchange Act will serve only to make 
business less attractive in the United States. Already, American 
competitiveness in the financial services arena is under assault from 
foreign markets which are eager to attract lucrative U.S. financial 
services activity. As recently noted in the paper ``Sustaining New 
York's and the U.S.'s Global Financial Services Leadership,'' sponsored 
by New York Mayor Bloomberg and U.S. Senator Charles Schumer:

        ``Europe's also the center for derivatives innovation. `People 
        feel less encumbered overseas by the threat of regulation and 
        so are more likely to think outside of the box,' notes one 
        U.S.-based business leader.''

    OTC energy trades are done in the U.S. by the choice of the market 
participants, who favor the current regulatory environment and prefer 
the strength of U.S. courts and their respect for privately negotiated 
agreements. But there is simply no reason that energy transactions 
which do not call for the actual physical delivery of a commodity need 
be done in the United States. Indeed, because these transactions can be 
done electronically their execution can be readily relocated to more 
favorable regulatory environments should they feel that the costs and 
burdens of regulation have become too onerous.
    Therefore Congress should tread carefully if considering 
legislating in this area. To date the OTC derivatives markets have been 
robust, stable and liquid, and provided the means for end-users of 
energy products to manage the risks of recent price volatility in a 
cost-efficient manner. Making the use of these products too costly, 
through the application of an inappropriate regulatory regime, would 
serve only to hurt American businesses and ultimately consumers, while 
doing nothing to alleviate energy prices.
Conclusion
    Mr. Chairman and Members of the Committee, thank you very much for 
your time today. This is an important issue, and the leadership which 
this Committee has shown on this topic over the years has greatly 
improved the legal and regulatory environment in the United States. 
Going forward we are confident that you will continue to play a leading 
role in promoting the health and growth of these markets. Thank you 
again and I would be privileged to answer any questions you might have.

    The Chairman. Thank you, sir. Mr. Corbin.

         STATEMENT OF ARTHUR CORBIN, PRESIDENT AND CEO,
 MUNICIPAL GAS AUTHORITY OF GEORGIA, KENESAW, GA; ON BEHALF OF 
                AMERICAN PUBLIC GAS ASSOCIATION

    Mr. Corbin. Mr. Chairman and Members of the Committee, I 
appreciate this opportunity to testify before you today on the 
important issue of energy based derivatives trading and in 
particular, natural gas market transparency. Again, my name is 
Arthur Corbin and I am President and CEO of the Municipal Gas 
Authority of Georgia. The Municipal Gas Authority of Georgia is 
a nonprofit natural gas joint action agency that supplies all 
the natural gas requirements of its 76 member cities. I am 
testifying today on behalf of the American Public Gas 
Association.
    APGA is the national association for publicly owned not-
for-profit natural gas distribution systems. These retail 
distribution systems are owned by public agencies and 
accountable to the citizens they serve. There are approximately 
1,000 public gas systems in 36 states and almost 700 of these 
systems are APGA members. APGA's top priority is the safe and 
reliable delivery of affordable natural gas. To bring gas 
prices back to an affordable level, we ultimately need to 
increase the supply of natural gas. However, equally critical 
is to restore public confidence in natural gas pricing. This 
requires the natural gas market be fair, orderly and 
transparent so that the price consumers pay reflects 
fundamental supply and demand forces, and not the result of 
manipulation or other abusive conduct.
    An appropriate level of transparency does not exist and 
this has led to a growing lack of confidence by our members in 
the natural gas market. Without question, natural gas futures 
contracts traded on NYMEX and those financial contracts of 
natural gas traded in the over-the-counter markets are 
economically linked. A participant's trading conducted in one 
venue can affect and has affected the price of natural gas 
contracts in the other. A recent report released by the Senate 
Permanent Subcommittee on Investigation affirmed these economic 
links. The impact of last year's activities of the Amaranth 
Advisors hedge fund is a perfect example of these economic 
links between markets.
    When the excessively large positions accumulated by 
Amaranth began to unwind, gas prices decreased. Unfortunately, 
many distributors, including the Municipal Gas Authority of 
Georgia, had already locked in prices prior to that period at 
levels that did not reflect fundamental supply and demand 
conditions, but rather were elevated during this period when 
Amaranth held these exceedingly large positions. As a result of 
the elevated prices, the Gas Authority's members were forced to 
pay an $18 million premium and pass it through to their 
customers on their gas bills.
    Today the Commodity Futures Trading Commission has 
effective oversight of NYMEX and the CFTC and NYMEX provide a 
significant level of transparency. Despite the economic links 
between prices on NYMEX and the OTC markets, the OTC markets 
lack such transparency. The simple fact that the CFTC's large 
trader reporting system, its chief tool in detecting and 
deterring manipulative market conduct, generally does not apply 
to transactions in the over-the-counter market.
    This lack of transparency in a very large and rapidly 
growing segment of the natural gas market leaves open the 
potential for a participant to engage in manipulative or other 
abusive trading strategies, or simply to accumulate excessively 
large positions with little risk of early detection by the CFTC 
until after the damage has been done to the market. It simply 
makes no sense to have transparency in one small segment of the 
market and none in a much larger and growing segment.
    Accordingly, APGA believes that transparency in all 
segments of the market, including those transactions that take 
place off-exchange and platforms are critical to ensure that 
the CFTC has a complete picture of the market. The CFTC has 
stated that it is nearing the outer limits of its authority. We 
believe that the CFTC does not currently have the tools 
necessary to police its beat. Today Congressman Barrow and 
Graves introduced legislation entitled the Market TRUST Act 
that would provide the CFTC with the tools to police their 
beat.
    The level of transparency created by this legislation will 
significantly reduce opportunities for market manipulation and 
restore public confidence in natural gas markets. APGA strongly 
supports this legislation and commends Congressmen Barrow and 
Graves for their efforts on behalf of consumers. The CFTC has 
done a good job in catching market abuses after the fact. 
However, by the time these cases are discovered, using the 
tools available to government regulators, our members and their 
customers have already suffered the consequences of those 
abuses in terms of higher natural gas prices.
    Whether or not Amaranth's trading meets the legal 
definition of the manipulation, it is beyond dispute that the 
CFTC did not have a complete picture of the full extent of 
Amaranth's trading position until after Amaranth's collapse. 
Greater transparency with respect to large trader positions, 
whether entered into on a regulated exchange or in the over-
the-counter market in natural gas will provide the CFTC with 
the tools to detect and deter potential manipulative activity 
before our members and their customers suffer harm.
    The current situation is not irreversible. Congress can 
provide American consumers with the production they deserve by 
passing the Market TRUST Act, which would turn the lights on in 
these currently dark markets. APGA looks forward to working 
with you to accomplish this goal and I will be happy to answer 
any questions you have.
    [The prepared statement of Mr. Corbin follows:]

 Prepared Statement of Arthur Corbin, President and CEO, Municipal Gas 
  Authority of Georgia, Kenesaw, GA; on Behalf of American Public Gas
                              Association
    Chairman Etheridge, Ranking Member Moran and Members of the 
Committee, I appreciate this opportunity to testify before you today 
and I thank the Committee for calling this hearing on the important 
subject of energy derivatives. My name is Arthur Corbin and I am the 
President and CEO of the Municipal Gas Authority of Georgia. The 
Municipal Gas Authority of Georgia is the largest nonprofit natural gas 
joint action agency in the United States. Our agency is made up of 76 
publicly-owned natural gas distribution system members in five states: 
Georgia; Alabama; Florida; Pennsylvania; and Tennessee. Our principal 
role is to supply all the natural gas requirements of these systems. 
Together, our members meet the gas needs of approximately 243,000 
customers.
    I testify today on behalf of the American Public Gas Association 
(APGA). APGA is the national association for publicly-owned natural gas 
distribution systems. There are approximately 1,000 public gas systems 
in 36 states and almost 700 of these systems are APGA members. 
Publicly-owned gas systems are not-for-profit, retail distribution 
entities owned by, and accountable to, the citizens they serve. They 
include municipal gas distribution systems, public utility districts, 
county districts, and other public agencies that have natural gas 
distribution facilities.
    APGA's number one priority is the safe and reliable delivery of 
affordable natural gas. To bring natural gas prices back to a long-term 
affordable level, we ultimately need to increase the supply of natural 
gas. However, equally critical is to restore public confidence in the 
pricing of natural gas. This requires a level of transparency in 
natural gas markets which assures consumers that market prices are a 
result of fundamental supply and demand forces and not the result of 
manipulation or other abusive market conduct. APGA strongly believes 
that this level of transparency currently does not exist, and this has 
directly led to a lack of confidence in the natural gas marketplace.
    The economic links between the natural gas futures contracts traded 
on the New York Mercantile Exchange (``NYMEX'') and those contracts, 
agreements and transactions in natural gas traded in the over-the-
counter (``OTC'') markets are beyond dispute. Without question, a 
participant's trading conduct in one venue can affect, and has 
affected, the price of natural gas contracts in the other.\1\ Today, 
the Commodity Futures Trading Commission (``CFTC'') has effective 
oversight of NYMEX, and the CFTC and NYMEX provide a significant level 
of transparency with respect to NYMEX's price discovery function. But, 
the OTC markets lack such price transparency.
---------------------------------------------------------------------------
    \1\ See ``Excessive Speculation in the Natural Gas Market,'' Report 
of the U.S. Senate Permanent Subcommittee on Investigations (June 25, 
2007) (``PSI Report''). The PSI Report on page 3 concluded that 
``Traders use the natural gas contract on NYMEX, called a futures 
contract, in the same way they use the natural gas contract on ICE, 
called a swap. . . . The data show that prices on one exchange affect 
the prices on the other.''
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    This lack of transparency in a very large and rapidly growing 
segment of the natural gas market leaves open the potential for a 
participant to engage in manipulative or other abusive trading 
strategies with little risk of early detection; and for problems of 
potential market congestion to go undetected by the CFTC until after 
the damage has been done to the market. It simply makes no sense to 
have transparency over one segment of the market and none over a much 
larger segment, especially when the OTC markets are the fastest growing 
sectors of the natural gas marketplace. APGA strongly believes that it 
is in the best interest of consumers for Congress to rectify this 
situation by passing legislation that would ensure an adequate level of 
transparency with respect to OTC contracts, agreements and transactions 
in natural gas.
The Market in Natural Gas Contracts
    The market for natural gas financial contracts is composed of a 
number of segments. Contracts for the future delivery of natural gas 
are traded on NYMEX, a designated contract market regulated by the 
CFTC. Contracts for natural gas are also traded in the OTC markets. OTC 
contracts may be traded on multi-lateral electronic trading facilities 
which are exempt from regulation as exchanges. They may also be traded 
in direct, bilateral transactions between counterparties, through voice 
brokers or on electronic platforms. OTC contracts may be settled 
financially or through physical delivery. Financially-settled OTC 
contracts often are settled based upon NYMEX settlement prices and 
physically delivered OTC contracts may draw upon the same deliverable 
supplies as NYMEX contracts, thus linking the various financial natural 
gas market segments economically.
    Increasingly, the price of natural gas in many supply contracts 
between suppliers and local distribution companies (``LDC''), including 
APGA members, is determined based upon monthly price indexes closely 
tied to the monthly settlement of the NYMEX futures contract. 
Accordingly, the futures market serves as the centralized price 
discovery mechanism used in pricing these natural gas supply contracts.
    Generally, futures markets are recognized as providing an efficient 
and transparent means for discovering commodity prices.\2\ However, any 
failure of the futures price to reflect fundamental supply and demand 
conditions results in prices for natural gas that are distorted and 
which do not reflect its true value. This has a direct affect on 
consumers all over the U.S., who as a result of such price distortions, 
will not pay a price for the natural gas that reflects bona fide demand 
and supply conditions. If the futures price is manipulated or 
distorted, then the price a consumer pays for the fuel needed to heat 
their home and cook their meals will be similarly manipulated or 
distorted.
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    \2\ See the Congressional findings in Section 3 of the Commodity 
Exchange Act, 7 U.S.C.  1 et seq. (``Act''). Section 3 of the Act 
provides that, ``The transactions that are subject to this Act are 
entered into regularly in interstate and international commerce and are 
affected with a national public interest by providing a means for . . . 
discovering prices, or disseminating pricing information through 
trading in liquid, fair and financially secure trading facilities.''
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Regulatory Oversight
    NYMEX, as a designated contract market, is subject to oversight by 
the CFTC. The primary tool used by the CFTC to detect and deter 
possible manipulative activity in the regulated futures markets is its 
large trader reporting system. Using that regulatory framework, the 
CFTC collects information regarding the positions of large traders who 
buy, sell or clear natural gas contracts on NYMEX. The CFTC in turn 
makes available to the public aggregate information concerning the size 
of the market, the number of reportable positions, the composition of 
traders (commercial/non-commercial) and their concentration in the 
market, including the percentage of the total positions held by each 
category of trader (commercial/non-commercial).
     The CFTC also relies on the information from its large trader 
reporting system in its surveillance of the NYMEX market. In conducting 
surveillance of the NYMEX natural gas market, the CFTC considers 
whether the size of positions held by the largest contract purchasers 
are greater than deliverable supplies not already owned by the trader, 
the likelihood of long traders demanding delivery, the extent to which 
contract sellers are able to make delivery, whether the futures price 
is reflective of the cash market value of the commodity and whether the 
relationship between the expiring future and the next delivery month is 
reflective of the underlying supply and demand conditions in the cash 
market.\3\
---------------------------------------------------------------------------
    \3\ See letter to the Honorable Jeff Bingaman from the Honorable 
Reuben Jeffery III, dated February 22, 2007.
---------------------------------------------------------------------------
    Although the CFTC has issued ``special calls'' to one electronic 
trading platform, and that platform has determined to voluntarily 
provide the CFTC with information on traders' large positions,\4\ the 
CFTC's large trader reporting surveillance system does not routinely 
reach traders' large OTC positions.\5\ Despite the links between prices 
for the NYMEX futures contract and the OTC markets in natural gas 
contracts, this lack of transparency in a very large and rapidly 
growing segment of the natural gas market leaves open the potential for 
participants to engage in manipulative or other abusive trading 
strategies with little risk of early detection and for problems of 
potential market congestion to go undetected by the CFTC until after 
the damage has been done to the market, ultimately costing the 
consumers or producers of natural gas.
---------------------------------------------------------------------------
    \4\ Id, at 7. The CFTC presumably issued this call for information 
under Section 2(h)(5) of the Act.
    \5\ As explained in greater detail below, special calls are 
generally considered to be extraordinary, rather than routine, 
requirements. Although special calls may be an important complement to 
routine reporting requirements in conducting market surveillance, they 
are not a substitute for a comprehensive large trader reporting system.
---------------------------------------------------------------------------
Amaranth Advisors LLC
    Last year's blow-up of the Amaranth Advisors LLC and the impact it 
had upon prices exemplifies these linkages and the impact they can have 
on natural gas supply contracts for LDCs. Amaranth Advisors LLC was a 
hedge fund based in Greenwich, Connecticut, with over $9.2 billion 
under management. Although Amaranth classified itself as a diversified 
multi-strategy fund, the majority of its market exposure and risk was 
held by a single Amaranth trader in the OTC derivatives market for 
natural gas.
    Amaranth reportedly accumulated excessively large long positions 
and complex spread strategies far into the future. Amaranth's 
speculative trading wagered that the relative relationship in the price 
of natural gas between summer and winter months would change as a 
result of shortages which might develop in the future and a limited 
amount of storage capacity. Because natural gas cannot be readily 
transported about the globe to offset local shortages, the way for 
example oil can be, the market for natural gas is particularly 
susceptible to localized supply and demand imbalances. Amaranth's 
strategy was reportedly based upon a presumption that hurricanes during 
the summer of 2006 would make natural gas more expensive in 2007, 
similar to the impact that Hurricanes Katrina and Rita had had on 
prices the previous year. As reported in the press, Amaranth held open 
positions to buy or sell tens of billions of dollars of natural gas.
    As the hurricane season proceeded with very little activity, the 
price of natural gas declined, and Amaranth lost approximately $6 
billion, most of it during a single week in September 2006. The 
unwinding of these excessively large positions and that of another 
previously failed $430 million hedge fund--MotherRock--further 
contributed to the extreme volatility in the price of natural gas. The 
Report by the Senate Permanent Subcommittee on Investigations affirmed 
that ``Amaranth's massive trading distorted natural gas prices and 
increased price volatility.'' \6\
---------------------------------------------------------------------------
    \6\ See PSI Report at p. 119.
---------------------------------------------------------------------------
    Many natural gas distributors locked-in prices prior to the period 
Amaranth collapsed at prices that were elevated due to the accumulation 
of Amaranth's positions. In the case of the Municipal Gas Authority of 
Georgia, Amaranth's activities had a significant impact on the price 
we, and ultimately our members' customers, paid for natural gas. To 
reduce volatility and mitigate additional price spikes on supplies of 
natural gas, the Gas Authority's hedging procedures required that we 
hedge part of our 2006-2007 winter natural gas in the spring and summer 
of 2006. In the spring of 2006 we knew natural gas prices were still 
extremely high, but it would have been irresponsible if we were to 
gamble and not hedge a portion of our winter gas in the hope that 
prices would eventually drop. As a result, we hedged half of our winter 
gas prior to September 2006. By hedging earlier in 2006 when natural 
gas prices were high as a result of Amaranth's market activities, our 
members incurred hedging losses of $18 million over the actual market 
prices during the winter of 2006-2007. The Gas Authority's members were 
forced to pay an $18 million premium and pass it through to their 
customers on their gas bills as a result of the excess speculation in 
the market by Amaranth and others.
    The lack of OTC transparency and extreme price swings surrounding 
the collapse of Amaranth have caused bona fide hedgers to become 
reluctant to participate in the markets for fear of locking-in prices 
that may be artificial.
Greater Transparency Needed
    Our members, and the customers served by them, do not believe there 
is an adequate level of market transparency under the current system. 
This lack of transparency leads to a growing lack of confidence in the 
natural gas marketplace. Although the CFTC operates a large trader 
reporting system to enable it to conduct surveillance of the futures 
markets, it cannot effectively monitor trading if it receives 
information concerning positions taken in only one segment of the total 
market. Without comprehensive large trader position reporting, the 
government is currently handicapped in its ability to detect and deter 
market misconduct. If a large trader acting alone, or in concert with 
others, amasses a position in excess of deliverable supplies and 
demands delivery on its position and/or is in a position to control a 
high percentage of the deliverable supplies, the potential for market 
congestion and price manipulation exists. Unless Congress moves forward 
to enable the CFTC to increase transparency with respect to OTC 
financial contracts, agreements or transactions in natural gas, the 
government will continue to be woefully unprepared to: (1) detect a 
problem until it is too late; (2) protect the public interest; and (3) 
ensure the price integrity of the markets, thus impairing our ability 
as a nation to maintain the flow and deliverability of a fundamental 
fuel.
    Over the last several years, APGA has pushed for a level of market 
transparency in financial contracts in natural gas that would 
routinely, and prospectively, permit the CFTC to assemble a complete 
picture of the overall size and potential impact of a trader's position 
irrespective of whether the positions are entered into on NYMEX, on an 
OTC multi-lateral electronic trading facility which is exempt from 
regulation or through bilateral OTC transactions, which can be 
conducted over the telephone, through voice-brokers or via electronic 
platforms.
Bilateral Trading
    Because Amaranth's trading was largely conducted on both a 
regulated futures exchange and on an unregulated electronic trading 
facility, the immediate focus has been confined to the relative 
inequality of transparency between those two multi-lateral trading 
venues. Moreover, because the volume of transactions in bilateral 
markets may not be as apparent as the volume of transactions on 
exchanges or electronic trading facilities there may be a tendency to 
discount the impact that the bilateral markets have upon the price 
discovery process. APGA believes that, to be comprehensive, a large 
trader reporting system must include large positions amassed through 
the OTC bilateral markets in addition to those accumulated on futures 
exchanges or on OTC electronic trading facilities.
    Bilateral trading can also take place on an electronic trading 
venue that may be as attractive to traders as multi-lateral trading 
facilities. Enron On-line, for example, was an all-electronic, 
bilateral trading platform. Using this platform, Enron offered to buy 
or sell contracts as the universal counterparty to all other traders. 
On the Enron On-line trading platform, only one participant--Enron--had 
the ability to accept bids and offers of the multiple participants--its 
customers--on the trading platform. This one-to-many model constitutes 
a dealer's market and is a form of bilateral trading.\7\
---------------------------------------------------------------------------
    \7\ This stands in contrast to a many-to-many model which is 
recognized as a multi-lateral trading venue. This understanding is 
reflected in section 1a(33) of the Act, which defines ``Trading 
Facility'' as a ``group of persons that . . . provides a physical or 
electronic facility or system in which multiple participants have the 
ability to execute or trade agreements, contracts or transactions by 
accepting bids and offers made by other participants that are open to 
multiple participants in the facility or system.''
---------------------------------------------------------------------------
    Section1a(33) of the Act further defines bilateral trading by 
providing that, ``the term `trading facility' does not include (i) a 
person or group of persons solely because the person or group of 
persons constitutes, maintains, or provides an electronic facility or 
system that enables participants to negotiate the terms of and enter 
into bilateral transactions as a result of communications exchanged by 
the parties and not from interaction of multiple bids and multiple 
offers within a predetermined, nondiscretionary automated trade 
matching and execution algorithm. . . . .'' This means that it is also 
possible to design an electronic platform for bilateral trading whereby 
multiple parties display their bids and offers which are open to 
acceptance by multiple parties, so long as the consummation of the 
transaction is not made automatically by a matching engine.
    Both of these examples of bilateral electronic trading platforms 
might very well qualify for exemption under the current language of 
sections 2(g) and 2(h)(1) of the Commodity Exchange Act. It is entirely 
foreseeable that if a CFTC large-trader reporting regime were expanded 
to require the reporting of positions entered into only on multi-
lateral electronic trading facilities and does not include bilateral 
electronic trading platforms too, traders who wish to evade the new 
reporting requirement would simply be able to move their trading 
activities from an electronic trading facility to a bilateral 
electronic trading platform, just as Amaranth moved its trading from 
NYMEX to ICE.
    Moreover, even in the absence of electronic trading, the ability of 
traders to affect prices in the natural gas markets through direct or 
voice-brokered bilateral trading should not be underestimated. For 
example, a large hedge fund may trade bilaterally with a number of 
counterparty/dealers using standard ISDA documentation. By using 
multiple counterparties over an extended period of time, it would be 
possible for the hedge fund to establish very large positions with each 
of the dealer/counterparties. Each dealer in turn would enter into 
transactions on NYMEX to offset the risk arising from the bilateral 
transactions into which it has entered with the hedge fund. In this 
way, the hedge fund's total position would come to be reflected in the 
futures market.
    Thus, a prolonged wave of buying by a hedge fund, even through 
bilateral direct or voice-brokered OTC transactions, can be translated 
into upward price pressure on the futures exchange. As futures 
settlement approaches, the hedge fund's bilateral purchases with 
multiple dealer/counterparties would maintain or increase upward 
pressure on prices. By spreading its trading through multiple 
counterparties, the hedge fund's purchases would attract little 
attention and escape detection by either NYMEX or the CFTC. In the 
absence of routine large-trader reporting of bilateral transactions, 
the CFTC will only see the various dealers' exchange positions and have 
no way of tying them back to purchases by a single hedge fund.
    Legislation is needed to remedy this critical lack of transparency. 
The CFTC recently proposed an amendment to its Rule 18.05 ``special 
call'' provision to make explicit that its special call authority to 
traders applies to OTC positions, including bilateral transactions and 
transactions executed on the unregulated electronic trading facilities 
where the trader has a reportable position on a designated contract 
market in the same commodity.\8\ This amendment, however, merely makes 
explicit authority that the CFTC has previously exercised under Rule 
18.05.\9\ Moreover, special calls are extraordinary in nature and will 
not be used until a problem has been detected by some other means. 
Thus, this special call requirement is not an effective tool for 
conducting routine market surveillance. Moreover, the provision, even 
as it is proposed to be amended, only applies when a trader has a 
reportable position on a regulated futures market. Thus, by maintaining 
positions in the regulated futures market below the reporting level, a 
trader can avoid being required to report, even on a special call 
basis. This is exactly the path that Amaranth took when ordered to 
reduce its NYMEX position.
---------------------------------------------------------------------------
    \8\ ``Maintenance of Books, Records and Reports by Traders,'' 72 
Fed. Reg. 34413 (June 22, 2007).
    \9\ The CFTC stated in its Federal Register release that, 
``Commission staff has interpreted Regulation 18.05 to include position 
and transaction data for non-reporting transactions [transactions 
executed over-the-counter and or pursuant to Sections 2(d), 2(g) or 
2(h)(1)-(2) of the Act] and has received such information in response 
to requests made pursuant to the Regulation.'' Id. at 34415.
---------------------------------------------------------------------------
    Only a comprehensive large trader reporting system that includes 
all segments of the market would have enabled the CFTC to spot the 
relative size of Amaranth's OTC position prior to its collapse. A 
comprehensive large trader reporting system would enable the CFTC, 
while a scheme is unfolding, to determine whether a trader is using the 
OTC natural gas markets to corner deliverable supplies and manipulate 
the price in the futures market.\10\ A comprehensive large trader 
reporting system would also enable the CFTC to better detect and deter 
other types of market abuses, including for example, a company making 
misleading statements to the public or providing false price reporting 
information designed to advantage its natural gas trading positions, or 
a company engaging in wash trading by taking large offsetting positions 
with the intent to send misleading signals of supply or demand to the 
market. Such activities are more likely to be detected or deterred when 
the government is receiving information with respect to a large 
trader's overall positions, and not just those taken in the regulated 
futures market.
---------------------------------------------------------------------------
    \10\ See e.g., U.S. Commodity Futures Trading Commission v. BP 
Products North America, Inc., Civil Action No. 06C 3503 (N.D. Ill.) 
filed June 28, 2006.
---------------------------------------------------------------------------
    The need to provide the CFTC with additional surveillance tools is 
not meant to imply that the CFTC has not been vigilant in pursuing 
wrongdoers. Experience tells us that there is never a shortage of 
individuals or interests who believe they can, and will attempt to, 
affect the market or manipulate price movements to favor their market 
position. The fact that the CFTC has assessed over $300 million in 
penalties, and has assessed over $2 billion overall in government 
settlements relating to abuse of these markets affirms this. These 
efforts to punish those that manipulate or otherwise abuse markets are 
important. But it must be borne in mind that catching and punishing 
those that manipulate markets after a manipulation has occurred is not 
an indication that the system is working. To the contrary, by the time 
these cases are discovered using the tools currently available to 
government regulators, our members, and their customers, have already 
suffered the consequences of those abuses in terms of higher natural 
gas prices. Greater transparency with respect to traders' large 
positions, whether entered into on a regulated exchange or in the OTC 
markets in natural gas will provide the CFTC with the tools to detect 
and deter potential manipulative activity before our members and their 
customers suffer harm.
    Accordingly, APGA has petitioned Congress to pass legislation that 
would expand the large trader reporting system to mandate the reporting 
of positions held in financial contracts for natural gas in all 
segments of the market. Specifically, we believe that large traders 
should report their positions regardless of whether they are entered 
into on designated contract markets, on electronic trading facilities, 
on OTC bilateral electronic trading platforms, in the voice-brokered 
OTC markets or in direct bilateral OTC markets. This would treat all 
trading positions in financial natural gas contracts equally in terms 
of reporting requirements. Extending large trader reporting to OTC 
natural gas positions and to positions entered into on electronic 
trading facilities will provide the CFTC with a complete picture of the 
natural gas marketplace and ensure that the cop on the beat has the 
tools necessary to be effective.
Greater Transparency Is a Reasonable Response to Conditions in the 
        Natural Gas Market
    It is important to note that APGA's proposal is narrow in scope. 
First, APGA is requesting a comprehensive large trader reporting system 
only with respect to financial contracts, agreements and transactions 
in natural gas. The legislation that APGA is seeking is not intended 
to, and would in no way effect financial swaps. Natural gas contracts 
are more susceptible to manipulation than other commodities or 
instruments because the deliverable supply of natural gas is often 
small relative to the size of the derivatives positions held by large 
traders and, as mentioned previously, natural gas is constrained by the 
manner in which it can be delivered. These conditions do not 
necessarily pertain to other commodities or instruments which are 
``exempt commodities'' under the Act \11\ and they most certainly do 
not pertain to contracts, agreements or transactions in the ``excluded 
commodities'' under the Act.\12\ Accordingly, it must be emphasized 
that APGA's proposal is limited to contracts in natural gas. It would 
have no effect with respect to the OTC markets in financial swaps or in 
any other contracts, agreements or transactions on an ``excluded 
commodity'' or in any ``exempt commodity'' other than natural gas. 
Moreover, APGA's proposal with respect to financial contracts, 
agreements or transactions in natural gas is merely a reporting 
requirement and would not impose any regulatory requirements with 
respect to such transactions.
---------------------------------------------------------------------------
    \11\ ``Exempt commodities'' are defined in Section 1a(14) of the 
Act as, ``a commodity that is not an excluded commodity or an 
agricultural commodity.'' Thus, for example, exempt commodities include 
other energy commodities and base and precious metals.
    \12\ ``Excluded commodities'' are defined in Section 1a(13) of the 
Act and include interest rates, currency, indexes and various other 
types of financial instruments or interests.
---------------------------------------------------------------------------
    Second, the CFTC's large trader reporting system would not in any 
way result in the public release of information relating to an 
individual entity's trading positions. Information collected through 
the CFTC's large trader reporting system is used for the government's 
market surveillance purposes only and is kept confidential by the CFTC 
in accordance with Section 8 of the Act. Any information which is made 
publicly available by the CFTC, as described above, is on an aggregated 
basis and does not disclose individual trading positions. APGA is not 
advocating a change in this practice.
    Finally, although some have raised concerns about the costs of 
expanding the large trader reporting system, we believe the costs would 
be reasonable. Insofar as the CFTC's large trader reporting system is 
already operational, the CFTC will not be creating an entirely new 
program to collect this information. In addition, large traders, such 
as those which would be required to report to the CFTC, will likely 
have automated record keeping systems for their own internal risk 
management purposes that could be adapted for the purpose of reporting 
positions to the CFTC. Finally, as discussed above, certain trading 
facilities have already taken steps to make information available to 
the CFTC. Accordingly, APGA believes that the costs of a comprehensive 
large trader reporting system for natural gas would be reasonable and 
are far outweighed by the benefits in terms of helping assure consumers 
that the market price is a reflection of appropriate market forces.
          * * * * *
    Natural gas is a lifeblood of our economy and millions of consumers 
depend on natural gas every day to meet their daily needs. It is 
critical that the price those consumers are paying for natural gas 
comes about through the operation of fair and orderly markets and 
through appropriate market mechanisms that establish a fair and 
transparent marketplace. Without giving the government the tools to 
detect and deter manipulation, market users and consumers of natural 
gas who depend on the integrity of the natural gas market cannot have 
the confidence in those markets that the public deserves. The current 
situation is not irreversible. Congress can provide American consumers 
with the protection they deserve by passing legislation that would 
expand the CFTC's large trader reporting requirements to include 
financial contracts for natural gas that are currently exempt from 
reporting. APGA and its approximately 700 public gas system members 
stand ready to work with you towards accomplishing that goal.

    The Chairman. Thank you, sir. Mr. Cicio.

   STATEMENT OF PAUL N. CICIO, PRESIDENT, INDUSTRIAL ENERGY 
             CONSUMERS OF AMERICA, WASHINGTON, D.C.

    Mr. Cicio. Thank you, Mr. Chairman. The Industrial Energy 
Consumers of America is a nonprofit trade association whose 
membership are significant consumers of natural gas and from 
every major energy intensive manufacturing sector. At the heart 
of the matter is that every consumer in the county assumes that 
the government is protecting their interests and that energy 
markets are working fairly, without manipulation, and operating 
with a level playing field. Nothing could be further from the 
truth.
    The subject of excessive financial speculation, and market 
power, manipulation first came to our attention starting in 
2001 with the implementation of the Commodity Futures 
Modernization Act and concerns have continued to grow. The 
signs were obvious, but the lack of data, we could never prove 
it. This all changed with the implosion of the Amaranth 
Advisors hedge fund. The June 2007 Senate Permanent 
Subcommittee on Investigations report entitled, Excessive 
Speculation in the Natural Gas Market provides a clear and 
troubling picture of how easy it is for a large hedge fund or 
funds and Wall Street trading companies to potentially 
manipulate the market to the benefit of their investors, to the 
detriment of every consumer in the country. Amaranth completely 
dispels the Wall Street myth that the market is too large for 
one company to manipulate.
    All market inefficiencies are paid for by us, the consumer. 
And even a relatively small increase in the price of natural 
gas of just 25 cents over the course of a year would cost 
consumers $5.5 billion. Unlike other major commodities like 
currencies or gold, excessive speculation of natural gas has a 
direct impact on real people, homeowners, farmers and our 
manufacturing competitiveness. And because natural gas supply 
is fragile, it is particularly vulnerable to manipulation. We 
can't assume that had Amaranth not continued to increase their 
control of price by continuing to add to their positions, 
market conditions would have driven the price lower because 
national inventories of natural gas were above a 5 year average 
and production was stable.
    In fact, after Amaranth collapsed, so did the price of 
natural gas. In September 2006 the price was $6.81; after the 
collapse, it fell to $4.20. If we simply assume that $1 of that 
$2.61 was due to Amaranth's activities, consumers would have 
paid some $9 billion over the period of April to August of 
2006. The Amaranth event raises several important questions for 
Congress to address. The CFTC has known for a long time that a 
significant market oversight gap existed. Why didn't the 
Chairmen of the CFTC step forward to say there is a problem? 
Why wasn't the CFTC responsive and accountable to the public 
interest? Did the Commodity Futures Modernization Act of 2000 
go too far? Did it weaken CFTC's market oversight 
accountability? Is the relationship between CFTC and the 
exchanges and Wall Street too cozy? Why aren't there time 
limits to prevent CFTC officials from taking top positions in 
the exchanges?
    It is not without notice that last year Wall Street trading 
companies weighed in on Congress to oppose the same reporting 
and transparency provisions that we are asking for that would 
have prevented Amaranth activities. Interestingly, these same 
companies do mark to market position accounting at the end of 
each trading day and they do it for their internal financial 
management. It is also safe to say that companies currently 
reporting to NYMEX and to CFTC are the same companies that are 
not being required to report their positions through ICE.
    IECA recommends that Congress take immediate action to give 
CFTC regulatory oversight over ICE, and the OTC markets, in 
general; require large traders to report their positions daily 
to CFTC; give CFTC the ability to aggregate positions taken on 
these exchanges and OTC markets; establish responsible daily 
volume trading limits; increase monitoring in future months; 
and increase the funding to allow for better enforcement. Thank 
you.
    [The prepared statement of Mr. Cicio follows:]

   Prepared Statement of Paul N. Cicio, President, Industrial Energy 
                 Consumers of America, Washington, D.C.
    Chairman Etheridge and Ranking Member Moran, thank you for the 
opportunity to testify before this Subcommittee on the important issue 
of trading of energy-based derivatives.
    The Industrial Energy Consumers of America (IECA) is a nonprofit 
trade association whose membership are significant consumers of natural 
gas and from every major energy intensive manufacturing sector. 
Corporate Board Members are top energy procurement managers who are 
leaders in their industry, technical experts, strongly committed to 
energy efficiency and environmental progress. IECA membership 
represents a diverse set of industries including: plastics, cement, 
paper, food processing, aluminum, chemicals, fertilizer, brick, 
insulation, steel, glass, industrial gases, pharmaceutical, 
construction products, automotive products, and brewing.
    At the heart of the matter is that every consumer in the country 
assumes that the government is protecting their interests and that 
energy markets are working fairly, without manipulation and operating 
with a level playing field. Nothing could be further from the truth.
    The subject of excessive speculation, market power and market 
manipulation first came to our attention in 2001 and has continued to 
grow in concern. The signs were obvious but because of the lack of 
transparency, we could never prove it. This all changed with the 
implosion of the Amaranth Advisors hedge fund. The fund reportedly lost 
$6.0 billion on natural gas trades.
    The June 2007 U.S. Senate Permanent Subcommittee on Investigations 
report entitled ``Excessive Speculation in the Natural Gas Market'' 
confirms that Amaranth controlled 100,000 natural gas contracts which 
mean they controlled the equivalent of 1 trillion cubic feet of natural 
gas--the equivalent of 54 percent of our country's monthly demand. 
Clearly, this looks like market power and market manipulation to a 
consumer. We strongly encourage each Member of Congress to read the 
Senate report that provides a startling reality check on how markets 
are being manipulated.
    Amaranth provides a clear and troubling picture of how easy it is 
for large hedge fund and Wall Street trading companies to manipulate 
the market to the benefit of their investors and to the detriment of 
every consumer in this country. Amaranth completely dispels the Wall 
Street myth that the market is too large for any one company to 
manipulate.
    The Commodity Futures Trading Commission (CFTC) knows there are 
significant market oversight gaps and have failed to act in the public 
interest. There is excessive speculation but we can deal with it `if' 
we have transparency for the regulators to monitor the size of the 
natural gas volumes that any one player is controlling on NYMEX, the 
IntercontinentalExchange (ICE) and other over-the-counter (OTC) 
markets. Today, under existing law, regulators can only monitor trading 
volumes on NYMEX.
    We believe that markets work better when market participants know 
there is strong government oversight that has the ability to catch and 
severely penalize market manipulation. Unfortunately there is neither 
sufficient government oversight nor sufficient penalties to deter 
manipulation.
    All market inefficiencies are paid for by us, the consumer. And, 
even a relatively small increase in the price of natural gas such as 
$0.25, amount to significant cost impact of $5.5 billion over the 
course of a year. And, unlike, many other commodities such as 
currencies or gold, excessive speculation of natural gas has a direct 
impact on all sectors of the economy including homeowners, farmers and 
the manufacturing sector.
    IECA member companies are some of the world's largest consumers of 
natural gas. Natural gas is used as a feedstock and fuel. Member 
company competitiveness is impacted directly and indirectly from the 
price of natural gas and the functioning of natural gas markets. 
Indirectly, the higher price of natural gas is increasing the price of 
electricity across the country.
    For example, natural gas represents 85% of the cost of making 
anhydrous ammonia which is used to make fertilizer for our farmers. 
Much of our plastics today are made from either ethylene or propylene 
and a substantial portion of U.S. capacity is produced using natural 
gas as the feedstock. In this case 93% of the cost of ethylene and 
propylene is attributable to the cost of natural gas. Most 
manufacturers use natural gas as a fuel for their boilers and to co-
generate electricity and steam to operate their facilities. There is 
virtually no substitute.
    Member companies historically use hedging practices to protect 
themselves from volatility and to increase predictability of the 
purchase price of natural gas. Since 2001, volatility has significantly 
increased in large part due to excessive speculation which has also 
increased the cost to hedge. For example, using a ATR (Average True 
Range 15 week moving average) and comparing May 2000 to June 2007, the 
volatility is up greater than 100%. If we compare May 2000 to the 
September 2006 (the time period after the Amaranth implosion) the 
volatility increased by 475%. Volatility is a manufacturer's nightmare 
and a trader's dream. Volatility makes it extremely difficult for 
manufacturers to plan product pricing, capital expenditures and plant 
operations.
    It is now a well known fact that Amaranth continued to increase the 
volume of natural gas they controlled on the NYMEX and 
IntercontinentalExchange (ICE) during the spring and summer of 2006. 
Doing so resulted in higher prices than what would have otherwise been 
the case. National natural gas inventories at the time were above the 5 
year average and domestic production was stable. It is impossible for 
anyone to accurately determine the premium consumers paid because of 
Amaranth. However, we can provide perspective.
    We can assume that had Amaranth not continued to increase their 
control of the price by continuing to add to their positions, market 
conditions would have driven the price lower. In fact, after Amaranth 
collapsed, so did the price of natural gas. In September 2006, the 
price was $6.81 per mm Btu and after the Amaranth collapse the price 
fell in October 2006 to $4.20 per mm Btu, a $2.61 difference. If we 
assume that only $1 of the $2.61 price was due to Amaranth, it would 
have cost consumers an estimated $9 billion over the time period of 
April thru August of 2006!
    The clear responsibility of the CFTC is to ensure that the natural 
gas market is functioning efficiently, fairly and that the derived 
market price is trustworthy. That is, without manipulation. They cannot 
succeed in doing so without greater jurisdiction to provide oversight 
of the over-the-counter markets (OTC) including ICE. It is well known 
to all market participants that because CFTC has oversight of NYMEX and 
requires large players to report their positions to the ``Commitment of 
Trader Report'', that traders have moved much of their trading volumes 
to ICE where there is no reporting. Without jurisdiction over ICE, it 
is impossible for the CFTC to reduce excessive speculation and make 
sure that market power and market manipulation does not occur.
    The Amaranth event raises several important questions for Congress 
to address. The CFTC has known for a long time that a significant 
market oversight gap exists. Why hasn't the Chairman of the CFTC 
stepped forward to say there is a problem? Why isn't the CFTC 
responsive and accountable to the public interest? Did the Commodity 
Futures Modernization Act (CFMA) of 2000 go too far and did it weaken 
CFTC's market oversight accountability? Is the relationship between the 
CFTC and the exchanges to cozy? Why are there not time limits that 
prevent CFTC officials from taking top positions with the exchanges?
    At least one CFTC Commissioner has said there is a problem. Below 
are the remarks of CFTC Commissioner Michael V. Dunn before the 
National Grain Trade Council on September 8, 2006.

        ``However, a large portion of energy trading occurs in the 
        over-the-counter market, mostly beyond the scrutiny of any 
        Federal agency. The Commission's enforcement actions continue 
        to uncover repeated examples of people and companies trying to 
        game the energy markets, often in the belief that no one is 
        watching, or that if someone is, there is nothing that can be 
        done to them.''

        ``Because the CFTC is barred from regulating the OTC energy 
        markets, it cannot collect large trader data from unregulated 
        energy markets, or conducting regular surveillance of them. It 
        is virtually impossible to know, therefore, the extent of fraud 
        and manipulation that may be occurring in the over-the-counter 
        markets.''

    CFTC opines it has subpoena power. It does. But that is not the 
type of government oversight that is needed. Subpoena power is used 
after the damage to markets has already been done. We want a preemptive 
approach that effectively monitors markets and prevents manipulation.
    IECA recommends that Congress take immediate action to give CFTC 
regulatory oversight of ICE and other over-the-counter markets; require 
large traders to report their positions daily to CFTC; give CFTC the 
ability to aggregate positions regardless of where they are held; 
establish daily volume trading limits; increase monitoring in all 
months, not just near term months; increase CFTC funding for monitoring 
and enforcement; and lastly, increase the supply of natural gas.
    Asking OTC `large traders' to report their position to the CFTC 
just like the NYMEX does today, is not asking too much of these 
companies. These same companies do `mark-to-market' position accounting 
at the end of each trading day for internal financial management 
reasons anyway. Plus, it is safe to say that the same companies who are 
reporting to CFTC thru NYMEX are the same companies who are not 
reporting thru ICE. Reporting large positions to the CFTC is not asking 
much when the public trust is at stake.
    Thank you.

    The Chairman. Thank you, sir. Mr. Eerkes.

       STATEMENT OF CRAIG EERKES, PRESIDENT, SUN PACIFIC
             ENERGY; CHAIRMAN, PETROLEUM MARKETERS
ASSOCIATION OF AMERICA, KENNEWICK, WA; ON BEHALF OF NEW ENGLAND 
                         FUEL INSTITUTE

    Mr. Eerkes. Chairman Etheridge and Ranking Member Moran and 
the distinguished Members of the Committee, thank you for the 
opportunity to testify before you today. My name is Craig 
Eerkes and I appreciate the opportunity to provide some insight 
on the way that the energy-based futures markets affect 
independent petroleum marketers. I am here today offering 
testimony on behalf of the Petroleum Marketers Association of 
America and the New England Fuel Institute. Both PMAA and NEFI 
have worked together to advocate increased CFTC oversight of 
the energy futures markets.
    PMAA is a national federation of 45 state and regional 
associations representing some 8,000 independent petroleum 
marketing companies from coast to coast. NEFI is a regional 
trade association representing over 1,000 fuel marketers in the 
New England region. Combined, our members own or supply 
gasoline and diesel to 100,000 convenience stores and sell 90 
percent of the heating oil and farm fuel sold in the United 
States.
    My petroleum marketing company, Sun Pacific Energy, owns 
and operates 32 gas stations and convenience stores in 
Washington State and we also supply Shell and ExxonMobil 
gasoline to 75 independent dealers. Independent marketers began 
to pay closer attention to futures markets in the aftermath of 
September 11, 2001. Many petroleum marketers were stunned by 
the immediate price volatility that spiked from coast to coast. 
Many marketers in the Pacific Northwest were hit with dramatic 
wholesale price increases on 9/11 and we did not think it 
correlated to supply and demand. Our area refineries were not 
affected, our terminals had plenty of supply, yet wholesale 
prices quickly increased up to 40 cents per gallon.
    First of all, I want to stress that we are not alleging any 
wrongdoing by any person or any company. Our point of view is 
really quite simple: Because the futures markets have become 
the basis for the daily wholesale price of gasoline, diesel and 
heating oil, it is imperative that Federal regulators monitor 
all significant trading activity. Several weeks ago the House 
of Representatives passed a gas price gouging bill that will 
severely restrict my ability to operate my company during a 
national emergency. I can say with firm conviction that my 
marketer colleagues did everything possible to hold down gas 
prices following 9/11 and Hurricane Katrina.
    By contrast, one oil trader bragged that his profits 
following Hurricane Katrina, in an industry newsletter, this 
particular futures marketer bragged that he made enough money 
in the week following Katrina that he would not have to work 
the rest of the year. Can you imagine what would happen if a 
gas station owner made a similar comment? If you want to do 
something meaningful about retail petroleum prices, make sure 
the energy futures markets are effectively monitored by the 
CFTC. Because of the ``Enron Loophole,'' 75 percent of futures 
trading which occurs on the over-the-counter exchanges, 
including offshore exchanges such as ICE, are completely opaque 
and are not accountable to U.S. law.
    This is unacceptable. There needs to be transparency, 
accountability and the rule of law on all energy commodity 
markets. We urge you to close the ``Enron Loophole'' and give 
the CFTC the authority and the tools to do the job. Please 
ensure that energy futures trades are made subject to the same 
oversight as wheat, corn and pork bellies. Energy consumers are 
affected by excessive speculation and price volatility in the 
energy commodity markets in profound ways. When excessive 
speculation and volatility results in high prices for gasoline 
and diesel, few Americans have transportation alternatives.
    When heating oil, natural gas and other fuels skyrocket, it 
places at risk the health and welfare of American families who 
need heat for their homes. The commodity markets are the price 
discovery points for all energy commodities. Excessive 
speculation and questionable trading practices have an instant 
and tremendous impact on the consumer. American families and 
small businesses are at the financial whim of the energy trader 
and the hedge fund manager. It is time that Congress stepped in 
and said, ``Enough is enough.''
    Please make sure that these markets are completely driven 
by supply and demand for the benefit of all U.S. citizens. I 
thank you for permitting me to participate in today's hearing 
and I look forward to answering any questions you may have. 
Thank you.
    [The prepared statement of Mr. Eerkes follows:]

   Prepared Statement of Craig Eerkes, President, Sun Pacific Energy;
Chairman, Petroleum Marketers Association of America, Kennewick, WA; on 
                  Behalf of New England Fuel Institute
    Chairman Etheridge and Ranking Member Moran and distinguished 
Members of the Committee, thank you for the invitation to testify 
before you today. I appreciate the opportunity to provide some insight 
on the way that the energy based futures markets affect independent 
petroleum marketers. I hope that my many years of experience in the 
industry will help shed light on this issue and assist you in your 
policy-making and oversight endeavors.
    I am here today offering testimony on behalf of the Petroleum 
Marketers Association of America (PMAA) and the New England Fuel 
Institute (NEFI). Both PMAA and NEFI have worked together to advocate 
increased Commodity Futures Trading Commission (CFTC) oversight of the 
energy futures markets. PMAA is a national federation of 45 state and 
regional associations representing some 8,000 independent petroleum 
marketing companies from coast to coast. NEFI is a regional trade 
association representing over 1,000 fuel marketers in the New England 
region. Combined our members own or supply gasoline and diesel to 
100,000 convenience stores and sell 90% of the heating oil sold in the 
U.S. Also, of particular interest to this Committee, PMAA and NEFI 
member companies supply an estimated 90% of the gasoline, diesel, 
kerosene and heating oil to our nation's farms.
    My petroleum marketing company, Sun Pacific Energy, owns and 
operates 32 gas stations and convenience stores in Washington State. We 
also supply Shell and ExxonMobil gasoline to 75 independent dealers.
    Independent petroleum marketers began to pay closer attention to 
futures markets in the aftermath of September 11, 2001. Many petroleum 
marketers were stunned by the immediate price volatility that spiked 
from coast to coast. Many marketers in the Pacific Northwest were hit 
with dramatic wholesale prices increases on 9/11 and we did not think 
it correlated to supply and demand fundamentals. Our area refineries 
were not affected; our terminals had an abundance of product yet 
wholesale prices increased up to 40 cents per gallon at some terminals.
    From that day forward, PMAA and NEFI leaders began to take a hard 
look at the futures markets and their correlation to supply and demand.
    First of all I want to stress that we are not alleging any wrong 
doing by any person or any company. Our point of view is really quite 
simple. Because the futures markets have become the basis for the daily 
wholesale prices for gasoline, diesel and heating oil, it is imperative 
that Federal regulators monitor all significant trading activity. It is 
unacceptable for Federal law to shield some energy trading activity 
from needed oversight.
    Several weeks ago, the House of Representatives passed a ``gas 
price gouging bill'' that will severely restrict my ability to operate 
my company during national emergencies. I can say with firm conviction 
that my marketer colleagues did everything possible to hold down gas 
prices following 9/11 and Hurricane Katrina. By contrast, one oil 
trader bragged about his profits following Hurricane Katrina in an 
industry newsletter. This particular futures market trader bragged that 
he made enough money in the week following Katrina that he would not 
have to work the rest of the year. Can you imagine what would happen if 
a gas station owner made a similar comment?
    If you want to do something meaningful about gasoline, diesel and 
heating oil prices, make sure the energy futures markets are 
effectively monitored by the CFTC. Because of the ``Enron Loophole,'' 
which Congress passed in 2000 at the behest of Enron lobbyists, the 75% 
of futures trading which occurs on the over-the-counter (OTC) 
exchanges, including off-shore exchanges such as the 
IntercontinentalExchange, are completely opaque and are not accountable 
to U.S. law. This is unacceptable--there needs to be transparency, 
accountability and the rule of law on all energy commodity markets. We 
urge you to close the ``Enron Loophole'' and give the CFTC the 
authority and the tools to do the job. Please insure that energy 
futures trades are made subject to the same oversight as wheat, corn 
and pork bellies.
    Energy consumers are affected by excessive speculation and price 
volatility in the energy commodity markets in profound ways. When 
excessive speculation and volatility result in high prices for gasoline 
and diesel, few Americans have transportation alternatives. When 
heating oil, natural gas and other heating fuels skyrocket it places at 
risk the health and welfare of Americans families who need heat for 
their homes.
    The commodity markets are the price discovery points for all energy 
commodities. Excessive speculation and questionable trading practices 
have an instant and tremendous impact on the consumer. American 
families and small businesses are at the financial whim of the energy 
trader and the hedge fund manager. It is time that Congress stepped in 
and said, ``Enough is enough.''
    We and our customers need our public officials, including those in 
Congress and on the Commodity Futures Trading Commission (CFTC), to 
take a stand against a loophole that artificially inflates energy 
prices. We deserve to have confidence that the prices established in 
futures markets are in fact market based prices and not vulnerable to 
inappropriate trading practices.
    Do not be mistaken. We very much support the free exchange of 
commodity futures on open, well regulated and transparent exchanges 
that are subject to the rule of law and accountability. Many PMAA and 
NEFI members rely on these markets to hedge product for the benefit of 
their business planning and their consumers. Reliable futures markets 
are crucial to the entire petroleum industry and that is one reason why 
I am here today. I think it is so important for Congress to improve the 
futures markets for the benefit of all U.S. citizens.
    As I mentioned earlier, the futures markets have become the price 
point for wholesale refined product pricing in the U.S. Please make 
sure that these markets are competitively driven by supply and demand.
    I thank you for permitting me to participate in today's hearing and 
I look forward to answering any questions you may have.

    The Chairman. Thank you, sir. We have just gotten a call 
for voting on the floor. We will have three votes. They are 
probably going to take about 20 minutes at most, hopefully, and 
we will hustle right back. If you will just hang around, take a 
little break, we will try to get back as quickly as we can. I 
was hoping we would get through before they called the vote.
    [Recess]
    The Chairman. Let me thank you for your indulgence. It took 
longer than we thought. You know, they start the vote and they 
start dragging it out and it took a bit, but we appreciate you 
waiting around for us until we got back. We are going to move 
to our question area and we will allow each Member 5 minutes 
and I recognize myself for the first 5 minutes. And my first 
question will be to Dr. Newsome.
    Dr. Newsome, during the Senate hearing on Monday, the New 
York Merc, ICE and the CFTC were all in agreement that the ICE 
and New York Merc trading venues are now pretty tightly linked 
and strongly interactive with each other. My question to you is 
what consequences does this have for the price discovery role 
of the two venues?
    Dr. Newsome. Mr. Chairman, I think it links the price 
discovery role, as well. I mean, if you look at trading on both 
ICE and NYMEX, either exchange can lead the other exchange very 
quickly which follows within that price direction and even 
though NYMEX trades a physical contract, ICE trades a financial 
contract, the reality is that less than \1/10\ of 1 percent of 
NYMEX contracts go to physical delivery. Now, they trade 
functionally as a financial contract, so I think the two are 
definitely linked. The two markets can move each other and 
while the price that is published is officially the NYMEX 
price, I don't think there is any question that the activity on 
ICE is a component of that price is discovered.
    The Chairman. Okay. Mr. Sprecher, you said, at the Senate 
hearing, that ICE would support implementation of 
accountability levels to require traders to provide the 
exchange more information about their positions. Could ICE not 
implement this independently of any Commission authority or 
action?
    Mr. Sprecher. It is a very good question. We could. I think 
what the real issue is, is that ICE only has a limited view 
into the market. If you ask Dr. Newsome, he would tell you he 
only has a limited view into the market and increasingly, what 
we really need is for, in my mind, a central person, most 
likely the CFTC, to have an entire view of the market. If, in 
the context of that, the CFTC or Congress would like us to take 
some role in identifying large positions, that would be fine, 
but while I say we would be open to it, I don't necessarily 
think it is the best way of solving this. I actually think the 
CFTC, with an entire view of the market, is best positioned to 
decide who should be accountable and for what.
    The Chairman. Dr. Newsome, let me put you on the hot seat 
again with that very same question, because I think that is 
part of what some of the issues are as it relates to large 
positions and concerning, I would hope, all others who are 
concerned.
    Dr. Newsome. I think I definitely agree with Mr. Sprecher 
that the CFTC is the appropriate overseer. They are the ones 
that should have the global view of who is in these markets, 
how large they are in these markets, so Jeff and I are 
completely on the same page there, Congressman.
    The Chairman. Mr. Pickel, along that same line, you heard 
some of your fellow panelists call for greater reporting to the 
CFTC, but only of positions of large traders, as we just talked 
about here. Can you break down for us the potential cost to a 
large trader in complying with such a provision?
    Mr. Pickel. If we look at it from the perspective of the 
sector that we represent, the privately negotiated business, 
those are all bilateral contracts. There is not the building up 
of a market position in the way you would do certainly on an 
exchange and perhaps, to some extent, through an ECM, such as 
ICE. So you don't have that building up of a market in the same 
sense. You have a series of bilateral trades between parties 
and both of those parties typically will be looking at the 
market prices, typically the NYMEX price, to determine whether 
the price of that individual trade, which they have negotiated, 
is an appropriate price to enter into a contract.
    The Chairman. So give me a for instance, say on a $100,000 
position or a half million dollar position.
    Mr. Pickel. In terms of the cost of----
    The Chairman. Yes. If you know.
    Mr. Pickel. I don't have those numbers, specifically. It is 
fair to say that the members that we represent, and I think 
most people who are active in these markets, will be, as a risk 
management issue, collecting information and keeping records 
just for either accounting purposes, regulatory purposes or 
just good business sense.
    The Chairman. Okay, thank you. I yield back. Mr. Moran.
    Mr. Moran. Mr. Chairman, thank you. Let me talk to Mr. 
Sprecher and Dr. Newsome about Amaranth. What I am interested 
in knowing is who knew what when? And as I understand, there 
were positions taken on both of your exchanges. What I don't 
know yet is whether each of you knew about the positions taken 
on the other's exchange, and second, what the CFTC knew about 
both of those positions or both of those exchanges and its 
dealings with Amaranth.
    Dr. Newsome. Who do you want to go first?
    Mr. Moran. Well, you two are getting along so well, I will 
let you decide.
    Mr. Sprecher. We actually do get along.
    Dr. Newsome. I think both of us are in the position of 
saying, ``You can only manage what you can see.'' We could see 
the positions on NYMEX, the CFTC could see the positions on 
NYMEX, that is not the case, wasn't the case at the time in the 
ECM marketplace.
    Mr. Moran. And so you, Mr. Sprecher, only knew about the 
positions of Amaranth on your exchange; Mr. Newsome only knew 
about the positions that they took on his exchange. Is that 
true?
    Mr. Sprecher. That is correct.
    Mr. Moran. And then CFTC?
    Mr. Sprecher. At the time, which is not the case today, ICE 
was not giving the so-called large trader report information to 
the CFTC, so they would not have had a real-time way of looking 
at Amaranth. They would have been able to see it and I do 
believe they did see it through its special call provision 
after the fact. Today, with the more near real-time reporting, 
in other words, we send the positions every day, at the end of 
every day, they would have a near real-time view of the 
positions both on ICE and NYMEX, which didn't exist at the 
time.
    Mr. Moran. And what precipitated that change in that 
reporting?
    Mr. Sprecher. A special call from the CFTC, and as I said 
in our testimony, we believe that the CFTC has the authority to 
make that special call and indeed, we complied with it.
    Mr. Moran. And what would CFTC, they would be able to do 
something with that information, share it between the two 
exchanges, investigate positions taken in both places?
    Mr. Sprecher. Well, they have, with respect to ICE, they 
have tremendous authority over these over-the-counter markets 
as they affect Dr. Newsome's markets, to take broad action. But 
I should let you speak to----
    Dr. Newsome. Congressman, I don't think the CFTC would 
share each other's exchanges with another exchange. They will 
take the higher level picture, deal directly with the customers 
and say, ``We notice your positions on either exchange,'' start 
asking the questions, for instance, ``What is your intent,'' 
the `jawboning' that Chairman Lukken talked about earlier.
    Mr. Moran. Well, Doctor, the reason, that was at least an 
important question to me, is because of NYMEX's decision to 
allow an increase or change in their position eight times. My 
question is, if you had information related to what that hedge 
fund was doing in ICE, would you reach a different conclusion? 
And if the answer to that is yes, then that information is 
valuable to you.
    Dr. Newsome. Well, I mean, we certainly could have reached 
a different conclusion. Again, you can only manage what you can 
see. In those circumstances, and it was brought up in the 
Senate hearing and again, earlier today, when we look at 
positions, position limits, position accountability, the eight 
cases, as you just mentioned, is accurate. But is very 
difficult to pull out a position in a particular month and say 
they were over or they were below, because when we look at it, 
we are looking at trying to prevent manipulation. We are 
looking at trying to stem undue risk. We look at the entire 
position.
    So if you had a position in September that may be 
completely offset by a position in October, so from the 
exchange standpoint, we are looking at the aggregation of risk 
across all positions. That is typically the way the CFTC has 
done it. That is what our rules currently allow for. Now, that 
said, given the situation that happened with Amaranth, we have 
started paying much closer attention to futures only position 
and back months, where in the past, we never felt that it was 
necessary to do so. We are doing that now and in fact, we are 
adopting rules that relate to that, as well, so that is 
something that we have learned through the situation with 
Amaranth.
    Mr. Moran. Are there other exchanges in which Amaranth or 
any hedge fund could have taken positions in addition to NYMEX 
and to ICE that it is important for CFTC or you, internally, to 
know about? So now that this information is being gathered, 
have we got every exchange that is important to know about a 
hedge fund's position going to the CFTC?
    Dr. Newsome. Well, I think whether you are talking about 
exchanges or ECMs that function in an exchange-like manner, at 
least, in my opinion, and Mr. Sprecher can provide his 
comments. I think ICE and NYMEX provide the vast majority of 
the information that is necessary, given today's environment, 
because, to my knowledge, ICE and NYMEX are the only two that 
have the tight linkage in the natural gas market. They are the 
only two that function as equivalents and therefore the only 
two that it would have been necessary to look at the Amaranth 
positions as it occurred.
    Mr. Moran. My time is expired. In the past year, I would 
have been able to continue asking questions, but at the moment, 
I cannot. But in case the Chairman will allow me a second round 
of questions, I have a few things I would like to follow up on, 
Mr. Chairman. I may try to assume the time of any of my other 
Republican colleagues.
    The Chairman. I thank the gentleman. Mr. Scott.
    Mr. Scott. Thank you very much, Mr. Chairman. Mr. Sprecher, 
this is a very complex issue and I think it might be helpful to 
us on the Committee if you could share with us just how ICE 
operates, and second, how ICE operates differently from NYMEX.
    Mr. Sprecher. Sure. As it has been testified to, we are 
this category of ECM, which is different than Enron On-line, 
which sought and received an exemption from any oversight. We 
applied for and received designation as an ECM, which has 
certain anti-fraud, anti-manipulation record keeping 
requirements, to the CFTC. NYMEX is, as a full so-called DCM, 
is the designated contract market. Its market is designated as 
the source of price discovery for natural gas and outside of 
NYMEX's market exist ICE and many other bilateral markets. In 
fact, there are global markets that trade swaps and derivatives 
that are related to NYMEX, but are not designated by the 
government as a source of price discovery.
    And it is that distinction that I think was carefully 
crafted in the Commodity Futures Modernization Act and it is, 
in a large part, the underpinning of what we are discussing 
today, which is now that markets are increasingly linked 
globally, electronically, and investment dollars continue to 
come into this space as energy prices climb--what is the role 
of a marketplace that is not designated as a source of price 
discovery?
    Mr. Scott. Let me ask you this, too. My time is limited and 
I got to get a question to Dr. Newsome. You recently came out 
for agreeing to increase regulation, in light of the 
differentiation that you mentioned between yourself and ICE, 
how would that relate? Were you talking about increased 
regulations for yourself or would that apply to NYMEX, as well? 
And second, what would consist of your accountability stand and 
if you could be very brief with that, I would appreciate it.
    Mr. Sprecher. Yes. I think, as everybody has testified to 
today, giving the CFTC more information is a better thing, so 
while I don't believe we need a wholesale overhaul, I think the 
CFTC has, at least with respect to ICE, as an ECM, the 
authority it needs to gather that information. I think it is 
for you all to debate whether that should be broadened to non-
ECMs and I won't take a position on that.
    Mr. Scott. Thank you very much. Dr. Newsome, let me just 
add that I read in The Wall Street Journal recently, I think it 
was yesterday or the day before, that no less than eight times 
in 2006, NYMEX allowed Amaranth to trade far beyond its 
established accountability limits, seemingly at the request of 
Amaranth. In addition, the article states that although you 
issued warning letters to Amaranth, you rescinded the 
violations without explanation. So in light of that, I am 
having a little bit of trouble understanding why it is that you 
are pushing so hard for regulation of ICE when, in fact, 
according to this latest situation with Amaranth, you, 
yourself, refused to abide by already established 
accountability limits. Could you explain that, please?
    Dr. Newsome. Absolutely, sir. I would love to. As I was 
trying to refer to Congressman Moran's question, when you look 
at positions, you can't just look at individual months. I mean, 
we are talking about trying to prevent manipulation and trying 
to manage systemic risk. You have to look at the positions in 
an aggregate manner. Now, we have far tougher rules with regard 
to hard position limits on the front months, more flexible 
rules with regard to position accountability in the back 
months.
    But we do look at the positions across all contracts, not 
only futures contracts, but there are options contracts, as 
well, there are swaps contracts, and in many times these 
positions are offsetting to get to total futures position or 
risk position. In those instances, we looked at those 
positions, not necessarily by that exact month, but in 
aggregate. When we became concerned that in the aggregate 
position Amaranth had too much market power, that was the point 
in which we forced them to start liquidating those positions.
    Mr. Scott. I want to give you an opportunity to respond to 
something there, because Michael Greenberger, who is a former 
CFTC official who oversaw exchange trading in the late 1990s, 
mentioned this. He said that NYMEX is making a lot of money off 
these trades and they are very conflicted about what to do. I 
think it is a very powerful statement that has been made 
against NYMEX and I would like to give you an opportunity to 
clear that up and respond to that.
    Dr. Newsome. And I appreciate you giving me that 
opportunity, Congressman Scott. I cannot disagree with Mr. 
Greenberger more on this instance. In fact, if you look at our 
compliance department, you look at the firewall that we have 
between the compliance department and the business units of the 
exchange, at no point in time did the compliance department 
ever come to the business units or the Board to ask for 
permission to decrease the Amaranth positions, at no time.
    Mr. Scott. All right. Thank you very much, Mr. Chairman.
    The Chairman. Thank you. Mr. Marshall.
    Mr. Marshall. Thank you, Mr. Chairman. The Chairman has a 
scheduling problem with going beyond 1 p.m. and consequently, 
you all have come a long way and offered testimony and not had 
much of an opportunity to have exchange with one another and 
with us. What I would like to propose is that once the hearing 
is adjourned, if you have time on your schedules and I trust 
that you do, that all six of you gentlemen join me.
    We are trying to locate a room where we can have a more 
informal discussion which I will chair, but it will be pretty 
informal chairing, so that I can get--and those who wish to 
join me. I think Mr. Moran will join me and I expect Mr. Barrow 
will, if his schedule permits and perhaps Mr. Scott--so that I 
can get a better feel of the differences of opinion among you 
with regard to these different issues. What do you say? Anybody 
cannot do that? Great. That is very helpful.
    Mr. Pickel, in the past we have talked about reporting and 
record keeping in your industry and I am sure all the reputable 
players in your industry are keeping appropriate records. 
Frankly, all of the reputable characters in your industry are 
reporting as well, not necessarily to the CFTC, but they are 
divulging, at the request of brokerage houses and others, their 
positions so that houses can appropriately gauge risk with 
regard to different transactions.
    I know it is Mr. Corbin's view that an essential part of 
transparency in the market would be to have some kind of 
reporting and both NYMEX and ICE probably agree with that as 
long as they are going to have to be divulging things. What 
would be the problem with a simple reporting system as it 
affects the over-the-counter market?
    Mr. Pickel. I continue to go back to the fundamental nature 
of what I would call the pure OTC, or pure bilateral contract, 
that we represent and that is two parties getting together, 
individually negotiating a trade. Yes, they may do many trades, 
but it is an individual contract that ultimately they have 
entered into and there are protections under the CFMA for those 
types of contracts. You are certainly correct that the 
information is collected. It is just good business sense to 
collect that information and I know that our member firms, the 
reputable firms that you refer to are very cooperative with the 
CFTC and other agencies when they are investigating these 
situations.
    Mr. Marshall. When it is a special call?
    Mr. Pickel. Yes.
    Mr. Marshall. CFTC is not particularly anxious to have, to 
be flooded, frankly, with the details of all of the 
transactions that those you represent enter into. It doesn't 
have the capacity to actually analyze, wouldn't know what it 
received, would be worried that there is some sort of bombshell 
and consequently would have to devote resources. We might not 
provide adequate resources, devote resources to that and hence, 
take resources away from other oversight activities that it 
engages in; so there are real challenges here--but say, ``Let's 
narrow it to a certain market.''
    Let us say natural gas, which has had some obvious problems 
recently, and reporting where that narrow market is concerned. 
Make the reporting a very narrow question, just a few pieces of 
information about the trade; who the parties are, what the 
price was and try to take that, whatever the transaction is as 
between those bilateral entities and have those entities 
characterize that transaction so it fits into a simple 
reporting system; which then enables the CFTC, in advance, to 
anticipate problems with--and it is not just market 
manipulation here. Everybody is talking about the CFTC having 
authority where market manipulation is concerned or fraud, and 
that is the special call.
    The argument by Mr. Corbin, and others, is that these 
markets are not properly finding the price. If you have 
somebody like Amaranth out there that has a trading strategy 
that proves to be erroneous, but is willing to back that 
strategy despite the wisdom of the market. The market prices 
change rather dramatically as a result of the influence of that 
entity, the CFTC, seeing that in advance, could conceivably 
avoid the problem for purchasers like Mr. Corbin and others. 
And so what would be the problem with doing that from the OTC 
perspective?
    Mr. Pickel. I think, from our perspective, these individual 
transactions, the parties will typically reference prices on 
the NYMEX, perhaps over time. If ICE develops a certain 
reference price or there is a price discovery function there, 
they might reference those prices. And they will need to take 
positions and hedge on those regulated markets and therefore 
the information regarding the underlying, even if not regarding 
the individual transaction, the information regarding the 
strategies will play out in the regulated markets.
    Mr. Marshall. And assuming that is the case and I accept it 
is, what would be the harm with divulging the transaction in 
some simple way to the CFTC? Since you are the only market 
anyway.
    Mr. Pickel. Well, I think they would look at that 
information in the way that Dr. Newsome and Mr. Sprecher have 
described. They would have access to that information. I think 
that if they saw that that indicated some abnormalities in 
trading activities, they would certainly be in a position to 
ask for that information. I think that our member firms have 
been very good in turning over that information.
    Mr. Marshall. Dr. Newsome, you keep waving your hand there.
    Dr. Newsome. Yes, I wanted to make a comment on that, kind 
of as a non-OTC player. NYMEX, and I just want to get it clear 
for the record, NYMEX is in no way suggesting that the true, 
individually negotiated off-exchange bilateral markets should 
be subject to CFTC oversight and I think there are a couple of 
reasons. Just the fact that they are individually negotiated in 
terms of the size of the contract, the price of the contract 
and the fact that there is no aggregation of risk, like we have 
on our exchange, like Jeff has on his exchange. I think there 
is very little public good that can come out of that 
information.
    Mr. Marshall. Can I interrupt? Was Amaranth doing, in 
addition to things on your exchanges, things in the over-the-
counter market which were fairly similar to what it was doing 
in your exchanges?
    Mr. Pickel. I don't have the exact answer to that. My 
assumption would be that the bulk of their activity was on both 
NYMEX and ICE. They may have had some, but again, even if they 
were, there was no----
    Mr. Marshall. Well, hypothetically, let us assume Amaranth 
did, that a whole lot of what it was doing were bilateral 
trades, like you just described, on the OTC market. How does 
the CFTC adequately see the dangers, the risks, not just to 
Amaranth, but to the market and to market price discovery 
caused by a situation where a large player is just really going 
whole hog in a particular direction that the rest of the market 
thinks is crazy, but it is going to have to follow?
    Mr. Pickel. Well, I think the protections are self-built 
in. Again, since you have no aggregation of risk as you would 
on an exchange-type manner, I think the risk of a systemic 
problem is very, very small. Particularly, in natural gas, 
where somebody has to be able or the willingness to accept the 
counterparty credit risk, which in natural gas people are 
typically not willing to do so, that is why you see 90 percent 
of the natural gas market now cleared, either through ICE or 
NYMEX, because they don't want to accept that counterparty 
credit risk. So I totally understand the line of questioning, 
but I think, in terms of natural gas, it is not as big a risk 
as it could be and potentially other markets.
    Mr. Marshall. If I could just finish this line?
    The Chairman. Okay, quickly.
    Mr. Marshall. I will. By the end of your statement just 
now, I take it that you think that this risk could exist in 
other markets, not necessarily in natural gas, and that am I 
also to assume that it could well be that a large trader who is 
doing not only trades on your exchanges that are visible, but 
in addition, trades OTC, same commodity that that large 
trader's risk to the market, to itself, to consumers, et 
cetera, wouldn't be seen by the CFTC unless there was 
reporting?
    Mr. Pickel. I am not aware of any risk in other 
marketplaces. Certainly, if that risk was there, the CFTC would 
not currently be able to see it.
    Mr. Marshall. Thank you. Thank you, Mr. Chairman. I thank 
you for your generosity.
    The Chairman. I thank the gentleman. Mr. Moran.
    Mr. Moran. Mr. Chairman, I will try to be brief. I, too, 
have a 1 p.m. appointment that I must keep. Let me just follow 
up with a couple of thoughts that I wanted to explore further. 
In this regulatory world that we are talking about, is there a 
transaction cost, a differential between a DCM and an ECM based 
upon the regulatory structure that CFTC provides?
    Dr. Newsome. There is some cost, Congressman. I couldn't 
quantify that cost for you today. I think, looking at the cost 
of having to acquire and staff a compliance department, as we 
do, is certainly substantial cost for NYMEX. That is a more 
easily quantifiable cost. Position limits, there would be a 
cost there. Price reporting, that reporting is congregated at 
the clearinghouse level and submitted to the CFTC, so I don't 
think there would be any real cost on reporting.
    Mr. Moran. Thank you. And then, we heard, as we discussed 
CFTC reauthorization, about the unique nature of peculiarities 
of forex contracts, that at least allegedly make them more 
susceptible to manipulation fraud. Is there anything inherent 
in natural gas, oil, and gasoline contracts that you could say 
the same thing about them? Is there any inherent opportunities 
for fraud or manipulation?
    Dr. Newsome. I don't think there are more inherent 
opportunities other than we have seen more substantial 
volatility within the energy sector, so you have much more 
price movement and through that price movement, I guess there 
could, theoretically, be more opportunity.
    Mr. Moran. And finally, this is directed at Mr. Corbin. Mr. 
Corbin, there should be a gain that, in the cash market, that 
offsets losses if you are doing an appropriate hedge, so I 
assume that there were gains in the cash market that perhaps 
offset your losses?
    Mr. Corbin. No, there wasn't. What happened was, most of 
our members' consumption is in the wintertime and so what we 
are trying to do is hedge the risk of prices spiking in the 
winter, hitting levels that consumers literally have struggled 
to pay. And so here we are, earlier in the year, and we can't 
wait, hoping that prices are going to come down, so we saw them 
keep going up and up and up. You hope is not a risk management 
strategy, so we put on those hedges, in the summertime, prior 
to the Amaranth collapse. We locked in a price that may have 
been $9 or $10 a unit for wintertime gas. Following the 
collapse, those prices came down significantly. Yes, we bought 
gas. You are right. We physically bought gas cheaper, but you 
then have to add that loss that you incurred on your hedge that 
gets you right back up to $10 or $9. So the loss isn't offset 
in the physical market. It is a real loss.
    Mr. Moran. I assume that part of the losses are unrelated 
to Amaranth, they are related to the market, the volatility, 
the supply and demand.
    Mr. Corbin. Yes, we tried to simply look at that 
afterwards. We didn't go with where the market ultimately 
settled out, which I agree with you. Once it ultimately settles 
out, there are fundamental reasons, as well, for it to continue 
to move. We just tried to look at what was happening right at 
the time they were collapsing, how much did it decline right as 
they were exiting the market, and just use those numbers.
    Mr. Moran. Mr. Chairman, thank you for allowing me the 
opportunity to ask these questions. I would ask if anybody 
would like, not at this point, but in the future, in writing or 
in a conversation with me, I have heard about the ``Enron 
Loophole'' today and there is a suggestion that the ``Enron 
Loophole'' needs to be fixed. I would be happy to have the 
definition. Mr. Eerkes, you, in particular, used that in your 
testimony, but we heard it in the earlier panel. If there is an 
``Enron Loophole'', I would like to know what it is and what 
the potential fix that any of you see is required or not 
required. Thank you, Mr. Chairman.
    The Chairman. I thank the gentleman. Mr. Barrow, 5 minutes.
    Mr. Barrow. I thank the Chairman. I have a few matters I 
want to follow up on, but out of consideration for the chair's 
conflict and in light of the informal meeting that Mr. Marshall 
is going to convene, I will pass on this opportunity, but once 
again, I want you to accept my thanks for the opportunity to 
participate in this hearing. Thank you, sir.
    The Chairman. I thank the gentleman. Dr. Newsome, I am just 
going to ask you a question and in the expediency of time and 
everyone's schedule that it would be in writing, if I may get 
it? According to the Senate Investigative Subcommittee, in a 
report on, this by and large is a natural gas market. It said 
from almost every day from mid-February through July of 2006, 
Amaranth held more than 50 percent of the open interest on New 
York Merc and in January of 2007, as well as in November of 
2006, contracts.
    My question is, is this common or normal for a trader to 
hold such a large position or contract? Second, does holding 
such a position trigger action at the exchange or the CFTC, for 
that matter? And finally, if so, what did New York Merc do with 
regard to Amaranth's position as it relates to this? And I 
would be happy to have that in writing so we can expedite this 
and allow you gentlemen to get on the road because you have 
been very kind with your time today and we do appreciate you 
staying with us through the votes we have had today. And with 
that, unless the Ranking Member has a further comment?
    Mr. Moran. No, sir. Thank you, Mr. Chairman.
    The Chairman. Under the rules of the Committee, the record 
of today's hearing will remain open for 10 days to receive 
additional material and supplementary written requests and 
responses from witnesses to any question posed by a Member of 
this panel. This hearing of the Subcommittee on General Farm 
Commodities and Risk Management is adjourned. Thank you.
    [Whereupon, at 12:56 p.m., the Subcommittee was adjourned.]
    [Material submitted for inclusion in the record follows:]
      
                           Submitted Question
Response from Orice M. Williams, Director, Financial Markets and 
        Community Investment, U.S. Government Accountability Office, 
        Washington, D.C.
Question Submitted By Hon. Hon. Jim Marshall, a Representative in 
        Congress From Georgia
    Question. Please review how the Municipal Gas Authority of Georgia 
(MGA) calculated the $18 million in losses for 2006 that were 
attributed in the futures market because of the trading practices of 
Amaranth Advisors, LLC; and analyze MGA's recommendations for changes 
to the Commodity Futures Trading Commission's (CFTC) oversight 
authority.
    Answer. At the July 12, 2007, House Committee on Agriculture's 
Subcommittee on General Farm Commodities and Risk Management hearing on 
energy-based derivatives, you asked that we (1) review how the 
Municipal Gas Authority of Georgia (MGA) calculated the $18 million in 
losses for 2006 that were attributed in the futures market because of 
the trading practices of Amaranth Advisors, LLC; and (2) analyze MGA's 
recommendations for changes to the Commodity Futures Trading 
Commission's (CFTC) oversight authority. On July 20, 2007, we spoke 
with Arthur Corbin, President and Chief Executive Officer of MGA, and 
Jeff Billings, the head of risk management for MGA. We also reviewed 
data that MGA used to arrive at its $18 million loss estimate.
    According to MGA officials, they estimated the $18 million loss by 
calculating the difference between the prices MGA members paid for 
futures contracts and what members would have actually paid for natural 
gas in the physical markets in 2006. This analysis assumed that 
Amaranth's trading was the only factor affecting natural gas prices in 
2006, and did not include the possible effect of other factors such as 
changes in supply and demand or the trading activities of others. MGA 
officials acknowledged that other factors could have also played a role 
in futures prices during this period. As we testified, the factors 
affecting energy prices, including natural gas are complex and 
attributing a change in prices to any one fact is difficult. Therefore, 
we are unable to make any specific conclusions based on this analysis.
    MGA recommended that CFTC have the same oversight authority over 
all markets that trade derivatives in energy. Specifically, they noted 
that even though off-exchange transactions lack the requirement for 
physical delivery of exchange-traded contracts, the absence of the 
requirement does not preclude a trader from manipulating commodity 
prices. Further, they said that without a complete picture of trading 
in all of the energy markets, particularly by large traders, CFTC can 
not adequately protect consumers from artificial prices. They also 
noted that CFTC's special call authority, while helpful, does not 
provide for routine monitoring and oversight of trading in natural gas 
derivatives; and that CFTC's authority to expose manipulative behavior 
after it occurs does little good because, as they said, contract prices 
already would have been affected. The issues raised are consistent with 
those raised by others who support greater CFTC authority over certain 
derivatives markets. Given the growth in energy trading in the exempt 
and over-the-counter markets, further debate and analysis is warranted 
including whether CFTC's current authority is sufficient in light of 
recent events.

                                  
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