[Senate Hearing 110-705]
[From the U.S. Government Publishing Office]




                                                        S. Hrg. 110-705
 
                    HIGH PRICE OF COMMODITIES--2008

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

                                HEARINGS

                               before the

                              COMMITTEE ON
               HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               ----------                              

                              MAY 7, 2008
                            FUEL SUBSIDIES:
             IS THERE AN IMPACT ON FOOD SUPPLY AND PRICES?

                               ----------                              

                              MAY 20, 2008
              FINANCIAL SPECULATION IN COMMODITY MARKETS:
              ARE INSTITUTIONAL INVESTORS AND HEDGE FUNDS
            CONTRIBUTING TO FOOD AND ENERGY PRICE INFLATION?

                               ----------                              

                             JUNE 24, 2008
 ENDING EXCESSIVE SPECULATION IN COMMODITY MARKETS: LEGISLATIVE OPTIONS

                               ----------                              

       Available via http://www.gpoaccess.gov/congress/index.html

                       Printed for the use of the
        Committee on Homeland Security and Governmental Affairs




                                                        S. Hrg. 110-705

                    HIGH PRICE OF COMMODITIES--2008

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

                                HEARINGS

                               before the

                              COMMITTEE ON
               HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 7, 2008
                            FUEL SUBSIDIES:
             IS THERE AN IMPACT ON FOOD SUPPLY AND PRICES?

                               __________

                              MAY 20, 2008
              FINANCIAL SPECULATION IN COMMODITY MARKETS:
              ARE INSTITUTIONAL INVESTORS AND HEDGE FUNDS
            CONTRIBUTING TO FOOD AND ENERGY PRICE INFLATION?

                               __________

                             JUNE 24, 2008
 ENDING EXCESSIVE SPECULATION IN COMMODITY MARKETS: LEGISLATIVE OPTIONS

                               __________

       Available via http://www.gpoaccess.gov/congress/index.html

                       Printed for the use of the
        Committee on Homeland Security and Governmental Affairs





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20402-0001




        COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS

               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 SUSAN M. COLLINS, Maine
DANIEL K. AKAKA, Hawaii              TED STEVENS, Alaska
THOMAS R. CARPER, Delaware           GEORGE V. VOINOVICH, Ohio
MARK L. PRYOR, Arkansas              NORM COLEMAN, Minnesota
MARY L. LANDRIEU, Louisiana          TOM COBURN, Oklahoma
BARACK OBAMA, Illinois               PETE V. DOMENICI, New Mexico
CLAIRE McCASKILL, Missouri           JOHN WARNER, Virginia
JON TESTER, Montana                  JOHN E. SUNUNU, New Hampshire

                  Michael L. Alexander, Staff Director
  Ryan McCormick, Legislative Assistant, Office of Senator Joseph I. 
                               Lieberman
       Ellen Cohen, Fellow, Office of Senator Joseph I. Lieberman
                Seamus A. Hughes, Deputy Press Secretary
     Brandon L. Milhorn, Minority Staff Director and Chief Counsel
                    Asha A. Mathew, Minority Counsel
           Clark T. Irwin, Minority Professional Staff Member
           Amy B. Carroll, Minority Professional Staff Member
                  Trina Driessnack Tyrer, Chief Clerk
         Patricia R. Hogan, Publications Clerk and GPO Detailee
                    Laura W. Kilbride, Hearing Clerk












                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Lieberman.......................................  1, 31, 75
    Senator Collins.........................................  3, 33, 77
    Senator Carper.........................................  4, 65, 111
    Senator Sununu...............................................    22
    Senator Coburn.............................................  24, 54
    Senator Levin..............................................  36, 99
    Senator Pryor................................................    58
    Senator McCaskill.........................................  63, 105
    Senator Coleman..............................................   102
    Senator Warner...............................................   108
Prepared statement:
    Senator Lieberman for May 7 hearing..........................   119
    Senator Collins for May 7 hearing............................   120
    Senator McCaskill for May 7 hearing..........................   121
    Senator Stevens for June 24 hearing..........................   122

                               WITNESSES
                         Wednesday, May 7, 2008

Andrew Siegel, Vice President and Treasurer, When Pigs Fly, Inc..     5
Bruce A. Babcock, Ph.D., Director, Center for Agricultural and 
  Rural Development, Iowa State University.......................     6
Rev. David Beckmann, President, Bread for the World..............    10
Mark W. Rosegrant, Ph.D., Director, Environment and Production 
  Technology Division, International Food Policy Research 
  Institute......................................................    12

                         Tuesday, May 20, 2008

Jeffrey H. Harris, Chief Economist, U.S. Commodity Futures 
  Trading Commission.............................................    37
Michael W. Masters, Managing Member and Portfolio Manager, 
  Masters Capital Management, LLC................................    40
Thomas J. Erickson, Chairman, Commodity Markets Council..........    43
Benn Steil, Ph.D., Senior Fellow and Director of International 
  Economics, Council on Foreign Relations........................    46
Tom Buis, President, National Farmers Union......................    48

                         Tuesday, June 24, 2008

Hon. Walter L. Lukken, Acting Chairman, U.S. Commodity Futures 
  Trading Commission.............................................    79
Hon. James E. Newsome, President and Chief Executive Officer, 
  NYMEX Holdings, Inc............................................    83
Michael W. Masters, Managing Member and Portfolio Manager, 
  Masters Capital Management, LLC................................    85
William F. Quinn, Chairman, Committee on Investment of Employee 
  Benefit Assets.................................................    88
James J. Angel, Ph.D., CFA, Associate Professor of Finance, 
  McDonough School of Business, Georgetown University............    90
Michael Greenberger, Professor, School of Law, University of 
  Maryland.......................................................    92

                     Alphabetical List of Witnesses

Angel, James J., Ph.D., CFA:
    Testimony....................................................    90
    Prepared statement...........................................   268
Babcock, Bruce A., Ph.D.:
    Testimony....................................................     6
    Prepared statement with an attachment........................   156
Beckmann, Rev. David:
    Testimony....................................................    10
    Prepared statement...........................................   162
Buis, Tom:
    Testimony....................................................    48
    Prepared statement...........................................   219
Erickson, Thomas J.:
    Testimony....................................................    43
    Prepared statement...........................................   208
Greenberger, Michael:
    Testimony....................................................    92
    Prepared statement...........................................   278
Harris, Jeffrey H.:
    Testimony....................................................    37
    Prepared statement...........................................   170
Lukken, Hon. Walter L.:
    Testimony....................................................    79
    Prepared statement...........................................   222
Masters, Michael W.:
    Testimony on May 20..........................................    40
    Prepared statement with an attachment........................   191
    Testimony on June 24.........................................    85
    Prepared statement...........................................   246
Newsome, Hon. James E.:
    Testimony....................................................    83
    Prepared statement...........................................   232
Quinn, William F.:
    Testimony....................................................    88
    Prepared statement...........................................   264
Rosegrant, Mark W., Ph.D.:
    Testimony....................................................    12
    Prepared statement...........................................   166
Siegel, Andrew:
    Testimony....................................................     5
    Prepared statement...........................................   153
Steil, Benn, Ph.D.:
    Testimony....................................................    46
    Prepared statement...........................................   212

                                APPENDIX

Charts submitted by Senator Collins..............................   124
General Motors Press Releases submitted by Senator Carper........   128
Charts submitted by Senator Levin................................   134
Charts submitted for the Record by Mr. Masters...................   137
Charts submitted for the Record by Mr. Lukken....................   139
Joint Analysis prepared by Majority and Minority Staffs of the 
  Permanent Subcommittee on Investigations.......................   142
Additional prepared statements submitted for the Record from:
    American Farm Bureau Federation..............................   289
    Governor M. Jodi Rell, State of Connecticut..................   299
    American Cotton Shippers Association.........................   306
    National Grain and Feed Association..........................   314
    American Benefits Council....................................   321
    Council of Institutional Investors...........................   324
    IntercontintentalExchange, Inc. (ICE)........................   326
Responses to Post-Hearing Questions for the Record on May 7 from:
    Mr. Babcock..................................................   332
    Mr. Beckmann.................................................   337
    Mr. Rosegrant................................................   339
Responses to Post-Hearing Questions for the Record on May 20 
  from:
    Mr. Harris...................................................   344
    Mr. Masters..................................................   348
    Mr. Erickson.................................................   349
    Mr. Steil....................................................   351
    Mr. Buis.....................................................   352
Responses to Post-Hearing Questions for the Record on June 24 
  from:
    Mr. Lukken...................................................   353
    Mr. Newsome..................................................   364
    Mr. Masters..................................................   369
    Mr. Greenberger..............................................   371
    Mr. Angel....................................................   382


     FUEL SUBSIDIES: IS THERE AN IMPACT ON FOOD SUPPLY AND PRICES?

                              ----------                              


                         WEDNESDAY, MAY 7, 2008

                                     U.S. Senate,  
                           Committee on Homeland Security  
                                  and Governmental Affairs,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:01 a.m., in 
Room SD-342, Dirksen Senate Office Building, Hon. Joseph I. 
Lieberman, Chairman of the Committee, presiding.
    Present: Senators Lieberman, Carper, Pryor, McCaskill, 
Collins, Coburn, and Sununu.

          OPENING STATEMENT OF CHAIRMAN LIEBERMAN \1\

    Chairman Lieberman. Good morning and welcome to our hearing 
today. This is the first of at least two hearings this 
Committee will hold to examine the current rapid increase in 
the price of food that is occurring here in the United States 
and across the globe, to consider actions the Federal 
Government should take to alleviate the pressure these high 
prices have imposed on America's families and businesses. I 
want to thank Senator Collins for her suggestion that we hold 
these hearings on this issue, which is of such everyday genuine 
concern to so many millions of Americans and people throughout 
the world.
---------------------------------------------------------------------------
    \1\ The prepared statement of Senator Lieberman appears in the 
Appendix on page 119.
---------------------------------------------------------------------------
    The specific issue that we are going to examine today is 
the effect of Federal Government subsidies for ethanol on the 
current food price crisis. Our next hearing will occur within a 
couple of weeks, and on that occasion we will focus on the 
question of whether speculators are driving up commodity 
prices.
    Food prices in the United States rose 4 percent last year 
and are predicted to rise at least 4 percent, perhaps 5 
percent, this year. These are the largest increases in annual 
food prices since 1990, 18 years. Of course, any of these 
increases disproportionately affect people in relation to their 
income. Middle-income families are squeezed, particularly as 
gas prices are also rising at the same time, and other costs, 
like health care, are rising and shrinking disposable income. 
Lower-income consumers are hit hardest because their food 
expenditures make up a larger share of their total household 
expenses.
    Here is an interesting set of numbers, I think. Overall, 
American households spend 12.6 percent of their income on food. 
But low-income households spend 17.1 percent on food. So you 
can see the impact.
    The World Bank reports that global food prices have 
increased 83 percent in the last 3 years. That is a devastating 
rate of inflation. When you apply some of those same statistics 
I mentioned to families abroad, families in Nigeria spend an 
average of 73 percent of their income on food, Vietnamese spend 
65 percent, and Indonesians spend about 50 percent on food.
    When you add in an 83 percent increase over the last 3 
years, you can see why people are suffering. In fact, as we 
know from the news, people have actually already died in food 
riots in, for example, Somalia.
    Bob Zoellick, who is the President of the World Bank, 
recently warned that 33 other countries are not just suffering 
hunger, malnutrition, in some cases starvation, certainly 
stress as a result of the increase in food prices, but that 33 
nations are at risk of societal unrest as a result of the food 
price increase and food shortage, and one billion Asians are at 
risk of hunger or malnutrition.
    There are many explanations of how this crisis came to be 
and it is our intention in this oversight Committee to explore 
the various explanations or suggestions and try to judge the 
merit of them to inform our own legislative behavior. This 
Committee has the unique ability to look across the Federal 
Government to assess the range of policies that influence food 
prices. This is now the Homeland Security and Governmental 
Affairs Committee, but the Governmental Affairs responsibility 
that we have, which is the historic responsibility of the 
Committee, is an oversight Committee not just focused on a 
particular department but on the overall government. That is 
why the questions that we will discuss today, we hope, will 
have the potential to influence debates that will occur on the 
floor of the Senate and the House and at the White House on the 
best way for Congress to respond to this global food crisis.
    In regard to the question we are focusing on, I was 
thinking about the old quote from Pogo, which is a cartoon we 
don't see much anymore, but the famous Pogo quote said, ``We 
have met the enemy and it is us.'' It may be that when it comes 
to ethanol and the increase in corn prices, that we have met 
the problem and we caused it: Not with bad intentions, but as 
everyone knows, in an effort to promote American energy 
independence and help reduce greenhouse gas emissions that are 
causing global warming. Congress has required a five-fold 
increase in renewable fuels, which in turn led to an increase 
in demand for corn and a further decrease in supplies of wheat 
and soybeans as farmland that traditionally was used to grow 
those crops has been converted to the more profitable corn 
crops.
    So our question for this excellent group of witnesses we 
have today is, bottom line, did this change in policy by the 
Federal Government for a good reason cause this bad 
consequence, which is rising food prices, and if it did, to 
what extent is it the cause? Is it the sole cause, or is it a 
minor cause as compared to other causes?
    We hold a lot of hearings in this Committee. This probably 
is as significant as any we have ever done to more people in 
the world and the way they live every day. So again, in 
introducing Senator Collins to deliver her opening statement, I 
want to thank her for being the impetus to this series of 
hearings that we begin today.
    Senator Collins.

           PREPARED STATEMENT OF SENATOR COLLINS \1\

    Senator Collins. Thank you, Mr. Chairman, and thank you so 
much for agreeing to look into this important issue.
---------------------------------------------------------------------------
    \1\ The prepared statement of Senator Collins appears in the 
Appendix on page 120.
---------------------------------------------------------------------------
    Today, we consider whether a change in American 
agricultural policy that was aimed at reducing our reliance on 
imported oil may instead be having serious unintended 
consequences for food supplies and prices. According to the 
World Bank, as the Chairman has indicated, global food prices 
have increased by 83 percent in the past 3 years. Here in the 
United States, as the chart before you shows,\2\ an analysis of 
April 2008 prices shows an even more remarkable one-year trend 
of increases. Wheat, for example, is up by 95 percent. Soybeans 
are up by 83 percent. Corn, up by 66 percent. And oats, up by 
47 percent.
---------------------------------------------------------------------------
    \2\ The charts submitted by Senator Collins appear in the Appendix 
on page 124.
---------------------------------------------------------------------------
    Such increases in basic commodities naturally work 
themselves through the food supply chain. According to the U.S. 
Department of Agriculture (USDA), consumer prices for all foods 
increased by 4 percent last year, and as the Chairman pointed 
out, that is the highest annual rate increase since 1990. 
Furthermore, the Department projects continued increases.
    The consequences have reached far beyond data cells on some 
spreadsheet. They affect families who are forced to cut back on 
bread, meat, and dairy purchases and to apply their economic 
stimulus checks to their grocery bills. The nutritional threat, 
especially to very low-income families with children, or to 
senior citizens living on fixed incomes, is clear. The high 
prices and shortages also hurt small businesses, like a Maine 
family bakery, whose future is less secure due to escalating 
costs.
    The global consequences are also grim. As the Chairman 
indicated, the President of the World Bank has identified some 
33 countries around the world that face potential social unrest 
because of the enormous hike in food and energy prices. For 
these countries where the consumption of food comprises half to 
three-quarters of all the consumption, there is literally no 
margin for survival. The impact of rising prices, food 
shortages, and export restrictions has had devastating 
consequences for the billion people around the world who live 
in dire poverty.
    We need a clear view of how biofuel prices shape this 
troubling picture. So again, I am so pleased that the Chairman 
has agreed to have the Committee carefully examine this 
important issue.
    Subsidies for ethanol production, tariffs on ethanol 
imports, and mandates for ethanol use have certainly had an 
impact on the U.S. corn crop. In 1997, as this chart 
demonstrates, only 5 percent of the corn harvest was used for 
ethanol production. That portion grew to 20 percent of the 2006 
harvest. The Department of Agriculture estimates that 24 
percent of last year's corn crop is being used for ethanol and 
that ethanol's claim on the 2008 harvest will climb to 33 
percent. So just look at that astonishing change, from 5 
percent in 1997 to a third of the corn crop next year being 
diverted to ethanol.
    Not surprisingly, increased demand for corn-based ethanol 
has diverted acreage from crops like wheat and soybeans to corn 
and has had ripple effects on the cost of feed for livestock. 
The USDA's long-term projections released in February note that 
the strong expansion of corn-based ethanol production affects 
virtually every aspect of the field crop sector, from domestic 
demand and exports to prices and allocation of acreage among 
crops. After 2008, the USDA believes that the high returns for 
corn crops will lead to still further reductions in wheat and 
soybean planting. As our witness from Maine, who runs a family 
bakery, will attest, such changes in the use of distant crop 
lands can have profound local effects.
    Certainly, American and European policies that promote corn 
or other food crops for ethanol are not the only factors in the 
sharp increase in food prices. Other factors include higher 
food demand in developing countries, higher energy and 
fertilizer costs, and weather events, like the drought in 
Australia. But most of those factors are beyond the control of 
mankind, much less governments. By contrast, however, biofuel 
subsidies and mandates are within the control of government and 
the International Food Policy Research Institute estimates 
that, globally, biofuels development may account for a quarter 
to a third of the increased costs of food.
    Therefore, it is incumbent upon us to examine the impact 
that American biofuel policy is having on the global food 
crisis and whether our policy needs to be adjusted to mitigate 
the unintended consequences in the United States and elsewhere. 
This is not an abstract matter of public policy. It affects the 
poorest people in our country and around the world. It affects 
our bakeries, our markets, our restaurants, and our family 
kitchens here and around the world.
    I look forward to hearing today's witnesses and to 
obtaining their assistance in helping us better understand the 
trade-offs inherent in our current biofuels policy.
    Thank you, Mr. Chairman.
    Chairman Lieberman. Thanks, Senator Collins, for that 
excellent statement. Your graphs and your statement really made 
the case for why this hearing is so important.
    Senator Carper has asked to be recognized to make a 
statement.

              OPENING STATEMENT OF SENATOR CARPER

    Senator Carper. Just very briefly. I know we don't do 
opening statements beyond you and the Ranking Member. Thank you 
for doing this. This is a great hearing, timely and very 
important.
    I met with some folks from General Motors (GM) this week 
and they shared with me that they have taken an equity position 
in two companies, brand new, very promising technology with 
respect to creating biofuels in a way that provides a lot more 
energy density, in a way that uses a whole lot less water to 
create, and it is just some very promising ideas. There is a 
lot of cutting edge stuff that is going on like this at the 
DuPont Company, as you may recall.
    I would just ask unanimous consent to be able to include in 
the record at this point some information, press reports that 
deal with these encouraging developments. Thank you.\1\
---------------------------------------------------------------------------
    \1\ The General Motors Press Releases submitted by Senator Carper 
appear in the Appendix on page 128.
---------------------------------------------------------------------------
    Chairman Lieberman. Thank you, Senator Carper. Without 
objection, we will do that.
    We will go to the witnesses, and our first witness is 
Andrew Siegel, who is the owner of the When Pigs Fly Bakery in 
York, Maine. We have asked Dr. Siegel to discuss how rapidly 
rising commodity prices have negatively impacted his business, 
but before you do that, we all want to know what the other part 
of the sentence is. When Pigs Fly, what? [Laughter.]
    Mr. Siegel. The other part was, you will be paying your 
bills when pigs fly by baking loaves of bread.
    Chairman Lieberman. Go right ahead.

 TESTIMONY OF ANDREW SIEGEL,\2\ VICE PRESIDENT AND TREASURER, 
                      WHEN PIGS FLY, INC.

    Mr. Siegel. Good morning. I am here actually to tell my 
brief story. I do own When Pigs Fly Bakery with my brother and 
it is 15 years old. We started out in the beginning baking 
about 100 loaves of bread a day and selling them to a few local 
accounts. Currently, we deliver bread to approximately 250 
supermarkets in Maine, New Hampshire, Massachusetts. We have 
some presence in Connecticut, Rhode Island, New York, and New 
Jersey. We have also opened five of our company stores where we 
deliver bread fresh 7 days a week, and we also have an Internet 
Website where people can order bread throughout the country.
---------------------------------------------------------------------------
    \2\ The prepared statement of Mr. Siegel appears in the Appendix on 
page 153.
---------------------------------------------------------------------------
    What has happened actually from 1993 all the way up until 
current, there are a lot of challenges with running any kind of 
business. The challenges that we face are pretty much how to 
make a quality product and get it to our customers at a 
reasonable price, and the dynamics of that have changed 
significantly in the last probably year and a half.
    Over the past 18 months, prices of every food product have 
increased anywhere in the neighborhood of 50 to 100 percent, 
and owning a bakery, because we use flour as our main 
ingredient, we have really felt the brunt there. But we also 
bake with propane. We deliver our bread in diesel trucks and 
gas trucks. And the breads themselves have lots of fruits, 
seeds, and nuts, and again, prices have increased 
significantly.
    Back in September, our price of flour--we go through 
probably about 50,000 pounds of flour a week right now, so in 
dollar terms, the flour was costing us $7,700 a week. In 
October, it had risen to about $9,600 a week. And then December 
came along and it went to over $12,000 a week.
    I talked to our flour distributor and he had mentioned what 
he thought some of the concerns were, ethanol being one, and 
also some other items, but he said that there is a good chance 
that we might not have enough flour to get through until the 
next crop comes in, and that is when things got really crazy.
    I think the first chart had shown that by the end of April, 
wheat was up 99 percent, and in February at one point, it was 
up 300 percent. There were a lot of rumors flying around. We 
ended up buying our flour upwards of about $22,000 per 
truckload all the way from $7,000, and what has that done for 
us? I mean, we have actually gone out and we have raised our 
prices. People in the bakery, they work very hard and nobody is 
getting raises. They are all feeling the brunt because they 
have to go to the supermarket and pay higher prices for all 
their food. So it seems like everybody is getting squeezed in 
every area.
    My concern is that at this point, we are going to survive 
what is going on right now. I am more concerned about what is 
going to happen next year. It seems that the weather has had an 
impact. China has had an impact. I think you had mentioned that 
there are going to be some upcoming hearings on commodities 
markets and how their trading might have an impact.
    I know in our business, we have lots of decisions to make 
every day. The decisions that we make are really based on what 
can we or what can't we control. If we can't control it, then 
it is out of our hands. But if we can control it, then we take 
a good hard look at it, and I think that the ethanol is a 
factor in the increasing food and wheat prices. So why not 
reconsider it?
    Why not take a look maybe and my thought is we put it in a 
little micro environment and perfect it so maybe we can go and 
do the switchgrass and produce ethanol through water, and then 
once we have that technology perfected, we can move into those 
areas, because in my own business, I would never go out and 
bake a bread that I wasn't sure was good and bake it on a large 
scale and put it out in every supermarket just to have it fail. 
I would test it, and if I did go out and it got to the point 
where it went full scale and it still wasn't successful, then I 
would reconsider what I had done.
    Chairman Lieberman. Thanks, Dr. Siegel. That was both 
compelling and very sensible, so I appreciate that very real 
description of how increasing commodity prices are affecting 
your business and your customers and your workers.
    Bruce Babcock is an agro-economist from Iowa State 
University and we welcome you today. Actually, it is a nice 
sequence here, because from your perspective, we hope you can 
in some ways help not only us, but Dr. Siegel understand what 
the causes of those food price increases for him are. Dr. 
Babcock.

 TESTIMONY OF BRUCE A. BABCOCK, PH.D.,\1\ DIRECTOR, CENTER FOR 
   AGRICULTURAL AND RURAL DEVELOPMENT, IOWA STATE UNIVERSITY

    Mr. Babcock. Thank you, Mr. Chairman and Senator Collins, 
for the opportunity to participate in today's hearing and to 
share my thoughts on the role that Federal policies play in 
affecting the amount of corn ethanol that we produce and the 
impact these policies have on crop and food prices.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Babcock with an attachment 
appears in the Appendix on page 156.
---------------------------------------------------------------------------
    Many people are confused about the impact of Federal 
ethanol policies. Much of this confusion is caused by people 
assuming that because government support was instrumental in 
bringing forth the ethanol industry, that a withdrawal of that 
support would get us back to a time when prices of corn, 
soybeans, and wheat were less than half of today's levels.
    The additional demand for corn from the ethanol industry 
has been a major factor causing the price of corn to more than 
double in the last 18 months, from $2.50 a bushel to more than 
$6 per bushel. This link between ethanol and corn prices gives 
us insight into the following question. What would happen to 
the price of corn if we were to eliminate the U.S. ethanol 
industry? But this link does not give us any insight into what 
would happen to the price of corn, food, and gasoline if 
current Federal biofuels policies were relaxed or eliminated. 
They are two different questions. We need to recognize that 
U.S. ethanol plants will not simply disappear with a change in 
U.S. ethanol policy. Plants will keep operating as long as it 
makes economic sense for them to do so.
    So the three Federal policies that I want to consider in 
this testimony are the Renewable Fuel Standard (RFS), the 
blenders' tax credit, and the tariff on imported ethanol.
    The RFS specifies minimum biofuels consumption levels for 
the U.S. Mandated use rises from 9 billion gallons in 2008 to 
10.5 billion gallons in 2009. These mandates can be met from 
either domestically produced or imported biofuels.
    The 51-cent-per-gallon blenders' tax credit is a direct 
subsidy given to gasoline blenders. The credit increases the 
willingness of blenders to buy ethanol. This increased demand 
increases the price of ethanol, ethanol profits and production, 
the demand for corn, and the price of corn. The tax credit has 
greatly stimulated the growth of the industry.
    The import tariff is a tax on imported ethanol. It has 
prevented the United States from importing large quantities of 
Brazilian ethanol, except for a short time during 2006 when the 
phase-out of Methyl Teritiary Butyl Ether (MTBE) caused U.S. 
ethanol prices to skyrocket.
    So given the level of concern about current crop prices, I 
first want to examine the short-term impacts of a policy 
change. By short-term, I mean the following: What impact would 
a change in Federal policy have on the supply of ethanol and 
the market price of corn during the period September 1 of this 
year to August 31 of next year? This is the period that 
corresponds to the marketing year for corn and soybeans, so it 
is a logical time period to look at.
    A focus on corn is warranted because it is the crop most 
directly affected by U.S. biofuels policies and it is the crop 
that most determines the impacts on the cost of food because of 
its importance in determining the cost of feeding livestock. My 
graduate student and I have considered a number of different 
policy scenarios, but I want to focus on three today. These 
are: What would happen if we waive the mandates but keep the 
tax credit and the import tariffs? Or we could keep the 
mandates but eliminate the import tariff and the tax credits. 
Or we could eliminate all three. So I want to look at these in 
turn.
    Because both the blenders' tax credit and the mandate 
increase the demand for ethanol, elimination of only one of 
them would have little impact because the other one would 
effectively keep the industry operating at close to capacity. 
Elimination of the mandate would reduce expected ethanol 
production by only about 4 percent. The ethanol price would 
drop by less than 2 percent. Ethanol imports would fall by 18 
percent. And the price of corn wouldn't change.
    Maintenance of the tax credit would keep demand for ethanol 
high and the import tariff would keep imports down. Thus, 
recent calls for an easing of the RFS would do almost nothing 
to reduce food prices or ease the financial pain of the 
livestock industry, at least in the short run.
    The impact of eliminating both the blenders' tax credit and 
the import tariff but keeping the mandate would be somewhat 
larger because increased imports would reduce the amount of 
domestic ethanol that would be needed to meet the mandate. 
Domestic ethanol production would decline by about 11 percent 
and the price of corn would drop about 7 percent, so it is 
something. The impacts of this policy change are not any larger 
because the RFS keeps total demand high and the supply of 
imported ethanol simply is not unlimited.
    A rollback of all ethanol incentives and protection would 
have the largest impacts. Domestic ethanol production would 
drop by 21 percent. The loss of demand subsidies would cause 
the price of ethanol to drop by 18 percent. And the price of 
corn would drop by 13 percent. So that is the biggest impact I 
could find.
    We estimate that the drop in ethanol supply would increase 
gasoline pump prices by about four cents per gallon. That is, 
the expanded ethanol actually is keeping gas prices down a 
little bit.
    The livestock industry has been hard hit by the run-up in 
feed costs, but high gasoline prices combined with existing 
ethanol plants means that corn prices in the near term will 
remain well above historical levels, even if the RFS, the 
blenders' tax credit, and the import tariff were all 
eliminated. This is not to say, however, that a 13 percent drop 
in corn prices would not help livestock producers and to a 
lesser extent reduce food prices. A 13 percent drop in corn 
prices would reduce the cost of feeding beef cattle by about 5 
percent of revenue, hogs by about 7 percent of revenue, 
chickens by 4 percent, dairy cattle by 3 percent. This drop in 
production costs would eventually translate into consumer 
prices that would be a bit lower than they otherwise would be.
    The longer-term impact of a change in Federal biofuels 
policy depends crucially on what the price of crude oil is 
going to be. If we were to eliminate all Federal biofuels 
policies today and future crude oil prices support wholesale 
gasoline prices of about $3 a gallon, then we are looking at 
about $4 corn, and actually, the ethanol industry would expand 
just from profit incentive. A return of wholesale gasoline 
prices to $2--we should be so lucky--would keep ethanol 
production at about where we are today, maybe a little higher, 
and corn prices would fall substantially, to $3.60 a bushel. In 
contrast, if we move to $4 gasoline, corn prices won't fall 
below $5 and the ethanol industry will expand to take advantage 
of the market opportunities.
    The long-term results reveal two general findings. First, 
corn prices and gasoline prices are now inextricably linked 
through existing ethanol plants and the knowledge of how to 
efficiently convert corn to transportation fuel. This link will 
not be broken unless corn industry production is somehow 
capped. A return to inexpensive feed is simply not going to 
occur unless crude oil prices dramatically fall and biofuels 
policy is substantially changed.
    Second, in the long-run, if gasoline prices rise even 
higher and signal that we need alternative fuel, the corn 
ethanol industry will expand even beyond what we project today.
    I would like to now turn to the impact of policy on the 
prices of other crops and food. Expansion of corn use implies a 
cutback in planted acreage and higher prices for other crops. 
Soybeans are the crop most affected by competition for land. 
Wheat is affected by a much smaller amount. U.S. rice acreage 
is largely unaffected by corn prices because corn and rice are 
grown in different regions and it takes a fairly large 
incentive to move rice producers away from rice. The direct 
link that many people have made between U.S. biofuel subsidies 
and world rice prices is difficult to find.
    With regards to food prices, we must remember that to a 
large extent, Americans do not eat agricultural commodities. 
Rather, we eat food manufactured from these commodities. My 
colleagues and I estimated that a 30 percent change in the 
price of corn along with corresponding changes in the prices of 
other crops would change home food expenditures by about 1.3 
percent.
    As I have discussed, altering U.S. biofuels policies will 
change the price of corn by much less than 30 percent, which 
suggests that changing Federal biofuels policies will not 
dramatically affect the price that Americans will pay for food. 
In the longer run, the price of corn and food will be 
determined largely by the price of crude oil.
    Because the United States is a major exporter of corn, 
soybeans, wheat, and rice, a change in biofuels policies that 
does affect U.S. prices will also affect international prices. 
Again, corn and soybean prices are the ones most affected by a 
change in Federal policy. Wheat prices would be affected less. 
Rice prices would be largely unaffected.
    Some may be skeptical of my small estimates of the effects 
of a change in Federal biofuels policies because of the huge 
run-up in wheat, rice, and feed costs over the last 18 months. 
But again, I have not tried to determine the impact of the 
elimination of the ethanol industry on commodity prices. That 
impact is large. Rather, I am asking what would be the impact 
on these commodity prices from a change in Federal biofuels 
policies given that we are well on our way to having 11 billion 
gallons of ethanol capacity in this country and that markets 
expect high gasoline prices for the foreseeable future. The 
combination of in-place capacity and high-priced gasoline 
implies modest impacts of a change in policy.
    In conclusion, there is no doubt that the growth of the 
ethanol industry is an important factor in the run-up in corn 
and soybean prices, but this does not imply that a change in 
Federal biofuels policy would reverse this and make these 
prices go substantially lower. If we continue to see crude oil 
prices in excess of $100 per barrel, then there is little that 
the Congress or EPA can do in the short run to significantly 
reduce the price of corn short of an outright ban on producing 
ethanol from corn. Thank you.
    Chairman Lieberman. Very provocative testimony, so I look 
forward to the question period. Thanks, Dr. Babcock.
    Next is Rev. David Beckmann, President of Bread for the 
World, an organization that works to diminish, and, hopefully, 
end world hunger. We have asked Rev. Beckmann to testify today 
about how rapidly rising food prices have led to a global food 
crisis.
    Thanks so much for your work and thanks for being here.

 TESTIMONY OF REV. DAVID BECKMANN,\1\ PRESIDENT, BREAD FOR THE 
                             WORLD

    Mr. Beckmann. Mr. Chairman, Ranking Member, and 
distinguished Members of the Committee, I really appreciate 
your focus on this issue and the chance to speak. Bread for the 
World is a Christian advocacy organization that focuses on 
hunger in our country and around the world.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Beckmann appears in the Appendix 
on page 162.
---------------------------------------------------------------------------
    We haven't traditionally done much work on biofuels policy, 
but like you, we are, in fact, alarmed by the dramatic increase 
in world hunger in just the last year, and hunger and poverty 
are increasing in our own country right now. So we are 
grappling with the biofuel issues in the same way that this 
Committee is and I am glad to have a chance to talk with you 
about how we are thinking about it.
    I think I should focus first just on hunger in the world, 
hunger in our own country, what we think Congress can do about 
it, and then the role of biofuels and biofuels policy in that 
picture.
    The increase in world hunger, as Senator Lieberman and 
Senator Collins both discussed, has just been alarming. The 
world has been making progress against poverty, but this sudden 
and unexpected run-up in food prices, especially commodity 
prices, has reversed the progress against hunger and poverty.
    The commodity prices are the killer because the futures 
prices for the basic commodities--wheat, corn, and rice--have 
all shot up by something like two-thirds over the last 12 
months and poor people in developing countries spend the bulk 
of their income on a commodity. So they don't buy corn flakes. 
They go and they buy corn and they grind it up, or they buy 
rice and they put a little vegetable and salt with it. And that 
food is maybe 75 percent of their income, and rice or wheat or 
corn is 75 percent of that. So it is the rapid run-up in 
commodity prices that are killing children in developing 
countries and causing riots in many countries.
    That is caused by various factors, as others said, by crop 
failures in some places, by increasing incomes in Asia. That is 
the good news. A lot of Asians are eating better. They are 
eating more and they are eating a little bit of meat. That 
drives up commodity prices in the world. The high fuel prices 
are part of it. And then the shift to biofuels is part of it.
    Estimates vary on how much of the cause is the shift to 
biofuels. So the International Food Policy Research Institute 
(IFPRI) says 25 to 30 percent, according to their model. The 
Food and Agricultural Organization says 15 to 20 percent. That 
seems kind of vaguely consistent with what Dr. Babcock found 
from the way he worked at it. Administration officials last 
Thursday, when the President announced a request for additional 
food aid and agricultural development assistance, estimated 
that the increase in corn-based industry accounts for only 2 to 
3 percent in the increase in global food prices.
    So the extent to which biofuels are driving up food prices 
is controversial, and I take Dr. Babcock's point that the 
increase in biofuel production is not only driven by policy. I 
think what is incontrovertible is that the shift to biofuels, 
and especially corn-based ethanol, has helped to drive up 
commodity prices and there is a direct and immediate link 
between higher commodity prices and the increase in world 
hunger.
    In our own country, too, hunger and poverty are on the 
increase. We have seen increases in poverty in this country 
since the year 2000. So even in good economic times, poverty 
has slightly increased in our country. Right now, low-income 
people are being buffeted by a number of things. Higher food 
prices is one factor, not the kind of dramatic increases in 
food prices that poor people in developing countries are 
seeing, but a significant increase in food prices, especially 
for those foods where the commodity is a big part of the food 
cost.
    So locally baked bread has increased more in price, as 
opposed to bread that is shipped from Timbuktu or someplace, 
because the wheat is a big part, or milk, or eggs. The price of 
eggs has gone up 29 percent because chickens are fed mostly 
corn. So we have seen some increase in food prices, especially 
rapid increases in those that have big portions of commodity in 
them. But as Dr. Babcock says, mostly what we buy in the 
grocery store is not commodities. We pay for the marketing, 
processing, and transportation.
    What is also hitting poor people in this country is higher 
fuel prices directly. They have to fill their gas tank. They 
have to heat their house. Unemployment has gone up somewhat. 
The credit market has tightened. So we know that hunger is 
increasing. We know it mainly because if you go to any food 
pantry, any food bank in the country, they are swamped with 
people coming in who are in need.
    Now, how to respond to that. The two main things that need 
to happen are, first, we need to increase food assistance to 
people and other kinds of assistance to people who are hungry, 
and then we also need to have a more dynamic, responsive 
agriculture.
    On the food side, the Food, Conservation, and Energy Act of 
2008 (farm bill) is the immediate way to deal with this, and I 
am pleased the conferees have agreed on a $10.4 billion 
increase in food assistance. But they just a few days ago 
killed the House's proposal for an $800 million increase in the 
McGovern-Dole International School Feeding Initiative. That 
doesn't make sense.
    Within the farm bill, you can also get more food to hungry 
people overseas by reforming food aid, because more than half 
of our food aid dollars go to a handful of shipping companies. 
So you can reform food aid in the ways that President Bush has 
suggested and you get a lot more food to hungry people in a 
hurry.
    The farm part of the farm bill is also important because 
the United States should be providing leadership for a dynamic, 
efficient, responsive global agriculture. It is global 
agriculture that can bring down food prices again. But in fact, 
what the world has is a nation-by-nation, highly-managed, 
highly-protectionist agriculture. Many developing countries 
have slapped on food export limitations. But we are in no 
position to preach to them because our agriculture is also 
highly managed and protectionist.
    And the President is right to insist that Congress take a 
turn, set a new direction in farm policy, and make it clear 
that the future of global agriculture is not big subsidies to 
wealthy landowners. So with the reforms in the farm bill, I 
hope the Congress gets that job done. We need a farm bill 
desperately. We need a better farm bill. But reform in the 
agricultural part of the farm bill would also be a way to 
address the global hunger crisis.
    Finally, on the biofuels issue, I don't think that the 
arguments for the mandates and subsidies and the tariffs are 
very strong. I think it is another example of the power of 
special interest politics. The environmental and the economic 
arguments, I don't find convincing. And the increase in hunger 
is cause, I think, to reconsider. It is not just the next 12 
months we are thinking about. The mandates would increase 
demand for corn-based ethanol over the coming years. So it 
seems to me there is cause to reconsider here.
    Now, the ethanol plants and ethanol production have 
revivified a lot of struggling rural communities. So this isn't 
simple. People have changed their lives. They made investment 
decisions, including a lot of poor people, and you can't just 
turn around the next year and say, well, we are headed in a 
different direction. But it seems to me that nobody expected 
this sudden increase in food prices. Certainly nobody wants to 
see lots of people going hungry. So I think it is right that 
you are asking the question whether we could modify, slow down, 
or reconsider our biofuels policy.
    The connection to domestic hunger is not a very strong 
connection as far as I can see. It is one factor. That poor 
family also has to pay 30 percent more for eggs than last year. 
But it is the connection to world hunger that is clearest, that 
you have a lot of babies dying in developing countries, and our 
switch to biofuels has been one factor in making that happen.
    Chairman Lieberman. Thanks very much, Rev. Beckmann. Very 
compelling testimony. Straight talk. We will have some 
questions for you.
    Our final witness is Mark Rosegrant, who is Director of the 
Environment and Production Technology Division of the 
International Food Policy Research Institute. Among other 
things, we have asked Dr. Rosegrant to discuss the impact of 
global biofuels policies on food prices. Thank you for being 
here.

TESTIMONY OF MARK W. ROSEGRANT, PH.D.,\1\ DIRECTOR, ENVIRONMENT 
 AND PRODUCTION TECHNOLOGY DIVISION, INTERNATIONAL FOOD POLICY 
                       RESEARCH INSTITUTE

    Mr. Rosegrant. Thank you very much, and thank you for the 
opportunity to be here today. As we have already heard, the 
recent dramatic increases in food prices are having severe 
consequences for poor countries and poor people around the 
world. Food prices rose by nearly 40 percent in 2007 and 
another 40 percent, as we saw earlier, in early 2008. Nearly 
all agricultural commodities, including rice, corn (or maize as 
it is called internationally), wheat, meat, and soybeans have 
been affected.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Rosegrant appears in the Appendix 
on page 166.
---------------------------------------------------------------------------
    In response to these price increases, food riots have 
occurred in many developing countries, including Egypt, Haiti, 
Indonesia, and Senegal. According to the Food and Agricultural 
Organization of the United Nations, 37 countries are now facing 
food crises of various levels of severity.
    The primary triggers that have set off this rapidly-
spiraling food prices are, first of all, as we were discussing 
here, biofuel policies, which as we have heard have led to 
large volumes of food crops being shifted into bioethanol and 
biodiesel production.
    Second, bad weather in key production areas. This has been 
very clear in the case of wheat, where severe droughts in 
Australia and Ukraine resulted in very high increases in prices 
in the last 2 years.
    Third is the higher oil prices, which have contributed to 
increased costs of inputs, such as fertilizer and pesticide, as 
well as transportation and marketing costs in the food sector.
    But on top of these triggers, prices have moved sharply 
upward in the last few months as a result of poor international 
governmental policies, such as the rice export ban in Vietnam 
and import subsidies in India and elsewhere, which have tried 
to protect their own consumers but at the cost of higher prices 
for everyone. These, in turn, as you are going to discuss in a 
future meeting, have led to various types of speculative 
trading and storage behavior in reaction to these kinds of 
policies.
    However, the preconditions for rapidly rising food prices 
stem from underlying long-term trends in food supply and demand 
globally during the past decade and longer. Rapid income growth 
and urbanization in Asia has led to increased demand for wheat, 
meat, milk, oils, and vegetables, and has put very strong 
demand pressure on soybeans, corn, and other coarse grains as 
livestock feed.
    Something that hasn't been noticed as widely is that 
stronger economic growth in Sub-Saharan Africa since the late 
1990s has also significantly increased demand for wheat and 
rice, which are basic staples in Africa.
    On the supply side, long-term underlying factors include 
severe under-investment in agricultural research and technology 
development worldwide and a rural infrastructure, particularly 
irrigation and roads in developing countries, as well as trends 
towards growing scarcity of land and water globally. As a 
result, there has been a long-term and severe decline in 
productivity growth for grains such as corn, rice, wheat, and 
many other crops.
    Let me then take a look specifically at the role of biofuel 
policies in the food price hikes. Rapid increase for demand in 
production of biofuels, and particularly bioethanol from corn 
and sugar cane, has had a number of effects on supply and 
demand systems, with shifts away from producing corn for food 
and also in shifts of soybeans and other crops into corn. 
Interestingly, even rice has been affected by these shifts 
because in Asia and parts of Latin America, second and third 
season, drier season rice, has also been shifting into corn 
prior to the rapid recent run-up in rice prices. These indirect 
demand and supply-side effects on other crops have also caused 
bioethanol production to boost the price of rice and wheat and 
other crops.
    To look more specifically at the impact of biofuel demands 
on food prices, we have done a number of analyses at IFPRI. 
First, we compared actual food price changes since 2000 with a 
counterfactual simulation with lower biofuel demand 
corresponding to the 1990 to 2000 rates of growth in biofuel 
demand.
    Second, we did a couple of forward-looking assessments 
somewhat similar to what Dr. Babcock has presented. First was 
to look at an impact on food prices of a freeze in biofuel 
production from all crops at 2007 levels, and then what would 
happen if there was, in fact, a moratorium on biofuel 
production after 2007. We did these analyses using our impact 
model, which is a global modeling framework that covers supply 
and demand of prices and trade for agricultural commodities for 
115 countries around the world as well as the global totals.
    Turning first to the analysis of price evolution over the 
last 7 years, because again, we compared a simulation of actual 
demand for food crops as biofuel feedstock from 2000 to 2007, 
the scenario looking at the slower growth rates prior to 2007, 
the difference then in these two simulations shows the 
contribution of biofuel demand on price increases. Based on our 
assessment, the increased biofuel demand corresponding to the 
boom since 2000 accounted for about 39 percent of the increase 
in real corn prices and about just over 20 percent of the 
increase in rice prices and wheat prices during that period.
    We then looked at the projected impact of a freeze, what 
would happen if, in fact, crop-based biofuel production were 
frozen at 2007 levels. On this, we projected that by 2010, corn 
prices would decline by about 6 percent and there would be a 14 
percent decline by 2015. So this is somewhat comparable to some 
of the simulations that Dr. Babcock has shown. We also get then 
price reductions for oil crops, cassava, wheat, and sugar, 
about half of the results for corn prices, and the detailed 
results are in my written testimony.
    Then what would happen if instead we actually abolished 
biofuel--a very severe policy of abolishing ethanol production 
from food crops in 2008. This would have more dramatic impacts, 
but again, the result would be a 20 percent drop in the price 
of corn, a 14 percent drop in the price of cassava, 11 percent 
for sugar, 8 percent for wheat, and only about a 4 percent 
decline in the price of rice.
    So in conclusion, we see that there are various pressures 
on international grain markets that have contributed to rapid 
price increases during the past several years and biofuels have 
been just one contributor, but certainly a very important one, 
especially for corn. The slowing growth in grain supplies and 
rapidly growing demand for grain for all uses, including food 
and feed, which had been made worse by recent policy-induced 
distortions, however, are long-term underlying factors that 
cannot be easily reversed. If the world food economy is to meet 
the increased demand for food, feed, and fuel that is being 
driven by rapid economic growth and also to cope with future 
challenges on land use pressures, and we will see soon the 
increasing pressures from climate change, we also have to deal 
with long-term agricultural productivity growth issues.
    Higher food prices have reduced poor people's access to 
food, which has possible long-term and irreversible 
consequences for health, productivity, and well-being, 
particularly if higher prices lead to continued reductions in 
food consumption by infants and preschool children. If the 
current biofuel expansion continues at its rapid levels, there 
can be expected to be a reduction in calorie availability in 
developing countries relative to a slower growth rate in 
biofuels, and you can expect increases in malnourishment in a 
number of countries.
    It is, therefore, important to find ways to keep biofuels 
from worsening the food price crisis, and a reduction in 
mandates or elimination of subsidies for biofuel production 
would contribute to somewhat lower food prices, as we have 
seen. But it is perhaps even more critical to focus on boosting 
agricultural productivity growth and improving investments in 
rural infrastructure in developing countries. These factors 
would continue to drive the future health of the agricultural 
sector and provide the largest role in determining food 
security and human well-being of the world's poorer and more 
vulnerable populations.
    The United States can play a leading role in boosting 
agricultural growth by increasing investment in agricultural 
research and supporting reforms targeted at increased 
productivity on a global basis, and a major program of enhanced 
investment in these areas could put the United States back into 
a very strong moral and practical leadership role in boosting 
agricultural productivity growth and reducing world hunger. 
Thank you.
    Chairman Lieberman. Thanks, Dr. Rosegrant.
    You were an excellent panel. I, for one, learned a lot 
listening to you, so I thank you. Let us do 6-minute rounds 
because we have a number of Senators here.
    Mr. Babcock, let me begin with you. In your testimony, you 
outline expected corn and fuel prices that would result from a 
total repeal of the three ethanol incentives and you graded the 
impact of less comprehensive action. Sometime soon, the Senate 
will vote on the farm bill itself, which would, as I understand 
it now, scale back the blenders' tax credit from 51 cents a 
gallon to 45 cents a gallon. I don't know whether you have 
specifically looked at the impact of that modest reduction on 
corn and fuel prices. If you have, I would be interested. If 
not, based on your research, what would you predict is the 
likely impact? And I suppose a final question is, if you want 
to play the game, if you were a Senator, how would you vote on 
that proposed reduction?
    Mr. Babcock. Yes. In fact, we did run that scenario because 
part of my Center's job is to try to keep track of farm policy 
and the impacts on the price of corn, soybeans, and wheat----
    Chairman Lieberman. Right.
    Mr. Babcock [continuing]. So we actually did run that 
scenario and it had almost no impact on the price of corn. I 
think it went down four cents a bushel or something like that, 
which is consistent with the testimony here that if you took 
off the blenders' credit completely, instead of just six cents, 
it would have a modest effect. So taking off just a little bit 
is going to have a very minor effect, because----
    Chairman Lieberman. Just go back and compare it to what the 
impact--you used the bushel as a standard. If this took off 
four cents a bushel, how about if we go back to your three 
ethanol incentives. How much would that reduce per bushel?
    Mr. Babcock [continuing]. If you took everything off, we 
estimate about 80 cents a bushel.
    Chairman Lieberman. OK.
    Mr. Babcock. So if you keep the mandate in place, a small 
reduction in the blenders' credit doesn't do very much.
    Chairman Lieberman. Right. So how would you vote if your 
name was called in the Senate?
    Mr. Babcock. On that particular issue?
    Chairman Lieberman. Yes.
    Mr. Babcock. It depends on what you are trying to 
accomplish with it.
    Chairman Lieberman. You have to vote aye or nay. 
[Laughter.]
    Mr. Babcock. And there is no change in the import tariff?
    Chairman Lieberman. Well, let us assume that. I don't 
believe there is any change in the import tariff contemplated. 
There may be an amendment--well, of course, if it is a 
conference report, there can't be. But let us just take it 
alone.
    Mr. Babcock. It would be more of a yea if they had an 
import tariff reduction commensurate with the change in the 
blenders' credit.
    Chairman Lieberman. Right. But alone, you would be likely 
to vote nay because the impact would be negligible?
    Mr. Babcock. Right.
    Chairman Lieberman. OK. I squeezed that one out of you. You 
see how hard a job we have. [Laughter.]
    I wish there was a third option--yea, nay, and it depends. 
[Laughter.]
    Because that is true a lot of the time.
    Senator McCaskill. Mr. Chairman, you just have to be 
independent. [Laughter.]
    Chairman Lieberman. Oh, yes. Very good, Senator McCaskill.
    In your testimony, you said, Dr. Babcock, ``unless we have 
a return to $40 or $50 a barrel crude oil, we can expect the 
price of corn to be well above historical levels for the 
foreseeable future, even if all support for corn ethanol were 
eliminated.'' So as policy makers, this puts us in an 
interesting position because that itself argues for the 
development of alternative fuels, not all based on corn, but a 
significant number of which will be based on commodities or raw 
materials which would also presumably have an impact on 
commodity prices. So how do we decide here?
    Mr. Babcock. Well, with high-price gasoline, the markets 
are demanding and hoping for alternative fuels. We know how to 
produce ethanol from sugar cane and from corn----
    Chairman Lieberman. Right.
    Mr. Babcock [continuing]. And so that is what we would do. 
So I think that if we don't want the impacts of taking land 
that can be used to grow food and use it to grow fuel, then we 
need alternatives to food-based transportation fuels. And so 
the investments that the Department of Energy (DOE) is making 
in trying to figure out how to make waste products into 
transportation fuels, how to use corn and wheat residues, maybe 
some perennial grasses that could be grown on land that is not 
suitable for growing food crops, jatropha that can be grown on 
degraded lands, all of those alternatives are being given a 
huge boost by the price of gasoline, but they also could stand 
for some public investment in just figuring out how to do it. 
And so DOE's pilot programs and their investment in research 
centers, I think is the right path.
    Chairman Lieberman. I cannot resist--thank you--saying at 
this point that the climate change bill that Senator Warner and 
I, and many others, will put before the Senate in June also has 
an enormous flow of revenue that derives from the sale of 
credits but will be reinvested in technologies such as the ones 
you are talking about.
    My time is coming to a close, but Rev. Beckmann, I was 
really interested that you want essentially global, not just 
American, but American and other programs of essentially 
protectionism price supports for agriculture that you would say 
are also a significant contributing factor in the increase in 
world food prices and, therefore, the increase in hunger. Do 
you want to talk any more about that?
    Mr. Beckmann. Sure. It just seems to me it is clear that we 
need an economically efficient, responsive, dynamic 
agriculture, and the United States, Europe, and Japan all have 
highly protected agricultures. The developing countries have 
recently put these export restrictions on food which have made 
the immediate problem worse.
    Chairman Lieberman. I assume they did it because of the 
price increases.
    Mr. Beckmann. Well, they are afraid, so like India, they 
put export restrictions on cheap rice----
    Chairman Lieberman. Right.
    Mr. Beckmann [continuing]. Because that is what ordinary 
people eat, but lots of countries have done that, and it has 
made the problem worse. So to have a more dynamic, responsive 
agriculture, it just seems that is going to bring down food 
prices in the medium term, and in particular, as Dr. Rosegrant 
said, it is agriculture in poor countries that is the hope in 
this crisis because there are about 100 million really very 
poor people who have been adversely affected.
    But there are about 600 million people who are equally poor 
who are making their living in agriculture. So I am really 
delighted that the President's supplemental request for 2009 
includes not just food aid, but local purchase for food aid and 
agricultural development through the U.S. Agency for 
International Development (USAID), because if we invest in the 
agricultural productivity of very poor people around the world, 
they can help to bring down food prices for the 100 million, 
but do it in a way that will raise their own livelihood so that 
you will get permanent progress against hunger.
    Chairman Lieberman. Thanks. I appreciate it. Senator 
Collins.
    Senator Collins. Thank you, Mr. Chairman.
    Mr. Siegel, I had a good time visiting your retail store 
yesterday in York and seeing firsthand the enormous variety of 
breads that you produce. I want to make sure that my colleague 
from New Hampshire knows that you sell in New Hampshire, as 
well---- [Laughter.]
    And I am sure he is interested in your testimony, also.
    It is really important that you came today because you are 
helping us understand the actual impact on a small business. I 
would like to go over with you some of the facts of your 
business because I am not sure that it was as clear in your 
quick testimony as it was when we were talking yesterday. So 
first, why don't you tell us how many employees you have.
    Mr. Siegel. We have about 50 employees right now.
    Senator Collins. So you have 50 employees. And am I correct 
that you use some 50,000 pounds of flour a week?
    Mr. Siegel. Fifty-thousand pounds of flour a week, yes.
    Senator Collins. And tell us how much you spent for that 
amount of flour last September.
    Mr. Siegel. Last September, flour was $7,600 a truckload.
    Senator Collins. Seventy-six-hundred dollars. And in 
February, you reached the high point so far, and what did you 
pay in February?
    Mr. Siegel. We actually bought in before the peak. We paid 
$22,000 a truckload.
    Senator Collins. Twenty-two thousand. So your costs in just 
a matter of months have gone from $7,600 for the ingredient 
that you use the most of to $22,000, is that correct?
    Mr. Siegel. That is correct.
    Senator Collins. And what has been the impact on your 
business in terms of pay raises for your employees or plans to 
expand? Has this enormous increase in your costs changed some 
of your plans for your business?
    Mr. Siegel. Well, what it has done is the employees aren't 
getting any pay raises right at the moment. We are a small 
business. For me, I have always had a comfort level in knowing 
what it would cost to make the bread and what it costs to sell 
the bread. The prices increasing has basically put a big 
unknown factor in there because we don't know if they are going 
to keep increasing. Now, the prices have come down from their 
peak of $28,000 a truckload down to--I think today it is 
probably $15,000. For me, being a baker, we didn't know when it 
went to $22,000 and $28,000, it could have gone to $38,000 or 
$40,000 at some point in time. It was just out of control.
    So what has happened with our business is that it is 
actually--we have taken kind of a different stance. We figured 
the only way to combat--we don't have control over the prices, 
so we raise the prices. We do have a lot of customers that 
aren't buying the bread anymore. But we are trying to grow our 
sales. We are just trying to increase, because we think that 
increased sales is the way to combat increased costs, and so we 
are just kind of winging it. We are trying to expand and we are 
going to hope that this will solve the problem.
    Senator Collins. Thank you, and I think that testimony is 
very compelling because it shows the impact not just on your 
business, but the 50 people who work for you whom you are not 
able to give pay raises to because your raw ingredients have 
increased, and that in turn has a ripple effect on their 
ability to purchase a new car, for example, or to buy more food 
for themselves. I think that is an important point.
    I want to go to Dr. Rosegrant and talk to you a little bit 
about the Federal policy. As Dr. Babcock has pointed out, we 
are really talking about three policies on ethanol, the 
subsidies, the mandates, and the tariffs. And it seems to me 
that the combined result of those policies has been to distort 
the market so that food is no longer being used for food. Food 
instead is being used in increasing proportions for fuel.
    Now, there is an alternative and that is cellulosic ethanol 
that doesn't use food. It uses wood chips or fiber or the corn 
stalks rather than the corn itself. Should our policies be 
revised so that instead of having this enormous subsidy, 
restrictive tariffs, and high mandates for corn-based ethanol, 
should we instead be revising those policies to encourage the 
development of cellulosic ethanol?
    Mr. Rosegrant. Yes, I would support a shift in priorities 
along those lines. As Dr. Babcock said, even if you reduce the 
subsidies and remove import tariffs now, the U.S. corn-based 
ethanol industry would not collapse. It would still produce 
significant amounts, but in that case, it would be competing in 
a sense on a level playing field with other sources, other 
parts of the corn industry. So I think a movement away from 
those and a reinvestment of the savings, for example, the 
subsidies, into other types of ethanol could have long-term 
benefits.
    So it is worth noting that even optimistic estimates would 
say that truly commercial cellulosic ethanol is probably 2 to 5 
years away, and pessimists say 10 years, so I think with 
additional science-based funding that lag could be shortened 
and the 2- to 5-year period could come into play. So I think 
greater investment in those fields could have much stronger 
long-term payoffs.
    Senator Collins. Thank you. Mr. Chairman, I know my time 
has expired. An issue that we haven't discussed is the cost to 
the taxpayers of these policies, as well, and whether that 
money could be more profitably invested elsewhere? But I have a 
feeling that perhaps my colleague from Oklahoma may get into 
that issue. [Laughter.]
    Chairman Lieberman. Good question.
    Senator Collins. Thank you, Mr. Chairman.
    Chairman Lieberman. I have that same feeling. Thanks, 
Senator Collins. Senator Carper is next, to be followed by 
Senator Sununu.
    Senator Carper. Mr. Chairman and Senator Collins, thank you 
very much for holding this hearing. This is a wonderful panel, 
illuminating, timely, and enlightening and we are grateful to 
you for your testimony.
    During opening statements, I mentioned, for those of my 
colleagues who just arrived, some news that I heard earlier 
this week that GM has taken, I think, an equity position in a 
couple of firms that are involved in producing biofuels in 
maybe a more cost-effective way. We are going to submit for the 
record some press reports about this, but I just want to share 
with my colleagues and those that are gathered here some of 
what I have learned.
    The investments to produce ethanol by GM and its partners 
suggest there might be ways to make biofuels work without 
having the adverse unintended consequences with respect to the 
environment and with respect to food security and food prices. 
One of the companies that I think GM has partnered with is a 
company called Coskata. And Coskata apparently has developed 
technology to make ethanol from a wide range of products, 
including garbage, automobile tires that are stacking up in our 
States across the country, and plant waste, among others. We 
are told by the folks at Coskata that its design produces 
ethanol for less than a buck a gallon and uses less than a 
gallon of water for a gallon of ethanol. They are going to have 
their first commercial plant up and running by 2011 to make 
anywhere from 50 to 100 million gallons of ethanol, which is 
not a huge amount of ethanol in terms of our overall demand.
    But the reason why I bring it up is to suggest that the 
free enterprise system, the marketplace, and technology can 
help us to address and to provide some good solutions to the 
challenge that we face today. I am encouraged by that and 
hopefully you are, too.
    In terms of the use of better using and better targeting 
Federal dollars, the idea of actually putting Federal dollars 
into that kind of technology, encouraging that technology, 
makes a lot more sense to me and maybe it does to you, as well. 
My colleagues in the Delaware's delegation worked to get an $18 
million Energy Department research grant about 4 years ago to 
go into work going on at the DuPont Experimental Station in 
Wilmington. That money has led to the creation of a fairly 
large pilot operation, a pilot plant now someplace in Iowa with 
a major partner that is going to hopefully get to full-scale 
cellulosic ethanol production in a few years, not 5 or 10 
years, but hopefully sooner than that.
    And also over at DuPont, they have been working on 
something called biobutanol, working on it with BP. There is 
actually a commercial operation selling the product now in 
Great Britain. Biobutanol has better energy density than 
ethanol. Biobutanol apparently travels in pipelines. Ethanol 
does not. Biobutanol mixes better with gasoline than 
traditional ethanol. So there are solutions on the way and my 
hope is that what we will do is be smart enough to figure out 
how to put our scarce Federal tax dollars into nurturing those 
kinds of technologies.
    That was a long statement. Dr. Babcock, you and Dr. 
Rosegrant talked, as I recall, about the effect and shared with 
us some numbers about the effect on corn prices and ethanol. 
But you talked about eliminating the blenders' tax credit, 
eliminating the import tariff, eliminating the ethanol mandate, 
and I think you both had numbers to share with us as to the 
consequences of doing that. Just explain again what you said. 
It sounds like you are pretty close together. But just say it 
to us again, please. The consequences of eliminating the 
blenders' tax credit, the import tariff, eliminating the 
ethanol mandate. What are the consequences?
    Mr. Babcock. My testimony is that if you eliminated all 
three of them, that it would drop the price of corn by about 80 
cents a bushel. It would increase the price of gasoline by 
about four cents a gallon because the ethanol supply would 
drop. So there is a trade-off there.
    If you eliminate them piecemeal, the effects are much 
lower. So if you just get rid of the blenders' credit, then the 
RFS kicks in. If you get rid of the RFS, the blenders' credit 
keeps things operating at capacity. So the maximum--and I am 
thinking short-run--of 80 cents.
    Senator Carper. All right. And Dr. Rosegrant, my 
recollection is you----
    Senator Collins. Senator Carper, could I just interrupt on 
that point? I think it is important that you get the percentage 
of the increase because 80 cents sounds very small to us.
    Senator Carper. Is it 13 percent?
    Mr. Babcock. Thirteen percent.
    Senator Collins. I just wanted to clarify that point.
    Senator Carper. Sure. Thank you. Dr. Rosegrant.
    Mr. Rosegrant. I think the closest analysis that we did to 
what Dr. Babcock said was--we didn't look explicitly at the 
separate items, but what would happen if you did a set of 
policies that would leave corn-based bioethanol production at 
its levels in 2007, which I think is what would happen if you 
implemented these. There might be a slight decline. And we 
ended up with an immediate decline of about 6 percent in corn 
prices, but a 14 percent decline by 2015 as it works through 
the system. So, in fact, it was quite remarkably similar, given 
the different kinds of models that we are using.
    Senator Carper. Your advice to us in terms of policy 
advice? One of my colleagues may have put this question to you 
before, but let me just ask it again. What should we do with 
respect to those three policies, the blenders' tax credit, the 
import tariff, and eliminating the ethanol mandate? Let me just 
ask everyone, from Dr. Siegel, just take it down the line, your 
advice to us.
    Mr. Siegel. Actually, I can't answer that question.
    Senator Carper. Thank you very much. Dr. Babcock.
    Mr. Babcock. It depends what you want to accomplish, but 
you are going to get very limited impact if you do it 
piecemeal.
    Senator Carper. What I want to do is to reduce our 
dependence on foreign oil. Frankly, I would like to be able to 
somehow supplement farm income to make farmers less likely to 
want to sell their land to developers and to maintain some of 
our open space and to try to find a way where biofuels can 
actually reduce our dependence on foreign oil and supplement 
farm income to some extent without just turning economics and 
supply and demand on its head. Rev. Beckmann.
    Mr. Beckmann. Well, I found this really instructive. I 
think a 13 percent decrease in the price of corn is not going 
to depress rural America and there are other things that you 
can do through farm and rural development policy that would do 
a lot more good for rural America. So I would get rid of all 
three.
    Senator Carper. All right, thank you. Dr. Rosegrant.
    Mr. Rosegrant. I think I would be cautious about flipping 
all three off immediately since this kind of off and on signals 
is----
    Senator Carper. I agree.
    Mr. Rosegrant. But I think a phase-down of all three would 
be an appropriate policy, and 15 percent isn't a lot, but it is 
enough to bring some starving children out of hunger in 
developing countries. It is not going to solve the food crisis, 
but it has contributed to it.
    Senator Carper. I think what one of you said, if we would 
ratchet down the blenders' tax credit from 51 cents and take it 
down to 46 cents over the next couple of years, that does not 
do much at all. I think everybody agrees on that.
    All right. This is a very helpful hearing. Thank you very 
much for holding this hearing today.
    Chairman Lieberman. Thanks very much, Senator Carper. 
Senator Sununu.

              OPENING STATEMENT OF SENATOR SUNUNU

    Senator Sununu. Thank you very much, Mr. Chairman. I want 
to take most of my time to make a few comments, so I may not 
have a lot of questions. I think the panelists have already 
addressed many of the important points, but I think there are a 
couple of things we haven't touched on.
    First, I want to take the time to welcome Dr. Siegel. I 
know he has operations in New Hampshire, and also 
Massachusetts. I am glad to see it is a growing small business. 
I am well aware of the operation because I read Senator 
Collins's news clips every day, and I saw a wonderful article 
not just about her visit, but about the great work you are 
doing at the bakery.
    A couple of the panelists made the comment that we have to 
recognize that the ethanol industry won't collapse if all of 
these subsidies are taken away. I think that misses the point 
entirely because this isn't a discussion about wanting to make 
the ethanol industry collapse. This is a discussion about 
stopping bad policy that has significant economic consequences, 
significant environmental consequences, and significant moral 
implications in dealing with the food crisis around the world. 
It is a question of what kind of an impact do these policies 
have, and frankly, I think they are universally bad and we need 
to be a little bit more candid about their impact.
    It was suggested by a couple of the panelists that it 
wouldn't make sense to cut back just a little bit. They 
suggested that we shouldn't support a small reduction in one of 
these programs because the impact wouldn't be that great. By 
that reasoning, the way to impose bad policy on America is to 
create 50 different programs that each imposed just a little 
bit of damage on our economy, just a little bit of damage on 
consumers. By that reasoning, Congress would never be able to 
justify rolling back any of those policies because rolling back 
any one of them would only help a little bit.
    We need to be sincere and honest that these policies are 
damaging. They are increasing corn prices, but they are also 
increasing prices of all the other crops that are crowded out 
by the 30 million acres of corn that is being planted to 
support the ethanol industry. We need to be honest about the 
fact that there are significant implications when we set up 
barriers, like a tariff. We get countries around the world to 
do the same thing. Fewer global exchanges of goods and 
services, agricultural products, means higher prices for 
everyone in the world of all of those products, whether they 
are corn-related or not.
    Let us talk about the impact. People say that it is really 
a small impact. It is only a small percent. This is a dramatic 
chart.\1\ The bars show the percentage of corn in America that 
is being diverted from food to ethanol, a third this year. That 
is the far end, 2008. It will be 33 percent of our corn in 
America being diverted to ethanol. I don't think it is suddenly 
going to drop off in 2009 or 2010 as the mandate goes from 7 
billion gallons to 10 billion gallons to 36 billion gallons in 
the future. That mandate is only going to create more pressure 
on prices, more crowding out on land. It is just hard to argue 
with the striking nature of that graph.
---------------------------------------------------------------------------
    \1\ The chart referenced by Senator Sununu appears in the Appendix 
on page 126.
---------------------------------------------------------------------------
    So let us talk about these impacts specifically. When you 
are diverting a third of the crop to ethanol, it has a real 
impact on prices. To produce a gallon of ethanol takes 1,700 
gallons of water, 30 million acres of land going to support the 
corn for ethanol mandate, and all the associated labor. Those 
are economic inputs that could otherwise go to producing other 
food crops, other products, other services, in a much more 
efficient way that doesn't depend on a billion dollars a year 
in subsidy.
    A lot of the justification early on was made that this was 
good for the environment. The most recent evaluations of the 
environmental impact, however, are quite different. It takes 
seventeen-hundred gallons of water to produce a gallon of 
ethanol. We have to be honest about the environmental impact in 
an age of scarcer water resources. Also, a recent study 
published in Science found that corn-based ethanol nearly 
doubles greenhouse gas emissions from the land that is 
cultivated over a 30-year period--a significant environmental 
consequence.
    Finally, I want to address the moral implications in a 
global food crisis. We have terrible economic policies in 
places like Venezuela and Zimbabwe creating local shortages, 
and terrible military consequences of the fighting in Darfur. 
We need to have the most efficient, fair production and 
distribution of food than we have ever had before. But 
unfortunately, we don't because we have a 54-cent-per-gallon 
tax on imported ethanol. We have a 51-cent-per-gallon credit 
for ethanol and we have a mandate of billions and billions of 
gallons per year.
    There is no product in the country where we mandate that 
consumers buy it and give the production side a tax credit. 
That is outrageous. And if it were any other product or service 
that we required consumers to buy and then gave the producers a 
tax credit, people would be taking to the streets because they 
would immediately see the injustice. But this has been papered 
over because of the vehicle that these subsidies move in, 
papered over because I think a lot of misleading information 
was given about the environmental consequences, and papered 
over because we didn't really have to suffer the price at the 
checkout counter until the last couple of years, until these 
policies have really come home to roost.
    I think there hasn't been enough candid discussion about 
this. Frankly, there has been too much vague talk about all the 
different areas of production that might come in the future 
from non-food sources, and I think that is an area of promise, 
whether it is from sustainable biomass, switchgrass, non-
agricultural areas, or municipal waste. These are areas where 
product is lying, not being used, and land is not being 
cultivated. These areas have a lot more promise and would do a 
lot less damage to our economy, to our environment, and to the 
global food shortage.
    But these corn-based ethanol subsidies have been a disaster 
for our economy. They have been a disaster for our environment. 
And today, consumers are realizing they are a disaster for 
their pocketbooks all over the country. Thank you, Mr. 
Chairman.
    Chairman Lieberman. Thank you, Senator Sununu. Senator 
Coburn.
    Senator Coburn. Great question.
    Senator Sununu. I think I was very candid at the top----
    Senator Coburn. You were. I loved it.
    Senator Sununu. I wanted to take the time to make a few 
points.
    Senator Coburn. I am with you.
    Chairman Lieberman. This seems relevant with a Maine baker 
here that the son of the Maine baker who used to be our 
colleague in the Senate, Bill Cohen, had a knack, which I 
noticed after a year or so, that when he had a 5-minute round 
of questions, he would make a 4 minute and 45 second opening 
statement, then ask his question, and the answer would go on 
for 5 or 10 minutes. [Laughter.]

              OPENING STATEMENT OF SENATOR COBURN

    Senator Coburn. Hopefully I won't do that. I apologize for 
missing some of your testimonies. I would like for each of you 
to let me make a statement and ask if it is a correct 
statement.
    The price of wheat right now really is not in this mix 
based on corn-based ethanol. Basically, we had crop failures in 
Ukraine, South America, and Australia that really drove up the 
price of wheat, is that not correct?
    Mr. Rosegrant. That is largely correct. There has been some 
contribution from biofuels, but----
    Senator Coburn. But the vast majority of the increase in 
the price of wheat has nothing to do with ethanol. Don't get 
confused. I am not a supporter of ethanol. But I think it is 
important for us to understand that oftentimes, like in Central 
Oklahoma, it is not corn land. You can't use the land for corn. 
So we are not seeing that, and wheat has moderated considerably 
since we saw the spikes.
    It is also interesting to note that wheat reserves in this 
country are at the lowest level they have been in 40 years, so 
that is the other reason why we saw an increase.
    According to my reading, at $65 a barrel oil, there is a 
break even on ethanol without a subsidy, is that correct or not 
correct? In other words, if you have $65 oil manifested to 
about $2.50 a gallon gasoline there is no need for a subsidy 
for blending ethanol. At what price of oil is there no longer a 
need to subsidize the blending of ethanol?
    Mr. Babcock. Well, I will answer that. Given the existence 
of about 11 billion gallons of plant capacity that we are going 
to have, there is a direct relationship between the price of 
crude oil and the quantity of ethanol you want. So if you want 
a lot of ethanol, you are going to have to subsidize it for a 
given price of oil. But there is a quantity of ethanol at $65 
crude that would probably be in the neighborhood of seven to 
eight billion gallons.
    Senator Coburn. But you are taking that completely out of 
any economic model. Let us say we have a real economic model 
and no subsidy. At what price of oil will you have people 
producing ethanol?
    Mr. Babcock. It depends on the cost of corn. It is an 
economic model. The price of corn is linked to the price of 
crude. You cannot have a price of corn that is low and a price 
of crude that is high. If you had that kind of situation, all 
the ethanol plants would turn on. The price of corn would just 
jump right back up.
    Senator Coburn. So why do we need the incentive?
    Mr. Babcock. My testimony here is if you got rid of all the 
incentives, that it would not have very much impact on the 
total quantity of ethanol relative to what we are producing 
now.
    Senator Coburn. So one of my economic primers is greed 
conquers all technologic difficulties, is not necessarily true. 
With oil at $122 a barrel yesterday, if we had a floor price 
out would we not get the same investment based on an economic 
model if they knew there was a fixed bottom price for the price 
of oil?
    Mr. Babcock. I think, frankly, that at today's crude oil 
prices, you get rid of all the incentives for ethanol, we are 
going to grow out to the projected volume of about 14 billion 
gallons of plant capacity, even if you got rid of the 
incentives today. It just makes sense over time.
    Senator Coburn. It makes economic sense.
    Mr. Babcock. It makes economic sense.
    Senator Coburn. Because money goes to the bottom line 
without it, and that is an important point. So in terms of 
policy, is it good economic policy to charge poor people taxes 
to incentivize ethanol production and the result of that is the 
cost of their food goes through the roof?
    Mr. Rosegrant. Certainly not from an international 
perspective where in my work, I am worried about poor people 
overseas, as well, and obviously that is not a good policy for 
them.
    Senator Coburn. Actually, what we have is a real inequity 
in this country today. We are going to take $13 to $15 billion 
worth of the taxpayers' money and incentivize something that 
otherwise economically would be produced with the price of oil 
where it is. Therefore, people with the smallest marginal 
disposable income are going to pay the taxes for it and will 
have an increased cost of living. What we have really done is 
we have shifted money away from the poorest to help the 
wealthiest. It is an absolute arcane policy that is directly 
opposite of what we should be about doing in this country to 
raise everybody up.
    Are you all aware of some of the shenanigans that are going 
on today where somebody imports biodiesel into a Southern port, 
blends a gallon of real diesel with it, collects the dollar tax 
credit, and then sells it in Europe because they get a dollar 
more a gallon for the biodiesel than they do here? Are you all 
aware of that happening?
    Mr. Babcock. [Nodding head.]
    Senator Coburn. Would you comment on that from an economic 
model?
    Mr. Babcock. Well, one way is to take away all subsidies 
for biofuels. That would do it. The European Union (EU) is 
trying to negotiate something less radical than that. I think 
the biodiesel producers in the United States would rather go 
see the EU way. But clearly, if you took away the dollar-a-
gallon blenders' credit, that kind of shenanigan would go away.
    Senator Coburn. Is anybody opposed to taking away the 
dollar-a-gallon blenders' credit for biodiesel?
    Mr. Rosegrant. No.
    Senator Coburn. Does anybody think it would have a negative 
impact on future production of biodiesel?
    Mr. Babcock. I will speculate that the dollar-a-gallon 
credit is not enough to keep biodiesel plants running right 
now, given the high vegetable oil prices, and they are going to 
rely on that mandated use that starts kicking in in 2009.
    Senator Coburn. All right. I have no further questions. 
Thank you.
    Chairman Lieberman. Excellent. Thanks very much, Senator 
Coburn.
    Let us do another 6-minute round. Dr. Babcock, I want to 
come back to your research. Incidentally, I really appreciate 
that you and Dr. Rosegrant have presented to us some quite 
relevant current estimates of the impact of various policies. 
Of the three policies now supporting ethanol, I wanted to ask 
you, and maybe I missed it earlier on, what is your estimated 
impact of the tariff on imported ethanol alone? In other words, 
if we removed the tariff, what would be the percentage 
reduction in the price of the commodity?
    Mr. Babcock. It would have very little impact because we 
would get a lot more imports into the United States, and we 
would more than double our imports of ethanol into the United 
States, but in the next year or two, the supply of ethanol that 
is exportable by Brazil would run out. We would take all their 
exportable surplus, we would bring it into the United States, 
and it would have some impact on the domestic production 
because we would essentially be subsidizing the Brazilian 
import of ethanol because they would qualify for the 51-cent-
per-gallon blenders' credit.
    Chairman Lieberman. I understand.
    Mr. Babcock. We would just be sucking the ethanol out of 
Brazil and it would also help meet our mandate. So it would 
have modest effects, though, in terms of the price of corn. It 
would have a bigger effect on the quantity of ethanol produced 
in the United States. But we would still have that 51-cent-per-
gallon blenders' credit.
    Chairman Lieberman. So is that the big one of the three, or 
really it is all of them and the way they work together?
    Mr. Babcock. It is all and how they work together. Does it 
really make a lot of sense to subsidize Brazilian ethanol 
production----
    Chairman Lieberman. No.
    Mr. Babcock [continuing]. And bring it into the United 
States? It doesn't to me. So I look at these policies as 
working together, and so just taking one of them off doesn't do 
perhaps what you think it might.
    Chairman Lieberman. OK. Dr. Rosegrant--because I know you 
are focused on the international aspects of this--am I right 
that Europe, as it has tried to diversify its energy supply, 
has focused on biofuels?
    Mr. Rosegrant. And particularly biodiesel, yes.
    Chairman Lieberman. Biodiesel, right. As we have said, 
Brazil has done really very well with sugar-based ethanol, and 
so far in the United States, we are talking about corn-based 
ethanol.
    Can you evaluate the impact that these three different 
approaches to the alternative fuel challenge have had on food 
prices? I think you understand my question.
    Mr. Rosegrant. Yes. Again, what we did was look at 
essentially the combination----
    Chairman Lieberman. Right.
    Mr. Rosegrant [continuing]. Rather than pricing them out 
separately, and as we said, we did try to look at the 
historical impact from 2000 to 2007. If we look particularly at 
the grains, which we were looking at because they are such 
important staple foods, if you did a production weighted 
average, then the increases in biofuels since 2000 have caused 
about 30 percent of the increase in grain prices up through 
2007. That doesn't include this policy-driven spike of the last 
4 months. But it has had a bigger impact on corn, or we project 
it has contributed to nearly 40 percent of the increase, but 
only about 20 percent of the increase for rice and wheat.
    Chairman Lieberman. Is it constructive for there to be more 
international cooperation in the adoption of these commodity-
based fuel alternatives? Is any of that happening now? If it 
did, what is the institutional way in which that could happen?
    Mr. Rosegrant. Yes. Very little has been done on that, 
probably because the different countries have pursued their, in 
a sense, highly subsidized or protected developments of their 
own markets.
    Chairman Lieberman. Right.
    Mr. Rosegrant. And in fact, I think one thing that should 
happen if, in fact, for example, there was a phase-out of some 
of the subsidies, would be that there should be a multilateral 
negotiation to have transparent markets in crop-based ethanol 
and diesel products that has not happened yet and try to 
establish, in a sense, a proper international commodity market 
in biofuels, but one that is not driven by the individual 
distortions in different countries.
    Chairman Lieberman. I am not an expert in this area, but is 
there an existing institutional framework through which that 
could happen?
    Mr. Rosegrant. I don't believe there is anything other than 
working through existing commodity exchanges to try to develop 
that. But there is nothing specific for these that I am aware 
of, unless the others know.
    Chairman Lieberman. Yes. I mean, the point here obviously 
is that these are now, like everything else, global markets, so 
what we do here has an impact there. What they do there has an 
impact here and everywhere. So that was the question.
    Rev. Beckmann, do you have a thought on this?
    Mr. Beckmann. Part of it could be the Consultative Group on 
International Agricultural Research, the whole network of 
agricultural research institutes in developing countries. I 
don't know that they are doing anything on it, but it makes a 
lot of sense. There is a demand here, and it could be things 
that Africa is producing that now have no economic value could 
have some economic value. Last year, I think almost 
inadvertently, the foreign aid appropriations dramatically 
dropped USAID funding for agriculture, including contributions 
to the Agricultural Research Network. So investing in 
agricultural research is one way to handle this.
    Also, it seems to me it is the broader question of if what 
we are trying to do here with biofuels is to deal with higher 
oil prices and the negative effects of reliance on fossil 
fuels, sharing information on how to conserve and on other 
kinds of alternative fuels besides agriculturally based sources 
of energy--I mean, we are not doing very much on wind, solar, 
or all the other possibilities. So I don't know of any 
international research. It is a really good point.
    Chairman Lieberman. Thank you. We will pursue that. Senator 
Collins.
    Senator Collins. Thank you, Mr. Chairman.
    Mr. Babcock, Dr. Siegel mentioned in his testimony the role 
of speculation in the commodity markets, and as the Chairman 
has indicated, we are going to look at that issue in a 
subsequent hearing. When I look at the price increases in the 
futures markets, they seem to have reacted very sharply to the 
2007 energy bill that included the increase in the renewable 
fuels standard. Would you agree that there was a correlation 
there? Is that something you have looked at?
    Mr. Babcock. There is a very strong correlation, first of 
all, in the price of corn, and then because the future price of 
corn went up, everyone knew the price of soybeans had to 
follow, so then soybeans went up right afterward. I am not 
saying it is causal, but it happened. It is a very strong 
coincidence if it wasn't causal.
    Senator Collins. It leads me to wonder if we revise the 
three ethanol policies whether there would be a similar 
reaction in the futures market where you might see a decline in 
commodity prices beyond what your models show. Could you 
comment on that issue?
    Mr. Babcock. Yes. It is very difficult to figure that out 
because you really have to look at 2 or 3 years down the road. 
But since that time occurred, you have got to remember also 
that the value of the dollar was falling at that time. The 
price of oil was skyrocketing at that time. And everything was 
pushing, at the same time as the biofuels energy act was 
passed, the price of corn higher at that time.
    But there is the possibility that if Congress made a strong 
statement by eliminating all support for the corn ethanol 
industry and said, you are on your own, there would probably be 
an initial reaction that would be larger than what I am 
estimating. But I am saying that after everything settles down 
and people look at the fundamental economics of corn ethanol, 
the plants that are being built, and the price of oil, my 
estimates are probably somewhere in the ballpark.
    Senator Collins. Rev. Beckmann, do you have any comment on 
the impact on the futures markets in this area? I know that is 
not an area you have looked at directly, but----
    Mr. Beckmann. No. That is not in the Bible. [Laughter.]
    Senator Collins. Good answer. Dr. Rosegrant.
    Mr. Rosegrant. I would essentially agree with what you have 
said and what Dr. Babcock said. I think there could be a larger 
impact on futures markets than you would see in the fundamental 
spot markets, so it would wring out some of the excesses that 
you are seeing in market prices right now.
    Senator Collins. I think that is an important point, given 
what happened when the mandate was put in place. It seemed to 
cause an immediate and sharp increase in prices on the futures 
markets. It seems that if the mandates were reduced, that you 
would see a similar impact in the opposite direction.
    I do want to make clear that I realize that the 
infrastructure that has grown up in Iowa and other States to 
support the corn-based ethanol industry is significant, and as 
Rev. Beckmann pointed out, has had an impact on rural 
communities in a positive way. So we do have to be careful as 
we adjust our policy in this area because people relied on 
those policies. But I do think we are in a different situation 
today because the high price of oil makes the rationale for all 
these subsidies and mandates far less compelling.
    Rev. Beckmann, the EPA has the authority right now to 
adjust the Renewable Fuel Standard mandate if there are 
unintended effects. That is what the standard is in the law. Do 
you think we as Members of Congress should ask the EPA to 
reevaluate the level of the mandate?
    Mr. Beckmann. That makes sense to me because when Congress 
made these decisions, I don't think anybody expected food 
prices to jump like they have. Nobody expected to see 100 
million people suffering severe consequences in developing 
countries. It has a political dimension. There is a security 
dimension to this. With a lot of governments feeling very 
threatened and the international discussion of this issue, the 
people who speak for developing countries, they see that this 
is one factor that somebody made a decision and it has resulted 
in severe hardship in their cities and threatens the political 
stability of their countries.
    So in the international discussion of this, the connection 
that you point out between corn-based ethanol and the sudden 
jump is important. So clearly, circumstances have changed, and 
I didn't know. If EPA has that authority, they ought to use it.
    Senator Collins. Thank you. Mr. Chairman, I want to thank 
you again for holding this very important hearing. I think this 
is an example, perhaps the best example I have ever seen, of 
the law of unintended consequences. All of us want to reduce 
our dependence on foreign oil, which I believe poses a threat 
to our economic and our national security. But in doing so, in 
rushing to embrace the use of food for fuel, my concern is that 
we have exacerbated the problem of hunger worldwide, that we 
are causing difficulties for small businesses such as Dr. 
Siegel's bakery, and the policy has had also consequences for 
low-income families right here in our country at a time when 
they are struggling with the high cost of energy.
    So I believe that we need to take a hard look at this 
policy and what appears to me to be a factor that is 
contributing to the high cost of food and a factor that we can 
control. And that is the important point to me. We can do 
nothing about drought in Australia. There is so much that is 
beyond our control. But this is a factor that we can control 
and I am very grateful to the Chairman for probing this issue. 
I hope you will all continue to help us find the path forward 
in this area and I very much appreciated the testimony of each 
of you today. Thank you.
    Chairman Lieberman. Thank you, Senator Collins, again, for 
inspiring the hearing. I agree with what you have said just 
now.
    The other lesson I think we learned here is that we saw the 
problem of dependence on foreign fossil fuel and all the 
impacts it has on our economy, our environment, and our 
security, but we, by our own action--well intended--sent a 
disproportionate set of subsidies to one form of alternative 
fuel. Presumably if we had passed a comprehensive program that 
sent a lot of signals to a lot of different industries--
including cellulosic, biodiesel, and electric cars and all the 
rest, hydrogen fuel cells--I understand that they wouldn't all 
come online at once, but at least the impact would have been 
reduced, and we didn't do that. Hopefully, we will have an 
opportunity to do something like that soon.
    But the other point that strikes me here is that none of 
you have said that the policies we adopted with regard to 
support and inventing corn-based ethanol are the only cause of 
food price increases. Obviously, there are others, including--
this does come into your Biblical area of expertise--natural 
phenomena like drought. I was thinking of Joseph, who stored up 
the grain for 7 years, but that is a longer story.
    But I am struck after your testimony this morning--I am 
building on the point that there is more than one cause of the 
global food price increase and food crisis, but that it may be 
that the most significant positive impact we in Congress can 
have in the short run on food prices is to remove these three 
incentives for corn-based ethanol. Your testimony has been very 
helpful, and I appreciate it very much.
    We are going to leave the record of this hearing open for 
15 days in case Members of the Committee have additional 
questions they would like to submit to you in writing or you 
have additional testimony you would want to submit for the 
final transcript of the hearing.
    But I thank you for the work that each of you do, and the 
service that you have given in your testimony this morning. It 
was extremely helpful.
    The hearing is adjourned.
    [Whereupon, at 11:48 a.m., the Committee was adjourned.]


FINANCIAL SPECULATION IN COMMODITY MARKETS: ARE INSTITUTIONAL INVESTORS 
    AND HEDGE FUNDS CONTRIBUTING TO FOOD AND ENERGY PRICE INFLATION?

                              ----------                              


                         TUESDAY, MAY 20, 2008

                                     U.S. Senate,  
                           Committee on Homeland Security  
                                  and Governmental Affairs,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:36 a.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Joseph I. 
Lieberman, Chairman of the Committee, presiding.
    Present: Senators Lieberman, Levin, Carper, Pryor, 
McCaskill, Collins, Voinovich, Coleman, and Coburn.

            OPENING STATEMENT OF CHAIRMAN LIEBERMAN

    Chairman Lieberman. Good morning and welcome. This is a 
very important hearing this morning that really matters to a 
lot of people, both in our country and around the world, and I 
thank our witnesses.
    Senator Collins and I just said to the witnesses directly 
that we are approaching this hearing with a great interest in 
learning about a very complicated matter, which is commodity 
markets, and examining the role of institutional investors and 
hedge funds in commodity markets and their effect on steadily 
rising oil and food prices. In other words, financial 
transactions that are either unknown or unfathomable by most of 
the country and the world, including not a small number of 
Members of Congress, are having a direct effect on each of us, 
and a lot of others, when we go out to buy food, fill our tanks 
with gasoline, or heat our homes with oil.
    So directly speaking, we want to know, to the best of our 
ability, whether speculation in commodity markets--unrelated to 
traditional market factors, such as supply and demand, or 
weather occurrences--is one of the reasons, perhaps a 
significant reason, why food and energy prices have 
skyrocketed.
    I will tell you that one of our colleagues said to us the 
other day, just in conversation as he heard about this hearing, 
that the executives of a major airline were in to see him about 
their own problems with rising fuel prices and contended that 
one-third of the increase in fuel prices they were paying was 
the result of speculation, not market factors. Now, I do not 
know, starting this hearing, whether that is right or wrong, 
but that is a very significant number.
    So as everyone knows, the cost of food and energy is at a 
record high, creating real economic distress for millions of 
working families in our country and around the world. At home, 
rising food and gas prices put a real and immediate strain on 
family budgets. In some regions of the country, as most of us 
now know, major retailers have actually started to ration 
items, such as rice, in response to rising demand, low 
inventories, and, of course, high prices.
    Overseas, the consequences are even more dire. Consumers in 
low-income countries spend as much as 80 percent of their 
income on food. Food riots in Somalia have already occurred and 
caused deaths. World Bank President Bob Zoellick has warned 
that there are 33 other nations, in his calculations, that are 
at risk of unrest as a result of food prices or food shortages, 
and one billion Asians--again, a World Bank number--are at risk 
of serious hunger or malnutrition.
    In recent years, commodity markets have attracted 
increasing amounts of money from large investors, such as 
pension funds. That much we know and understand. This influx of 
institutional investors and hedge funds into relatively small 
markets for goods such as rice and corn has raised important 
questions about the ability of the markets to absorb those new 
investors without undermining or distorting fundamental supply 
and demand forces.
    Speculative activity in commodity markets has grown by 
staggering leaps and bounds over the last several years, and 
the numbers here, at least to me, are staggering. From 1998 to 
2008, the share of so-called long interests in commodities held 
by financial speculators--which is to say market positions that 
benefit when prices rise--has grown from one-quarter to two-
thirds of the commodity market. By comparison, during the same 
period, the share of the market held by actual physical traders 
has dropped from three-quarters to just one-third. There is 
another number that is to me staggering. In only 5 years, from 
2003 to 2008, investment in index funds tied to commodities has 
grown 20-fold, from $13 billion to $260 billion.
    This unbridled growth raises justifiable concerns that 
speculative demand--divorced from market realities--is driving 
food and energy price inflation, and causing a lot of human 
suffering.
    In 1936, Congress authorized limits on speculative activity 
that could threaten the orderly functioning of commodity 
markets--limits on the size of any one investor's holdings in 
the futures markets with respect to a specific commodity. The 
purpose of these limits was and is to reduce the threat of 
market manipulation or congestion and reduce the potential 
thereby for price distortions. More recently, in 1974, Congress 
extended the authority for speculative position limits when it 
created the U.S. Commodity Futures Trading Commission. Since 
that time, 1974, we have, of course, seen tremendous growth in 
new and complex financial instruments that are marketed to 
large and sophisticated investors in over-the-counter 
transactions. These instruments, often tied to returns on 
commodities, are sold outside the commodity exchanges and 
create doubts about whether the speculative limits in the law 
continue to work in any meaningful way. And that is a question 
we are going to ask and hope to answer this morning.
    To examine these concerns, which we consider to be urgent 
concerns, we are really fortunate to have with us a 
distinguished panel of experts representing key actors and 
institutions that influence the commodity markets. And we have 
asked the experts to address several critical questions. First, 
what effect are institutional investors and hedge funds having 
on current food and energy prices? This is the bottom-line 
question that our constituents are asking. Second, do food and 
energy price increases constitute irrational speculative 
behavior, a rational response to market fundamentals, or a 
combination of both? Third, are rising prices creating an 
economic incentive for speculators to accumulate and hold 
stocks of food and energy commodities, therefore, obviously, 
aggravating supply problems? And finally, does the U.S. 
Commodity Futures Trading Commission, which is the primary 
regulator in our country of commodity futures markets, have the 
authority and the resources it needs today to adequately 
monitor and regulate commodity trading in the public interest?
    I would say finally that I believe our Committee is 
uniquely situated to look across the Federal Government and 
assess the complex interaction of economic activities and 
regulatory policies--that is the traditional and longstanding 
governmental affairs responsibility that this Committee has. 
The issues we discuss today will help shape future debates, we 
hope, and also potential legislative action on the appropriate 
balance between free market principles and regulatory oversight 
in the commodity markets.
    I really look forward to our witnesses' testimony and 
working with my colleagues to ensure that Congress takes a 
thoughtful, reasonable, and effective approach to the issues at 
hand.
    Senator Collins.

              OPENING STATEMENT OF SENATOR COLLINS

    Senator Collins. Thank you, Mr. Chairman, and thank you so 
much for holding this very important hearing. I was talking to 
the witnesses prior to the hearing, and I told them, just as 
you did, that this is not a hearing where the Committee is 
going in believing that we know all the answers and are just 
simply seeking confirmation from the witnesses, but, rather, it 
is a true inquiry into a very important issue, looking at 
financial speculation in the commodity markets and what the 
impact is on the spiraling increase in food and energy prices.
    Last December, I participated in the hearing held by the 
Permanent Subcommittee on Investigations, which Senator Levin 
chairs, where we looked at the causes of the increase in oil 
prices, and we looked specifically at speculation in addition 
to other factors. At that time, oil prices were then headed for 
$95 a barrel. We thought that was an outrage. Now most people 
would call it a relief.
    With oil now above $125 a barrel, millions of Americans 
face dire hardship. A few days ago, I met with an employee of a 
home heating oil company from Maine. He is telling Maine 
customers to expect home heating oil to rise to $4.50 a gallon 
next winter. In the summer of 2005, just 3 years ago, before 
the disruptions caused by Hurricane Katrina, the average price 
in Maine was $2.09 a gallon.
    Maine has long, cold winters, and oil is the main heating 
source for 80 percent of the homes in my State. Maine's housing 
stock and people are older and our incomes are lower than the 
national average. That is a formula for a winter of hardship. 
My visitor told me of an elderly customer who was forced to 
hand over half of her Social Security check each month in order 
to meet the demands of her budget payment plan for oil.
    I have also talked with countless families who have been 
forced to charge their oil bill to their credit cards--the very 
worst thing that they could be doing, but they have no other 
option. Maine families, on average, use between 800 and 1,000 
gallons of oil during the heating season. For our poorest 
citizens, the Low Income Home Energy Assistance Program 
(LIHEAP) provides a little bit of relief, but because the price 
of oil has soared and the LIHEAP program has not kept pace, it 
will cover only about 100 gallons at the prices that this oil 
dealer is predicting for this winter.
    Mainers, like other Americans, are facing record gasoline 
prices as well and the highest rate of food price inflation 
since 1990. As my constituent said, ``Something is wrong.''
    Truly, something is wrong--deeply wrong. Senior citizens 
and young working families, truckers and fishermen, small shops 
and big factories--all face difficulties and even disaster from 
the price trends in food and energy. Bringing about immediate 
relief is very difficult, but we are beginning to take some 
initial steps to mitigate the distress somewhat. We have just 
forced the Administration, for example, to stop the bizarre 
practice of taking oil off the market and putting it into our 
already enormous Strategic Petroleum Reserve during a time of 
record prices. This Committee has also begun a tough review of 
the effects of our ethanol promotion policies on food prices. 
And the new Food, Conservation, and Energy Act (farm bill), due 
to the hard work of Senator Levin and others, has an important 
provision that eliminates the so-called Enron loophole in our 
commodity regulatory system that exempted certain electronic 
exchanges from the trading and reporting requirements imposed 
on other commodity exchanges, such as those in New York and 
Chicago. This will give the U.S. Commodity Futures Trading 
Commission a clearer view of who is trading, what they are 
doing, what effect they are having, and whether laws against 
market manipulation are being respected.
    Which brings us to the subject of today's hearing. Over the 
past few years, a weak stock market and lower interest rates 
have persuaded many investors--including managers of pension 
funds, 401(k) plans, and endowments--to put cash into the 
commodity markets. A recent press release promoting a new 
commodities fund pointed out that commodities offer average 
returns that beat stocks and bonds over time, that they move 
independent of other investments, and that their prices go up 
if inflation increases.
    Now, these investors are not buying and selling actual 
barrels of oil, bushels of corn, or herds of live cattle. Their 
commodity investments--estimated at upwards of $250 billion--
are in futures contracts, options, swap agreements, or other 
financial instruments that seldom lead to taking possession of 
the underlying product. These financial markets provide useful 
services in risk hedging and price discovery for farmers and 
other producers, grain elevator companies, commodity brokers, 
and others who are involved in the production and use of 
physical products.
    Participants in the commercial markets have long used 
speculators' willingness to accept risk as a way to lock in 
prices for crops or hedge other risks. But many of them, 
including the National Farmers Union and the National Feed and 
Grain Association, now believe that the massive trading in the 
non-commercial futures market has disrupted the normal flow of 
price information and has caused price movements that may 
expose them to crippling margin calls.
    Federal economists--and we will hear this today--contend 
that index fund and institutional investors tend to follow 
changes in the physical market or react to news rather than 
directly pushing commercial prices up or down. They tell us 
that fundamental factors like the rising demand in developing 
countries, the declining dollar, weather events, the 
Organization of the Petroleum Exporting Countries (OPEC) 
production decisions, refinery capacity limits, or ethanol 
policies account for the dramatic developments that we have 
seen in markets for agricultural and energy commodities.
    But many other experts believe that large flows of 
speculative capital into the non-commercial side of futures 
markets are having disruptive and destructive effects. And that 
view is, of course, consistent with the earlier findings of the 
Permanent Subcommittee on Investigations that speculative 
investments in excess of what normal commercial risk hedging 
requires creates a ``virtual'' demand that can have a real 
effect on commercial markets and prices.
    Today's hearing should give us robust presentations of both 
views. I do not expect that this single hearing will settle the 
debate, but I do expect that it will show that we cannot afford 
to ignore the possibility that financial speculators are 
influencing the markets in unexpected ways.
    A critical point of inquiry must be whether the market 
monitors and the regulators at the U.S. Commodity Futures 
Trading Commission (CFTC) have adequate resources and 
authorities for their work. I was astonished to learn from 
Chairman Lukken of the CFTC that since 1976, the Commission's 
workforce has actually declined by 12 percent while the volume 
of commodities contracts that it must monitor has risen by more 
than 8,000 percent.
    The Commission, nevertheless, has imposed more than $2 
billion in sanctions over the past 5 years for actual or 
attempted manipulation, fraud, and false reporting. Vigorous 
Commission enforcement requires more resources, especially 
given the new authority that Congress has just voted to grant 
the Commission.
    I believe that the CFTC must also look into legal practices 
such as large purchases of commodity-linked financial products 
by institutional investors to ensure that they are not 
disrupting the essential market functions or exerting 
artificial pressure on the price of the underlying commodities.
    Achieving more transparency and reducing unintended 
disturbances to food and energy markets is more than a matter 
of fair dealing and economic efficiency. It is essential to 
help avert disaster for millions of Americans struggling with 
the soaring costs of feeding their families, filling their gas 
tanks, and heating their homes.
    Again, Mr. Chairman, thank you so much for holding this 
important hearing.
    Chairman Lieberman. Thank you, Senator Collins, for that 
statement and also for your characteristic support and 
involvement in this ongoing investigation.
    As Senator Collins indicated, this is the first time this 
full Committee, certainly in the midst of this run-up of 
commodity prices, has conducted an investigation. But the 
Permanent Subcommittee on Investigations, which is a historic 
Subcommittee, not just because of Senator Levin's age but 
because it is historic--I could not resist--has done some great 
work here. I want to directly ask Senator Levin if he would 
like to make an opening statement based on all the work that he 
has done in this area.

               OPENING STATEMENT OF SENATOR LEVIN

    Senator Levin. Well, thank you so much, Mr. Chairman and 
Senator Collins, for holding these hearings. As you both 
mentioned, our Permanent Subcommittee on Investigations has had 
three hearings on this subject. Four reports have been issued. 
We have looked at the way in which one hedge fund, Amaranth 
Advisors, surely a speculator, distorted the market in natural 
gas. We had a joint hearing on December 11, 2007, with Senator 
Dorgan's subcommittee, the Subcommittee on Energy, of the 
Committee on Energy and Natural Resources, on this subject as 
well, and it is very important what you are doing here. I want 
to just commend the full Committee for taking on this subject.
    We have closed one loophole where we hope to stop some of 
the excessive speculation that is taking place on the 
electronic exchange by closing the Enron loophole, but there 
are other loopholes that need to be addressed, one of which we 
will now call the London loophole.
    Just one quote here, which summarizes what my conclusion 
is, and that is the oil analyst for Oppenheimer and Company, 
Fadel Gheit, who says the oil market is a ``farce'' and ``the 
speculators have seized control, and it is basically a free-
for-all, a global gambling hall, and it won't shut down unless 
and until responsible governments step in.''
    One of the issues that I know the Committee is interested 
in is whether or not our regulator here, and regulators, are 
stepping in the way we expect when we passed the law which gave 
them the responsibility of prohibiting excessive speculation. 
But I very much appreciate your referring to our efforts in 
both of your statements, and I thank you for the opportunity of 
saying just a few words.
    Chairman Lieberman. Thank you, Senator Levin. Thanks for 
your substantial contribution, and I am really glad that you 
are here this morning. Your closing words are a perfect lead-in 
to our first witness, who is Jeffrey Harris, Chief Economist at 
the U.S. Commodity Futures Trading Commission. The Economic 
Division of the CFTC has conducted a fair amount of research in 
an effort to understand the role of financial speculators in 
commodity markets, and we look forward to hearing about that 
and whatever else Mr. Harris would like to tell the Committee. 
Thank you for being here.

   TESTIMONY OF JEFFREY H. HARRIS,\1\ CHIEF ECONOMIST, U.S. 
              COMMODITY FUTURES TRADING COMMISSION

    Mr. Harris. Thank you, Mr. Chairman and Members of the 
Committee. I am Jeffrey Harris, the Chief Economist of the U.S. 
Commodity Futures Trading Commission, and I appreciate the 
opportunity to discuss the CFTC's role with respect to the 
futures markets and our view of current trends in these 
markets.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Harris appears in the Appendix on 
page 170.
---------------------------------------------------------------------------
    These are extraordinary times. Many commodity markets have 
hit unprecedented levels. In the last 3 months, the 
agricultural staples of wheat, corn, soybeans, rice, and oats 
have hit all-time highs. We are also witnessing record prices 
in crude oil, gasoline, and other energy products.
    Adding to these trends, the emergence of the subprime 
crisis last summer and the weak returns in debt and equity 
markets have led investors increasingly to seek portfolio 
exposure in commodities as an asset class.
    Futures markets in the United States have served vital 
functions for risk management and price discovery for more than 
140 years. These markets allow farmers and other commercial 
producers and manufacturers to manage risk. Futures markets 
also serve the valuable function of price discovery, bringing 
diverse participants to the market in order to determine market 
prices, the basic future contract entered into by buyers and 
sellers for delivery of the underlying asset in a later month. 
The writer or seller of the contract agrees to sell a pre-
specified asset at a pre-specified price for delivery during a 
future month. The buyer is obligated to purchase the asset 
under the terms of that contract.
    When the contract is written, each party puts down a margin 
deposit with the clearinghouse to ensure that neither party 
reneges on the obligation written in the contract. These 
deposits usually represent 5 to 8 percent of the value of the 
underlying contract. In our futures markets, profits and losses 
are settled each day, and sometimes twice a day. The margin 
deposit is used as a performance bond to ensure that losses can 
be collected on the day that they occur.
    Notably, margin in the futures market refers to this 
performance bond and is not really analogous to the buying on 
margin that occurs in the stock market where purchases are made 
with borrowed money. In the futures markets, these contracts 
are standardized, a feature that enhances liquidity and ensures 
that market participants can return to the market to offset 
their existing positions when the market or business conditions 
change.
    The supply of futures contracts is not necessarily limited, 
but for every buyer there must be a seller on the other end to 
meet or enter into that contract. When buyers come to the 
futures markets, new contracts can be written at current market 
prices without the effect of directly bidding up existing 
contract prices. The number of contracts outstanding is known 
as ``open interest,'' which reflects the number of contracts 
being written in the marketplace. In both agricultural and 
energy markets, we are witnessing record levels of open 
interest that reflect unprecedented levels of selling interest 
in these commodities largely from commercial participants.
    We are continually doing new analysis of our detailed 
market data, applying new research methods, and building 
bridges to outside researchers and government entities, all to 
increase our view of the futures markets. And, separately, our 
Division of Enforcement investigates any specific instances of 
potential manipulative behavior on a case-by-case basis.
    In line with these efforts, the agency convened an 
agricultural forum a few weeks ago in which we brought together 
a diverse group of market participants for a full airing of 
views and opinions on the driving forces in these markets. The 
agency allowed a 2-week period for comment after the forum, and 
currently, the Commissioners and staff are reviewing the 
comments we received, and the Commission plans to announce 
several initiatives in the very near future in this space.
    The CFTC also recently announced the creation of an Energy 
Markets Advisory Committee and named public members of the 
Committee. Our first meeting of that group is scheduled for 
June 10 to look at issues related to energy markets and the 
CFTC's role in these markets under the Commodity Exchange Act.
    Clearly, the commodity futures markets are experiencing 
robust growth across commodities, particularly with the influx 
of institutional investors. The CFTC produces public reports 
detailing commercial and non-commercial trading on a weekly 
basis in our markets. Within the Commission, however, we 
analyze more detailed data and more detailed categories of 
positions of traders at the daily level. For instance, we can 
break down commercial traders by dealer, manufacturer, or 
producer categories. The non-commercial category can include 
floor participants, hedge funds, for example. We then use this 
daily data to analyze the impact of institutions or funds in 
our markets.
    There are two basic types of activity that people refer to 
as ``funds.'' Each is identified to some degree of accuracy in 
our large trader reporting system. The first type of fund 
represents speculative monies that enter the futures markets 
through various forms of managed money, like hedge funds or 
commodity pools. Managed money funds can either be long or 
short, depending on their speculative beliefs about future 
prices.
    The second type, referred to as ``index funds'' or 
``commodity index traders,'' has become more important in 
recent years. These funds, commonly pension funds or the 
university endowments that we speak of, seek commodities' 
exposure as an asset class, like stocks, bonds, or real estate, 
and aggregated index fund positions are relatively large, 
predominantly long, and passively positioned--that is, they 
simply buy exposure to the commodities in the futures markets, 
maintain their exposure through pre-specified rolling 
strategies before the futures enter the delivery month. It is 
the equivalent to a buy and hold strategy in the stock market.
    In response to the growing activity in commodity index 
traders, the Commission has increased transparency in 12 
agricultural markets by publishing weekly data on these 
positions held by index traders since January 2007. Some 
observers suggest that higher crude oil prices and commodity 
futures prices are being driven by speculators in the futures 
markets and have suggested steps to reduce or limit their 
actions in our marketplace. The CFTC has been actively engaged 
with industry participants during this time of extraordinary 
price increases. In addition, we have utilized our 
comprehensive data to rigorously analyze the role of hedges and 
speculators in energy and agricultural markets.
    All of the data that we have analyzed and the work we have 
done indicates that little economic evidence exists to 
demonstrate that futures prices are being systematically driven 
by the speculators in agriculture and energy markets. 
Generally, a few facts speak to this. Prices overall have risen 
sharply for commodities that neither have developed futures 
markets, like durum wheat, steel, and iron ore, or markets 
where no institutional fund investments exist, like the 
Minneapolis wheat contract and Chicago rice.
    Markets where index trading is the greatest as a percentage 
of the total open interest--the live cattle and hog futures 
markets--have actually suffered from declining prices during 
the past year. The level of speculation in commodity and crude 
oil markets has remained relatively constant in percentage 
terms as prices have risen.
    Our studies of agricultural and crude oil markets have 
found that speculators do tend to follow prices rather than set 
prices in our marketplace. Speculators such as managed money 
traders are both buyers and sellers in these markets, and data 
shows that there is almost the same number of bullish funds as 
there are bearish funds in our markets. For example, commercial 
and non-commercial open interest in crude oil has grown during 
the recent 22 months, but generally remains balanced between 
long and short positions among these trader groups.
    Simply put, economic data shows that overall commodity 
prices and levels, including agricultural commodity and energy 
futures prices, are being driven by powerful economic 
fundamental forces and the laws of supply and demand. 
Fundamental economic forces may be the increased demand from 
engagements, the decreased supply due to weather or 
geopolitical events, and the weakened dollar. Together, these 
fundamental factors have formed the perfect storm that is 
causing significant upward price pressure on futures across the 
board.
    Given the widespread impact of higher futures prices, the 
CFTC will continue to collect and analyze data closely. The 
agency prides itself on our robust surveillance and enforcement 
programs complemented by rigorous economic analysis that we use 
to oversee the U.S. futures and options markets. As you know, 
there is an amendment in the Commodity Exchange Act now that is 
part of the farm bill conference report that largely reflects 
the Commission's recommendations on the need for some 
additional tools to oversee exempt commercial markets. These 
provisions represent years of hard work and bipartisan effort 
to find the right balance of enhanced market oversight and 
transparency, while promoting market innovation and 
competition.
    The Commission strongly supports this legislation, and it 
would give us additional necessary oversight into these 
markets, particularly in exempt energy trading. Not 
surprisingly, additional authorities included in the farm bill 
will mean the need for additional funding for the agency above 
the current funding request of $130 million for fiscal year 
2009. The current staff estimates indicate that it may require 
roughly $6 million in additional funding to hire 30 additional 
staff to carry out our new authorities. The legislation that is 
part of the farm bill and commensurate increase in funding 
would ensure the agency has the tools necessary to oversee 
these $5-trillion-a-day markets.
    As a Commission, we are devoting, and will continue to 
devote, an extraordinary amount of resources to ensure that 
futures markets are responding to fundamentals and serving the 
role of hedging and price discovery.
    Thank you for the opportunity to testify today, and I look 
forward to your questions.
    Chairman Lieberman. Thanks, Mr. Harris, for that opening 
statement. I know we will have a lot of questions for you.
    Our second witness is Michael Masters, who is Managing 
Member and Portfolio Manager at Masters Capital Management. He 
is both a hedge fund founder and manager and has researched the 
effect of speculators--particularly those operating in over-
the-counter markets outside the scope of the CFTC's 
jurisdiction--on commodity markets.
    Mr. Masters, thanks for being here. We look forward to your 
testimony now.

    TESTIMONY OF MICHAEL W. MASTERS,\1\ MANAGING MEMBER AND 
       PORTFOLIO MANAGER, MASTERS CAPITAL MANAGEMENT, LLC

    Mr. Masters. Thank you, Mr. Chairman. Good morning, and 
thank you, Mr. Chairman and Members of the Committee, for the 
invitation to speak to you today.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Masters appears in the Appendix 
on page 191.
---------------------------------------------------------------------------
    You have asked a question: Are institutional investors 
contributing to food and energy price inflation? And my 
unequivocal answer is yes. Clearly, there are many factors that 
contribute to price determination in the commodities markets. 
However, I am here to expose what I believe is one of if not 
the primary factor in commodity prices. Commodity prices have 
increased more in the aggregate over the last 5 years than at 
any other time in U.S. history. Today, unlike previous 
episodes, supply is ample. There are no lines at the gas pump, 
and there is plenty of food on the shelves. If supply is 
adequate, how does one explain a continuing increase in demand 
when many commodity prices have tripled in the last 5 years?
    What we are experiencing is a demand shock, coming from a 
new category of participant in the commodities futures 
markets--institutional investors. Specifically, these investors 
include corporate and government pension funds, university 
endowments, and even sovereign wealth funds. Collectively, 
these investors now account, on average, for a larger share of 
outstanding commodities futures contracts than any other market 
participant.
    These parties, who I call ``index speculators,'' allocate 
money to the 25 key commodities futures that make up the two 
most popular indices: the Standard & Poor's Goldman Sachs 
Commodity Index, and the Dow Jones AIG Commodity Index.
    The first chart shows assets allocated to the commodity 
index trading strategies have risen from $13 billion to $260 
billion in the last 5 years, and prices have risen by an 
average of 183 percent over that same time frame.\1\
---------------------------------------------------------------------------
    \1\ The chart referenced appears in the Appendix on page 137.
---------------------------------------------------------------------------
    According to the CFTC and spot market participants, 
commodity futures are the benchmark for prices of actual 
physical commodities. So when index speculators drive futures 
prices higher, the effects are felt immediately in spot prices 
and the real economy.
    Looking at oil prices, the explanation given most often for 
rising oil prices is the increased demand for oil from China. 
According to the Department of Energy, annual Chinese demand 
for petroleum has increased over the last 5 years by 920 
million barrels. However, over the same 5-year period, index 
speculators' demand for petroleum futures has increased by 848 
million barrels. The increase in demand from index speculators 
is almost equal to the increase in demand from China.
    Let me say that again. The increase in demand from index 
speculators is almost equal to the increase in demand from 
China.
    In fact, index speculators have now stockpiled, via the 
futures market, the equivalent of 1.1 billion barrels of 
petroleum, effectively adding 8 times as much oil to their own 
stockpile as the United States has added to the Strategic 
Petroleum Reserve over the last 5 years.
    Chairman Lieberman. Why don't you repeat that one, too.
    Mr. Masters. In fact, index speculators have now 
stockpiled, via the futures market, the equivalent of 1.1 
billion barrels of petroleum, effectively adding 8 times as 
much oil to their own stockpile as the United States has added 
to the Strategic Petroleum Reserve over the last 5 years.
    Chairman Lieberman. Forgive me for interrupting, but just 
for clarity, is that real oil that they are stockpiling or 
contracts?
    Mr. Masters. These are futures contracts, which they roll 
over and over, so the effect is the same. It is via the futures 
markets. It has the same effect as a physical consumer.
    Chairman Lieberman. OK. Go ahead.
    Mr. Masters. Looking at food prices, when asked to explain 
the dramatic increase in food prices, many economists focus on 
the partial diversion of the U.S. corn crop to ethanol 
production. But institutional investors have purchased over 2 
billion bushels of corn futures in the last 5 years. Right now 
index speculators have stockpiled enough corn futures to 
potentially fuel the entire United States ethanol industry at 
full capacity for a year.
    Turning to wheat, in 2007 Americans consumed 2.2 bushels of 
wheat per person. At 1.3 billion bushels, the current wheat 
futures stockpile of index speculators is enough to supply 
every American citizen with all the wheat products they can eat 
for the next 2 years.
    Demand for futures contracts can only come from three 
sources: Physical commodity consumers, index speculators, and 
traditional speculators. Five years ago, index speculators were 
a tiny fraction of the commodity futures markets. Today, in 
many commodities futures markets, they are the single largest 
force. The huge growth in their demand has gone virtually 
undetected by classically trained economists who almost never 
analyze demand in the futures markets. Index speculator demand 
arises purely from portfolio allocation decisions. When an 
institutional investor decides to allocate 2 percent of their 
assets to commodity futures, for example, they come to the 
market with a set amount of money. They are not concerned with 
the price per unit. They will buy as many futures contracts as 
they need at whatever price is necessary until all their money 
has been ``put to work.'' Their insensitivity to price 
multiplies their impact on commodity markets. Furthermore, 
commodities futures markets are much smaller than the capital 
markets, so multi-billion-dollar allocations to commodities 
markets will have a far greater relative impact on prices.
    In 2004, the total value of futures contracts outstanding 
for all 25 index commodities amounted to only about $180 
billion. Compare that with worldwide equity markets which 
totaled $44 trillion at the time. That year, index speculators 
poured $25 billion into these markets, an incredible amount 
equivalent to 14 percent of the total market. The second chart 
shows this dynamic at work.\1\ As money pours into the markets, 
two things happen concurrently: The markets expand and prices 
rise.
---------------------------------------------------------------------------
    \1\ The chart referenced appears in the Appendix on page 138.
---------------------------------------------------------------------------
    One particularly troubling aspect of index speculator 
demand is that it actually increases the more prices increase. 
This explains the accelerating rate at which commodity futures 
prices are increasing. Rising prices attract more index 
speculators who want to profit from price increases.
    We calculate that index speculators flooded the markets 
with $55 billion in just the first 52 trading days of this 
year. That is an inflow of more than $1 billion a day. We 
believe that this is a primary factor behind the recent spike 
in food and energy prices.
    There is a crucial distinction between traditional 
speculators and index speculators: Traditional speculators 
provide liquidity by buying and selling futures. Index 
speculators buy futures and then roll their positions by buying 
calendar spreads. They never sell. Therefore, they consume 
liquidity and provide zero benefit to the futures markets.
    The CFTC has granted Wall Street banks an exemption from 
speculative position limits when these banks hedge over-the-
counter swaps transactions. This has effectively opened a 
loophole for unlimited speculation. When index speculators 
enter into commodity index swaps, which 85 to 90 percent of 
them do, they face no speculative position limits. In fact, the 
really shocking thing about the swaps loophole is that 
speculators of all stripes can use it to access the futures 
markets. So if a hedge fund wants a $500 million position in 
wheat, which is way beyond position limits, they can just enter 
into a swap with a Wall Street bank, and then the bank buys as 
a surrogate $500 million worth of wheat futures.
    I would like to conclude my testimony today by outlining 
several steps that can be taken to immediately reduce index 
speculation.
    One, Congress has closely regulated pension funds, 
recognizing that they serve a public purpose. Congress should 
modify the Employee Retirement Income Security Act (ERISA) 
regulations to prohibit commodity index replication strategies 
as unsuitable pension investments because of the damage that 
they do to commodities futures markets and to American 
consumers as a whole.
    Two, Congress should act immediately to close the swaps 
loophole. Speculative position limits must ``look through'' the 
swaps transaction to the ultimate counterparty and hold that 
counterparty to the speculative position limits. This would 
curtail index speculation, and it would force all speculators 
to face position limits.
    In conclusion, is it necessary for the U.S. economy to 
suffer through yet another financial crisis created by new 
investment techniques, the consequences of which have once 
again been unforeseen by their Wall Street proponents?
    This concludes my testimony.
    Chairman Lieberman. Well, that certainly frames the issue. 
Thank you, Mr. Masters, and we will come back to several of the 
questions you raised.
    Our next witness is Thomas Erickson, Chairman of the 
Commodity Markets Council, a trade association composed of the 
futures exchanges and members of the commodity futures trading 
industry. Mr. Erickson is a former Commissioner of the CFTC 
and, among other things this morning, I know he will share with 
us the insight of someone who has worked on both the regulatory 
and business sides of commodity trading.
    Thanks for being here.

TESTIMONY OF THOMAS J. ERICKSON,\1\ CHAIRMAN, COMMODITY MARKETS 
                            COUNCIL

    Mr. Erickson. My pleasure, Mr. Chairman. I am Tom Erickson, 
and I am Chairman of the Commodity Markets Council (CMC). It is 
a pleasure to be here. I also serve as Vice President of 
Government and Industry Affairs for Bunge Limited, which is a 
global agribusiness and food company.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Erickson appears in the Appendix 
on page 208.
---------------------------------------------------------------------------
    Mr. Chairman and Ranking Member Collins, Members of the 
Committee, the issues you plan to address today and are 
addressing are very important to markets and their users, and I 
thank you for convening this hearing. The CMC is privileged to 
participate.
    The Commodity Markets Council is a trade association that 
represents commodity futures exchanges and their industry 
counterparts, and the activities reflect the complete spectrum 
of the commercial marketplace involved in commodity futures.
    First, I would like to discuss the role of institutional 
investors and hedge funds in commodity markets. The CMC 
considers the investment activity of institutional investors 
and index funds as appropriate financial hedges. However, we 
recognize that these investments tend to be passive in nature 
and are not responsive to price levels or supply and demand 
fundamentals. Given the many concerns among commercial market 
participants about convergence of futures with cash, we believe 
the CFTC's recent decision to go slow in expanding current 
exemptions for this new class of investors will serve the 
marketplace well. It will also serve the CFTC and the market 
users, like Bunge, to give us more time to evaluate the impact 
this passively invested money may have on commodity markets.
    It is important to note that this type of investment is new 
and different, as has been mentioned, but it is not necessarily 
bad. Equally important is the distinction between passive 
investment and price-responsive investment. Typically, index 
funds are institutional investors who engage in passive 
investments. Passive investors typically buy a long position 
and hold it to a predetermined time. On the other hand, hedge 
funds tend to be more responsive to market signals, trading in 
a manner that is more similar to the traditional speculative 
participant that we have seen historically. As such, hedge 
funds are appropriately subject to speculative position limits 
of the markets and of the Commission.
    In the last decade, futures markets and physical 
commodities have grown immensely because of the growing 
relevance of their products. Increased liquidity in well-
functioning markets aids price discovery and generally enhances 
market efficiency.
    We recognize that passive investment in the commodity 
markets may have some price-lifting impact, but market 
fundamentals generally support the current price levels seen in 
the futures markets. Today's markets are reflecting global 
economics and trends. Speculative activity in futures markets 
may influence day-to-day prices, but it is ultimately 
relatively powerless in the face of these larger, fundamental 
forces that we are seeing.
    To address the concerns surrounding this new investor in 
commodity markets--that is, the passive investor--the Commodity 
Markets Council recommends: First, that exchanges and the CFTC 
continue to monitor index fund participation closely and be 
prepared, if necessary, to examine the structure of the hedge 
exemptions that have been currently granted.
    Second, the CMC would support legislation and regulations 
that allow the exchanges to continue innovating to provide new 
products to manage risks for those of us on the commercial 
side.
    And, finally, the Council recommends that the CFTC initiate 
a study of the trend toward ``alpha'' trading by index and 
hedge funds. It is a relatively new phenomenon where you have 
got index funds actually trading in a way to outperform the 
market.
    Next, I would like to briefly discuss margin requirements 
in the energy markets. With crude oil prices moving higher and 
higher, the Council shares the concerns of many lawmakers. We 
are confident in the ability of the CFTC's professional staff 
to monitor and evaluate trading in the regulated energy 
markets, as well as their conclusions about the impact of 
speculation on prices in the energy futures markets, and we 
will continue to look forward to working with them as we all 
face these unprecedented times.
    The Council is concerned about a provision in the Consumer-
First Energy Act. While the organization is generally 
supportive of the legislation, there is a provision that would 
require the CFTC to set ``a substantial increase'' in margin 
levels for crude oil. And while it appears the intent of the 
provision is to have some ability to lower prices, we believe 
that increased margin requirements unrelated to market signals 
could force many market participants off-exchange and perhaps 
into some of these less transparent markets that we have talked 
about and that the Enron loophole fix will at least give us 
some assistance. But that is one concern that we do have going 
forward.
    Finally, the Commodity Markets Council believes that it is 
important to discuss the unprecedented challenges facing the 
grain markets. The CMC recently brought together exchanges and 
exchange users to discuss futures market performance in the 
grain industry. The overriding concern expressed by 
participants and producer groups was the financial impact of 
high commodity prices and price volatility. Generally, 
participants did not blame institutional investors or hedge 
funds for pushing prices higher. Instead, they did identify 
five macroeconomic trends which I think we are all pretty 
familiar with, but I will list five of them here that came out 
of our own task force: One, strong economic growth in 
developing countries, such as China and India; two, increased 
demand for commodities used for biofuel production; three, 
reduced yields in some of the major global producing areas due 
to weather issues.
    Fourth is a relatively new development, and that is export 
controls. In the face of 60-year-low supplies of wheat and 35-
year lows of soybean stocks, we are seeing governments respond 
with export controls limiting supply to the global market and 
limiting the ability of the industry to really move efficiently 
stocks to areas of scarcity.
    And, fifth, the weakening U.S. dollar.
    Regarding technical futures market performance, 
participants in the Council's task force cited consistent price 
convergence as the primary area of concern, yet most of those 
interviewed by the task force urged exchanges at this point not 
to make dramatic changes to contracts until the markets can 
really adjust to this new operating environment of higher 
prices and increased volatility.
    For the short term, the consensus seemed to be changes were 
needed in the grain contracts that would increase storage rates 
to promote convergence during delivery of corn, soybeans, and 
wheat, and also giving the exchanges the authority to clear 
over-the-counter grain swaps as a new tool for risk management.
    In conclusion, these are very complicated times for the 
markets and market participants. The Commodity Markets Council 
believes that markets generally are the most efficient filters 
of information, and given time to respond, markets will and 
should adapt.
    Mr. Chairman, we compliment you and Senator Collins, for 
your efforts in this area, and we look forward to working with 
you. Thank you.
    Chairman Lieberman. Thanks, Mr. Erickson.
    Our fourth witness, Benn Steil, is a Senior Fellow and the 
Director of International Economics at the Council on Foreign 
Relations. In addition to being an expert on the behavior of 
institutional investors, Dr. Steil is one of our Nation's 
authorities on monetary policy. I once heard Bill Cosby say 
that the worst introduction that you could give him is to say 
he was the funniest man on the Earth, so I am worried that I am 
building you up too much. But the truth is you have had a very 
distinguished career, and we are particularly interested in 
hearing your thoughts not only on what we have discussed so 
far, but on the extent to which the weakness of the dollar 
today may be affecting commodity prices and obviously the 
relevant next step, which would be how would a stronger dollar 
affect commodity prices.
    In any case, thank you for being here, and we look forward 
to your testimony.

 TESTIMONY OF BENN STEIL, PH.D.,\1\ SENIOR FELLOW AND DIRECTOR 
    OF INTERNATIONAL ECONOMICS, COUNCIL ON FOREIGN RELATIONS

    Mr. Steil. Thank you, Chairman Lieberman, Ranking Member 
Collins, and Members of the Committee, for the opportunity to 
present to you this morning my views on the causes of rising 
financial speculation in commodities markets.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Steil appears in the Appendix on 
page 212.
---------------------------------------------------------------------------
    The sharp recent rises in global commodities prices, 
particularly in the energy and agricultural sectors, are 
undoubtedly causing hardship for many Americans and are indeed 
threatening the health of millions in developing countries. 
There is also no doubt that these price rises have been 
accompanied by a corresponding rise in interest from 
institutional investors in commodities as an asset class. The 
value of commodity index investments, for example, has grown by 
about one-third since the beginning of the year, to more than 
$250 billion.
    Certainly, much of this inflow is speculative in the sense 
that it is anticipating future supply constraints and robust 
demand. Both have been very much in evidence in recent years, 
and to the extent that speculation is driven by such factors, 
it is playing a proper and indeed important role; that is, 
signaling the need to expand investment in production capacity, 
and providing liquidity to hedgers.
    If this inflow is manipulative, on the other hand, it 
should be a matter of immediate regulatory concern. But there 
is very little evidence to date that it is. Low and declining 
levels of inventory for major food crops, for example, indicate 
no potentially manipulative hoarding going on in that sector.
    Now, so-called fundamental factors, related to supply of 
and demand for specific commodities, can certainly account for 
a goodly portion of the run-up in prices in recent years.
    The supply of global farm acreage and crop output is 
shrinking relative to a global population that is rising both 
in size and wealth.
    Rapidly growing demand from China is certainly part of the 
equation. Demand from China accounts for about 30 percent of 
the increase in crude oil demand over the past decade. A 6-
percent rise in base metals demand last year was driven by a 
32-percent increase in demand from China.
    The tripling in oil prices since 2004 has spurred the 
production of biofuels, like corn-based ethanol, which has in 
turn contributed to record prices in corn and rival grains. 
These in turn have made products whose production relies on 
grain-based feed, such as milk and eggs, more expensive. This 
year, about 30 percent of U.S. corn production will go into 
ethanol rather than into world food and feed markets.
    While all of these factors are acting to constrain supply 
or boost demand, governments around the world exacerbate these 
effects through public policy. Governments subsidize 
consumption of agricultural staples and energy products, for 
example, with the effect that demand does not moderate as it 
should. Governments have also been imposing agricultural export 
tariffs and bans, with the unintended consequence that farmers 
are motivated to reduce supply.
    Yet all these fundamental factors, as important as they 
are, cannot explain the magnitude of price rises in recent 
years. The stories about global population growth and the rise 
of China, for example, are by now very old.
    Many have recognized this and have, therefore, asserted 
that we are experiencing a commodities bubble. This conclusion, 
however, presumes that the U.S. dollar, which the world uses to 
price and trade commodities, is a fixed unit of measurement, 
like an inch or an ounce. Yet it is not, and, worryingly, it 
has become less so in recent years. Whereas the prices of oil 
and wheat measured in dollars have soared over the course of 
this decade, they have, on the other hand, been remarkably 
stable when measured in terms of gold--gold having been the 
foundation of the world's monetary system until 1971.
    It is, therefore, reasonable to conclude not that we are a 
experiencing a commodities bubble but, rather, the end of what 
might usefully be called a ``currency bubble.''
    The early 1980s witnessed the painful restoration of the 
global credibility of the dollar under the tight money policy 
of the Paul Volcker-led Federal Reserve. We reaped the benefits 
of this achievement in the subsequent decade. The period of the 
1990s through the early part of this decade was a golden age 
for the U.S. dollar. Investors around the world bought up 
dollar-denominated assets, and central banks sold off their 
gold reserves, believing they were no longer necessary or 
desirable, allowing our country to enjoy the fruits of a 
sustained period of low interest rates and low inflation. But 
the Federal Reserve has pushed rates too low and held them low 
for too long, and has since last autumn been exceptionally 
aggressive in driving them well below the rate of inflation. 
The Federal Funds Rate now stands at 2 percent, while consumer 
price inflation is near 4 percent and wholesale price inflation 
near 7 percent. More worrying, the latest survey from Reuters 
and the University of Michigan found that consumers' 1-year 
inflation expectations have risen to 5.2 percent, up from 4.8 
percent in April and 4.3 percent in March.
    The dollar's value against the euro being tightly linked to 
the interest rate differential between the currencies, 
investors have shifted funds dramatically from low-yielding 
dollars to higher-yielding euros in recent years. Much more 
worrying, however, the correlation between dollar depreciation 
and commodities prices has become dramatically more pronounced 
since 2007.
    Institutional investors around the world--prominent among 
them, large U.S. public pension schemes, such as the California 
Public Employees' Retirement System (CalPERS)--have come to 
view commodities as part of a rapidly growing asset class 
devoted to inflation protection.
    Longer term, governments themselves may actually fuel the 
upward commodities price trend by diversifying central bank 
reserves into commodities as a way to avoid precipitating 
further depreciation of their existing huge stocks of dollar-
denominated assets--in particular, U.S. Treasurys.
    What happens to commodities investment, and therefore 
commodities prices, going forward is, therefore, heavily 
dependent on the path of inflation and inflation expectations, 
and this path is itself critically dependent on developments in 
U.S. monetary policy.
    What policy measures, then, could help to relieve the 
damaging upward pressure on global commodities prices? I would 
identify two broad areas that merit attention.
    First, we and other nations need to revisit honestly and 
objectively the range of subsidies and taxes we apply to 
encourage or discourage consumption and investment in the 
agricultural and energy sectors. The mix is far from optimal 
and is becoming more damaging over time.
    Second, more of the burden of dealing with the fallout from 
the mortgage and interbank credit crisis should be moved on 
balance sheet. That is, Congress should look to targeted, 
explicitly funded, and market-oriented interventions to help 
revive the credit markets, which in turn will help revive the 
broader economy. To date, far too much of the burden has been 
borne by monetary policy, which is threatening to cause higher 
inflation, and leading individuals and institutions around the 
world to question whether the dollar will remain a credible 
long-term store of value. One highly undesirable result of this 
is soaring global commodity prices.
    Thank you, Mr. Chairman. Thank you, Senator Collins.
    Chairman Lieberman. Very interesting. Thank you, Dr. Steil.
    Our last witness is Tom Buis, who is President of the 
National Farmers Union. He is in a very good position, of 
course, to share the perspective of the family farming 
community, and we thank you, Mr. Buis, for being here.

  TESTIMONY OF TOM BUIS,\1\ PRESIDENT, NATIONAL FARMERS UNION

    Mr. Buis. Thank you, Mr. Chairman and Members of the 
Committee. I commend you for holding this hearing. This is 
probably the most friendly hearing I have been to in the last 
few months. It seems like everyone wants to blame farmers for 
everything, and we are finally getting the message across that 
there are a lot of other factors. It is not the price of those 
raw commodities, and I did not bring it with me today, Mr. 
Chairman, but we have a chart that we publish on our Website, 
the farmer's share of the consumer dollar. And it averages less 
than 20 percent, even at today's prices. And for all those 
people that want to blame everything on corn ethanol, I may 
just chime in. I got stuck in traffic for 2\1/2\ hours this 
morning, so I might as well blame it on that.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Buis appears in the Appendix on 
page 219.
---------------------------------------------------------------------------
    But there are a lot of factors at play. If you look at the 
skyrocketing energy prices and the impact that has on obviously 
food production, it is tremendous. You start at the farm. It 
takes a lot of energy to produce a crop. Farmers and ranchers 
are bearing the brunt of those higher energy prices, as our 
input costs have tripled over the past 2 years in many 
components, including petroleum-based fertilizers and 
pesticides. And there are a lot of hands that handle this 
product from the farmer before it gets to the consumer. And 
everyone has got their hand in the till, so to speak. Even the 
factors we are talking about today, the speculative limits and 
the speculation in the commodity markets, there are other 
factors that have not been discovered that I hope at some 
future date someone takes a look at, maybe some excessive 
profiteering going on between that farmer and the consumer, 
because I have been seeing the quarterly reports. There are a 
lot of people that have their hand in the till, and it is 
excessive.
    Energy prices no doubt have a huge impact, weather-related 
production problems, and like I mentioned, a lot of people want 
to blame corn ethanol for everything, but wheat and corn are 
not grown on the same acreage. That shifted 20 years ago, and 
that is because wheat is a less profitable crop. Most wheat 
production in acreage terms that increased both last year and 
this year. The problem was we had major weather-related 
disasters in all the major wheat-producing areas.
    The other thing was with rice, and we definitely had a 
worldwide problem with rice--not with the U.S. rice crop, which 
is bigger than it was even 3 years ago. But most rice, 90 
percent, is consumed within 60 miles of where it is produced. 
It was other worldwide areas.
    And, of course, there is the weak dollar. Several years 
ago, we did a chart--and I did not bring it with me, Mr. 
Chairman, but if you chart the strength of the dollar versus 
the value of commodities and commodity prices, you will see 
that when the dollar is weak, and it has reached its 30-year 
low, you have skyrocketing commodity prices on the markets.
    And probably more the issue today is the speculation in the 
commodities market. Is this having an effect? We would say yes. 
We do not fully know because we feel we do not have the full 
transparency needed to be able to address the problem.
    We have called on the U.S. Commodity Futures Trading 
Commission to do the following:
    Conduct a thorough and comprehensive investigation 
regarding the recent activities in the commodities market, 
including an explanation of the cotton market situation, which 
in a couple of weeks, we saw cotton prices on the futures 
market skyrocket. And some people say, well, that is probably 
market fundamentals, but it is not. We have cotton running out 
our ears. We have more cotton than we know what to do with. And 
when those prices went up, the cotton farmer could not get but 
about half that price bid to him. So there is something funny 
going on there, and it is not based on fundamentals, and we 
have asked for an investigation.
    We have asked for them to increase the transparency. 
Obviously, some of the sophisticated trading components on the 
futures markets have allowed certain transactions not to be 
reported through a clearinghouse on swaps, etc. It is pretty 
tough to say, as I think the CFTC has said, we do not see a 
problem when you do not know fully what is going on.
    Place a moratorium on any new commodity index trading, and 
evaluate the role and impact that the over-the-counter trading 
swaps are having on the market.
    Approve a proposal to clear swaps in certain over-the-
counter positions in an effort to create more transparency; not 
expand speculative limits, which was proposed in 2007; and take 
a broader look at the concept of manipulation.
    I am not really an expert on all these trading instruments, 
but last January and February, I started to get calls from the 
countryside where farmers were being shut out of using one of 
the most important financial risk tools that they have utilized 
over the years, and that was the ability to hedge the price of 
their commodities into the future, after harvest.
    As I mentioned, a lot of farmers have faced skyrocketing 
input costs, greater than ever. We have seen the biggest 
increase in inputs, yet they do not have the crop yet. And the 
way they protect their risk is to be able to contract it for 
delivery in the future. Many of those contracts were precluded 
because the tremendous rise in the commodities futures trading, 
the price on the markets, created a demand for margin calls. 
One country elevator in Kansas called me early in February or 
March and said they had a million bushels of wheat contracted 
with farmers for fall delivery, and their margin calls were 
$600,000 a day, 60 cents for each bushel.
    The problem becomes that the local elevator has a credit 
limit, just like with any business, with their bank. They were 
bumping up against their credit limit. So, in turn, they quit 
allowing that producer that tool to be able to manage his 
financial risk into the future.
    So it has had an impact. It has had an impact that so far 
we have not received satisfactory answers, I think, from the 
regulators or anyone else, and I commend you and the Members 
for holding this hearing. I also commend Senator Levin for his 
work on the farm bill, the veto of which hopefully will be 
overridden here shortly, and on closing the Enron loophole, and 
maybe we ought to close the latest loophole with the swaps. 
Thank you.
    Chairman Lieberman. Thanks, Mr. Buis. You provided us with 
a really good perspective from the farm, and I appreciate it.
    Let's do a 6-minute first round for each of the Senators 
because we have a good number of Senators here. We will keep 
going as long as Senators have questions.
    Mr. Masters has reached, it seems to me clear in his 
testimony, a baseline conclusion, which is that financial 
speculators, particularly index speculators, are contributing, 
I would say significantly, to higher commodity prices. Have I 
done you justice in that conclusion, Mr. Masters?
    Mr. Masters. That is right, Senator. It is important to 
understand that index speculators are a different--they are 
basically a subset of traditional speculators. I have no issue 
with traditional speculators. Their very nature of being 
passive, being long only, being buy and hold--these things make 
them wonderful investors in the capital markets, but it makes 
them terrible investors in the commodities markets.
    Chairman Lieberman. In other words, because they have a 
distorting effect on the markets and on the price of 
commodities.
    Mr. Masters. That is right. You have a situation in which 
they are effectively stockpiling these commodities via the 
futures markets, and they never use them. It begs the question, 
is anything an asset class? I mean, just because it is 
uncorrelated or it goes against what stocks and bonds have 
typically done in the past, is it worthwhile? Is it something 
that we should allow?
    Chairman Lieberman. And I take it that you are not saying 
that the index speculators are committing illegal acts. What 
they are doing is legal. In some sense, you are saying it ought 
to be illegal because of its effect.
    Mr. Masters. It is clearly a legal strategy, and the issue 
is the pension funds and the institutions that are doing it, 
they are not malicious. There is no malicious intent. There is 
no manipulative intent. But the issue is collectively it adds 
up. It is the analogy, where does the elephant sit in the room? 
Anywhere he wants. They look like one speculator.
    Chairman Lieberman. Yes. And I take it that, for instance, 
your conclusion and your recommendations do not of themselves 
deny, they may even confirm, some of what Dr. Steil has said 
about the impact of a weak dollar on their behavior.
    Mr. Masters. That is right. It is important to understand 
that prices do not move by themselves. People buy and sell 
things. Markets move because people take action. And an 
institution may decide to allocate to commodities because they 
have a view of inflation or they have a view of currency 
fluctuations. But the currency fluctuations themselves or their 
view on fundamentals do not impact the prices. What impacts the 
prices is their decision to act.
    Chairman Lieberman. Mr. Masters, is it possible for you to 
reasonably estimate what impact the index speculators, as we 
have defined them, are having on commodity prices, either by 
percentage or by categorizing it as little, moderate, or 
significant? How would you describe it?
    Mr. Masters. We think it is personally the single largest 
impact on commodity prices today because the size of the funds 
have grown. It is hard to understand----
    Chairman Lieberman. In other words, larger than the normal 
rules of supply and demand, weather realities, etc.
    Mr. Masters. Well, what is important to understand, 
Senator, is that these are a factor in demand.
    Chairman Lieberman. Right.
    Mr. Masters. They have dollars. Just like China is a factor 
in demand, these folks are a factor in demand. So if you are 
not studying investors, it is the old Willie Sutton analogy, if 
you will. Why did he rob banks? Because that is where the money 
is. I mean, if you understand where the money is coming from, 
then it is a little easier to understand what is motivating 
those decisions. Institutional investors are a focus for us 
because they are a component of demand today. And they are a 
component of demand that is one way, unlike traditional 
speculators.
    Chairman Lieberman. Right. Let me ask you to just spend a 
moment and further expand the two recommendations that you 
made. The second one was closing the so-called swaps loophole, 
and the first was to deal, through ERISA, I think you said, 
with pension fund flexibility. So just take them one at a time 
and just explain it in a little more detail what you would have 
us do.
    Mr. Masters. Sure. Well, many of these pension funds, as 
you are well aware, are tax-exempt institutions. They were set 
up in many cases for a public purpose. In many cases also, 
corporate pension funds are insured by the Pension Benefit 
Guaranty Corporation (PBGC). And so they have some benefits 
that are provided to them because of the theoretical public 
purpose that they provide. And the question that I ask is given 
this public purpose that they provide, should they be 
allocating to an asset class that has detrimental effects on 
American consumers at large? And I argue that they should not.
    So in terms of ERISA, it could be ERISA or it could be some 
other regulatory framework. But the practice of index 
replication should be stopped.
    Chairman Lieberman. You would specifically stop it 
legislatively?
    Mr. Masters. Yes.
    Chairman Lieberman. Just explain the swaps loophole one 
more time. I gather you would make sure that banks no longer 
have access to that loophole, that ability to do things that 
others cannot do in the markets.
    Mr. Masters. Right. The swaps loophole effectively 
circumvents position limits, so a small investor is subject to 
position limits, but large investors----
    Chairman Lieberman. And a position limit means how much you 
can have within the market?
    Mr. Masters. That is right. For instance, in wheat, you can 
have a total of 6,500 contracts for a total position limit. 
That is the total amount they have.
    Chairman Lieberman. OK.
    Mr. Masters. These are regulated somewhat in the sense that 
they have--the spot market that month, they are not allowed to 
exercise or to take delivery. But that is not their intent. 
Their intent is just to hold the asset. So it really does not 
change their behavior.
    Chairman Lieberman. Whereas, the banks uniquely have no 
such limits.
    Mr. Masters. I would have to get back to you on----
    Chairman Lieberman. Whether it is unique?
    Mr. Masters [continuing]. The specifics there, but 
basically banks function as a surrogate for investors to be 
able to go and operate. In other words, if I wanted to buy $500 
million worth of wheat, I could go to a bank, engage in an 
index swap. The bank would then buy the wheat for me, and I 
would own a swap contract.
    Chairman Lieberman. Right.
    Mr. Masters. Effectively, I would circumvent position 
limits.
    Chairman Lieberman. OK. And, again, your second suggestion, 
therefore, is for us legislatively to close that loophole.
    Mr. Masters. That is right. There should be transparency.
    Chairman Lieberman. Thank you. Senator Collins.
    Senator Collins. Mr. Masters, let me pick up where Senator 
Lieberman left off. I find your basic premise to be compelling. 
It seems to me that when you have this massive influx of funds 
by the index speculators who are buying and holding, just 
rolling over, not selling, that would drive up the cost beyond 
what you would otherwise see.
    On the other hand, I suspect if you talk to the managers of 
major pension funds or university endowments, they would argue 
that they are fulfilling their fiduciary responsibility under 
ERISA to get the best possible return for those who are going 
to be relying on those pensions in future years.
    So it seems to me we have an interesting conflict here. Is 
the public better served by limiting the ability of these 
pension fund investors, these institutional investors, to come 
into the commodity markets because it is artificially driving 
up the cost beyond what you would otherwise see? Or is the 
public good better served by ensuring that those retirees get a 
better future return as a result of the investment in 
commodities?
    So how do you resolve the conflict given that pension funds 
having a strong rate of return means fewer of them go broke and 
thus default onto the Federal Government's pension guarantee 
authority and that we want retirees to be able to have a good 
standard of living? I think that is a hard question.
    Mr. Masters. I think it is not maybe as hard as one would 
look at it on the surface, Senator. First of all, for the 
pension funds, they have lots of ways to express their view. If 
they want to express an inflation view, for instance, they can 
express it by buying TIPS, which are Treasury Inflation-
Protected Securities. That is a solution.
    If they want to invest in energy, they can buy Exxon. They 
can buy ConocoPhillips. They can buy Halliburton. They can buy 
many other companies. They do not need to buy inventories. The 
analogy that I would use effectively is, should institutions be 
buying all the tickets at Disney World when they could buy 
Disney World common stock? I mean, it seems ludicrous to buy 
all the tickets when you can just go and buy the stock. Should 
they be buying inventories that we need for production? I think 
that is a key issue. So they have plenty of opportunities to be 
able to have returns.
    There is another point which this brings up, and that is, I 
would imagine that if many retirees knew that their own pension 
funds were driving up the price of commodities, the price of 
gasoline that they buy on the way home from work, that they may 
not be happy to know that their own pension fund was costing 
them more in terms of groceries or fuel. I mean, I do not think 
people know this, and so this is one of the reasons I am here 
today. I wanted to raise awareness of this issue.
    Senator Collins. Mr. Erickson, why don't you accept the 
basic premise here. Explain to me why Mr. Masters' study is not 
a logical conclusion.
    Mr. Erickson. I do not think it is necessarily that there 
is a disagreement here. We in our testimony acknowledge that 
these passive investments can have a price-lifting impact on 
the market. As a point of distinction, one of the things that 
might help in clarifying, is that currently under the CFTC's 
rules and regulations, the pension funds cannot exceed 
speculative position limits on their own, nor can institutional 
investors.
    Senator Collins. Only if they go through the bank?
    Mr. Erickson. Which would be the swap, then.
    Senator Collins. Right.
    Mr. Erickson. But they are held to the speculative position 
limit so they cannot directly invest in those markets. There 
are several index funds that have petitioned the CFTC 
successfully in the last few years, I believe, to have 
exemptions from limits. And that is why we as an organization 
are saying to the CFTC it is appropriate to go slow here.
    There are a lot of factors that are hitting this market at 
the same time. Demand is one. We have gone through them all. 
And this certainly is another factor that we need to take the 
time to more fully evaluate the potential impact.
    Senator Collins. Do you think that there should be limits 
put on the ability of institutional investors to invest in the 
commodities market?
    Mr. Erickson. That is a terrific question, and I think that 
gets back to just this whole idea that we really need to 
evaluate, and I will give you an example of a situation that 
gives us pause.
    The wheat market that you referenced earlier in October 
2006 had an extraordinarily high level of index fund 
participation, and there were underlying market events that 
required commercial users to try and exit their short 
positions. And what we found in that relatively thinly traded 
market was that those folks were not in their roll period and 
that it was not real liquidity for commercial market 
participants. In other words, there was a seizing up of the 
market for about 2 weeks in wheat in October 2006 that 
exercised a great deal of financial pain for a number of 
participants.
    So there is that possibility, but we have taken the view 
that it is a reality that there is this interest, but we should 
not be going out and providing broad exemptions to this passive 
community.
    Senator Collins. Thank you.
    Chairman Lieberman. Thanks, Senator Collins. Senator 
Coburn, good morning. You are next.

              OPENING STATEMENT OF SENATOR COBURN

    Senator Coburn. Thank you. A couple of questions.
    Why should not all players in the commodity market be 
susceptible to a position limit, no matter where they are 
coming from? Does anybody disagree with that? Why shouldn't 
everybody be treated the same? Why should you have an advantage 
through a swap with a bank to be able to hold a position 
greater than what you would otherwise?
    Mr. Harris. I guess I can speak to that. The position 
limits in the markets actually are set during the expiration 
month, so most of the position limits we are talking about do 
not actually apply to most of the index trading in the sense 
that in the month before delivery, position limits typically 
are not binding. We have what we call accountability limits 
where before the expiration month, the CFTC views the market, 
sees who the participants are, and if they appear to be large, 
we basically have a call with them, interface with them, and 
say you are accountable for the position size that you have. 
And so we monitor the market that way. So most of the index 
trading, since they roll out of a commodity before the delivery 
month, do not really actually hit a position limit.
    So the position limits are usually in the marketplace 
because we want to limit the ability of a particular market 
class or a group of market participants to corner the market to 
try to pinch demand, to try to do something on a short squeeze 
during the delivery month. So that is really what position 
limits were intended to do.
    Senator Coburn. So, in essence, there is no difference 
between a swap and anybody else that is in the market?
    Mr. Harris. For the most part. Now, it is true that the 
commodity index trading--and we monitor this, and I think in 
response to some of these concerns a few years ago is why we 
started producing information about the index trading in the 
agricultural products because the swap dealers were not 
handling index trading at that time. So when we looked at a 
swap dealer's position, it was almost always exclusively 
handling an index trade.
    I guess the loophole might be classified in the oil or 
energy markets, we do have a large developed swap market that 
existed prior to this index trading. So if you look, for 
instance, at our data right now on swap dealer trades in crude 
oil, despite the fact that there is a tremendous amount of 
index trading in crude oil, the net position of a swap dealer 
as a group is actually short so that their business in handling 
over-the-counter swaps is actually completely offsetting the 
buying pressure from the index community.
    Senator Coburn. I am having a little bit of trouble with 
our commodity markets. I thought we had commodity exchanges so 
that we would level out price swings so that the real producer 
and the real consumer could go to the commodities market and 
hedge their positions so they could have price stability. And 
it seems from what we heard here today, we have anything but 
that.
    I think we need to go back and look at what the function of 
the commodity markets is if, in fact, they are not allocating 
this resource in a level way so the market can be transparent 
so people can make good decisions based on what the market is. 
How have we gotten away from the real function of a commodity 
market?
    I sit here and think, well, if I am a wheat producer, I 
ought to be able to sell into it; and if I am a consumer of 
wheat, I ought to be able to buy into it. And I am not sure, 
other than the commodity traders, who are the ones that create 
the liquidity, that we ought to have anybody else participating 
in this market; in other words, that the market has gone from 
what its original function was to something that is totally a 
speculative investment vehicle. How do you answer that?
    Mr. Harris. Well, I think from the CFTC standpoint, we do 
monitor it, and this is exactly why we are completely engaged 
with this development in the marketplace, and we are doing 
everything we can, week by week, day by day, to collect 
information and disseminate that information in hearings like 
this to make sure that people are informed about who is trading 
in our markets. Their Commitment of Trader Report comes out 
every week so we can see this.
    Now, I think it is true, though, historically that there 
has been a large degree of speculation interest in all of our 
markets. That is kind of the way futures markets operate.
    The one thing I would point out is that we have been 
engaged with the agricultural community as well. One of our 
agricultural hearing participants, we questioned them on 
whether there is a limit on the funds that are available, what 
is happening out in the heartland in access to finance, and why 
are people saying that they are not being able to carry their 
position and being squeezed out of the market from their margin 
calls. We brought Federal Reserve employees and got some 
reassurance that, despite the pain involved in the financing 
and the arrangement of higher credit limits, there is a lot of 
ingenuity going on out there, people recognizing they know what 
their production costs are going to be, they have been able to 
go to the futures markets and hedge that risk. The problem then 
becomes in maintaining that financing cost and carrying that 
position to when the crop is harvested.
    Senator Coburn. The elevator cannot do it.
    Mr. Harris. One thing I will point out is in these markets 
there is a record number of short positions from commercial 
participants. So the markets do seem to be working, and there 
is more interest now than there has been in the past.
    Senator Coburn. I am about to run out of time. I have two 
other questions.
    One, are pensions presently excluded under their limits 
from doing a swap?
    Mr. Harris. No.
    Senator Coburn. So they can participate in the swap index 
with a bank right now. They are not excluded.
    Mr. Harris. That is right.
    Senator Coburn. And, number two--and anybody can answer 
this--worldwide demand for oil has risen around 1 percent the 
last 2 years. Nobody disputes that. The total global demand. 
Why are we seeing such price inelasticity with this? You have a 
1-percent rise in demand, and you have a doubling in the price 
of oil. How does that explain a real market?
    Mr. Masters. It has to be another factor.
    Senator Coburn. That is right, and what is that other 
factor?
    Mr. Masters. To us, it is financial investors. I mean, they 
have never been here before to any size. Effective in 2003, 
they showed up and they have been here since. Investors, 
institutional investors, never looked at commodities as an 
asset class before 2003.
    Senator Coburn. So they are on permanent hold, they are 
just rolling a constant demand through the oil contracts and 
through the commodities contracts, the grain contracts. It is 
just a constant excess demand.
    Mr. Masters. Well, it is worse than that because it has 
been growing, so it is more demand every year. And if you think 
about institutional investment in terms of worldwide pension 
funds, collectively they are around $30 trillion. So they have 
allocated less than 1 percent of their investment to commodity 
futures as an asset class. There are many consultants out there 
that consult with this community that have recommendations as 
high as 10 percent. We can see what prices have done so far 
with just less than 1 percent of demand. Imagine, if we have 
another 10 percent, what prices will do then.
    There is lots of money on the sidelines looking at 
commodities as an asset class, and, again, that is why I am 
here. I am trying to raise awareness of this issue. This is 
absolutely important.
    Senator Coburn. Thank you, Mr. Chairman.
    Chairman Lieberman. That is a really important question, 
and with Senator Pryor's indulgence, Senator Coburn, if you 
want to ask it of any of the other witnesses. I would take a 
little time, if that is all right with Senator Pryor.
    Senator Coburn. Anybody else have a comment on that?
    Mr. Harris. I would like to address actually what we have 
seen in the data. One of the things we have seen, and 
particularly in the oil market, is that there is not only a 
demand for buying of the oil, but there is a tremendous 
uncertainty about supplies and uncertainty into the future. 
Five years ago, you could not buy an oil contract on the New 
York Mercantile Exchange (NYMEX) for beyond 4 or 5 years. Right 
now you can contract out more than 8 years in that space.
    So there are tremendous anxieties about world supplies. 
Since we are dealing with a futures market, most of these 
anticipatory events are priced into our markets. So I would not 
classify it as strictly a demand-driven thing. There has to be 
a buyer and a seller for each one of these commodities. And we 
find that not only is the record short hedging going on in the 
agricultural markets, but the hedging that is going on in the 
oil spaces extending out way beyond what we saw in the past.
    So the demand for hedging and the uncertain times that we 
live in, I think, is the primary factor in these markets.
    Chairman Lieberman. Dr. Steil, and then we will go to 
Senator Pryor.
    Mr. Steil. Senator, I agree that prices of commodities have 
skyrocketed, particularly over the past 6 years, and you cannot 
explain all of it looking at ``fundamentals.'' Fundamentals 
will only get you so far. But that does not mean that the 
interest in commodities as an investment vehicle has been 
willy-nilly. It tracks very closely developments in U.S. 
monetary policy and the decline of the dollar. And there is a 
deep, historical reason for that. If you go back throughout all 
of human history, until 1971, specific commodities played the 
role of money. It was often gold. It was often silver. But 
whenever people coalesced around one form of commodity as 
money, you saw the price of that commodity go up vis-a-vis 
other things.
    For example, in the late 19th Century, when countries 
around the world decided, voluntarily, to join the gold 
standard, demand for gold around the world went up, and the 
price of gold vis-a-vis other things went up very 
significantly.
    In the 1970s, that was a very bad period for the dollar and 
U.S. monetary policy, and, not surprisingly, people turned to 
commodities.
    When the Paul Volcker-led Federal Reserve restored the 
credibility of the dollar, you saw commodities prices plummet, 
and we really benefited from that for a very extended period of 
time.
    So when we ask, do commodity index investors push up 
commodities prices, undoubtedly they do. We have to say that 
anyone who buys commodities because they are looking at them as 
a substitute for money is pushing up commodities prices. And I 
agree with you, we should be deeply concerned about it. But I 
think it is very important that we ask ourselves why they are 
doing it.
    Chairman Lieberman. That is very interesting. So really 
what you have said is not inconsistent with Mr. Masters' 
conclusions about the impact of speculation on commodity 
prices. You are explaining why rational participants in the 
markets, worried about the decline of the dollar, the value of 
the dollar, will move to commodities to maximize their returns.
    Mr. Steil. The index investors, as it were, are the 
messengers, and I am concerned if we focus all of our public 
policy attention on the messengers, we are just going to induce 
them to send us the message through other vehicles.
    Chairman Lieberman. Yes. This is a good point, and this 
goes back to Senator Collins' point, because there is obviously 
a benefit. The pension managers are trying to maximize their 
returns for the beneficiaries of the pensions. But then if the 
managers of the pension funds do it through the commodity index 
speculation, then, of course, it has this terrible effect that 
we are hearing about or, at least, certainly contributes to the 
extremely high commodity prices.
    So I hear you, too, Dr. Steil. You are saying maybe Mr. 
Masters has a point, we should take some action there, but do 
not think that is the end of the problem; that really the 
underlying problem is that we have got to strengthen the dollar 
again.
    Senator Pryor.

               OPENING STATEMENT OF SENATOR PRYOR

    Senator Pryor. Thank you, and I want to thank both of you 
for this hearing. It is both interesting and helpful.
    I would like to start by following up on some of Senator 
Coburn's questions and also some of the things that you talked 
about in your opening statements and previous testimony.
    Mr. Harris, I will just pick on you since you are first at 
the desk. Just for clarification, the trading volume for 
commodities over the last 10 years has gone up considerably. Is 
that right?
    Mr. Harris. That is right.
    Senator Pryor. And about how many times has it gone up over 
the last decade?
    Mr. Harris. Total, probably like 600 percent or so.
    Senator Pryor. OK. And I am not sure that I got a clear 
answer on this from earlier testimony, but if we could just try 
to get a consensus on, for example, in the oil markets, what 
percentage of the price for oil today is based on speculation? 
If the speculators were out of the market, so to speak, how 
much difference would you see in a barrel of oil?
    Mr. Harris. I guess from our standpoint, speculators have 
to be in the market to be able to provide prices.
    Senator Pryor. I understand.
    Mr. Harris. I would say we would not have a market if there 
were no speculators.
    Senator Pryor. Right. But you understand what I am asking?
    Mr. Harris. Yes. I mean, this is what we have been chasing 
down.
    Senator Pryor. Yes.
    Mr. Harris. We have been trying to do study after study and 
trying to figure out the impact of different classes of 
traders.
    Now, the one thing we do not do in a market is we do not 
ask the traders' intent when they come to our market, but we 
know generally how they are classified. So we know a swap 
dealer from a floor broker from an index trader, for instance. 
So in the oil market, in particular, we have been looking for 
any footprint that shows from a daily price movement and a 
daily change of their positions whether commercial participants 
or non-commercial groups have been moving the price. We have 
yet to date to document that any group of speculative trades 
are moving prices. The general conclusions we get from the day-
to-day look on who buys on every day and what prices change on 
those days typically results in the fact in my testimony that 
if prices are up today, we will see a lot of speculative types 
of traders buying tomorrow. So that is the regularity we see.
    Senator Pryor. But you cannot really point to a dollar 
amount or percentage that type of investor adds to the price.
    Mr. Harris. I think my colleague John Fenton last week, I 
believe, testified. He would say zero.
    Senator Pryor. OK.
    Mr. Harris. Since we cannot find a footprint.
    Senator Pryor. Does the rest of the panel agree with that?
    Mr. Masters. I certainly would not. I mean, what moves 
prices? Magic? There is somebody buying and selling. I mean, 
clearly speculators, with the increase that they have had, they 
have to have had impact. There is just no question.
    One other comment in clarification of that. We do not 
actually know what the index traders are in crude oil because 
the CFTC does not release that data. We only get it on the 12 
agricultural commodities. It would be helpful if we could 
actually get that data from the energy markets as well as from 
the metals markets, something the CFTC currently does not 
provide.
    Mr. Harris. I would interject there that we do not provide 
it because we actually do not have it. We have classes of 
traders like I mentioned, and since a swap dealer in an 
agricultural product is almost exclusively doing index trading, 
we know that swap dealing trading is index trading. In the 
metals and the energy space, we know the swap dealers have vast 
amounts of other trading business that contaminates the index 
trading that they report to us.
    Senator Pryor. Did you all want to add anything to that?
    Mr. Buis. Senator, I would just add that I think all this 
calls for the modernization of giving CFTC the tools to 
accurately monitor all these newer trading schemes that have 
come up over the last couple decades. You cannot find out there 
is a problem if you cannot count it. And through the swaps and 
other mechanisms, I am not sure everyone is having a complete 
transparent look at what is going on.
    Mr. Steil. Senator, I would just add that the International 
Monetary Fund (IMF) recently suggested an estimate that about 
$25 of the recent increases in the cost of a barrel of oil 
could be attributed to the change in the level of the dollar 
since about 2002. One thing that I find quite telling is, as 
you will see in my written testimony, these sharp movements in 
prices of commodities are highly correlated with each other, so 
that very different assets, like wheat and oil, are moving 
upward together in tandem with the decline of the dollar. So 
you will see in one figure I show side by side the price of oil 
and wheat measured in dollars obviously trending up; and the 
price of oil and wheat measured in gold over the course of the 
decade, and they are both very flat. So this is a phenomenon 
that really cuts across almost all asset classes within 
commodities.
    Mr. Erickson. Two points. First, I think from our 
perspective, speculative liquidity is absolutely critical to 
well-functioning markets from a commercial perspective. People 
who are in the markets to hedge their risk to price movements 
need that speculative liquidity day in and day out to be there. 
The passive investor raises some new issues for us.
    Second, just maybe to build on Dr. Steil's comments, not 
only have we seen this increase in all asset classes of wheat 
and agricultural commodities with oil, there is an absolute 
correlation that has emerged where agricultural commodities are 
now tracking energy commodities really almost to their parity 
energy value levels, something that was not seen before the 
last 5 years.
    Senator Pryor. And the fact that agricultural commodities 
are tracking so closely with oil commodities, what conclusions 
do you reach from that? Why is that happening?
    Mr. Erickson. Well, the energy value of commodities, there 
has been some work done basically trying to correlate Btu 
energy values of corn and wheat with oil. And at some point, 
the highest and best economic value for the food commodities is 
to use them as energy because of their energy value. It is not 
just biofuels. It is decisions of whether to use pure vegetable 
oil as a substitute for diesel fuel in running plants.
    Senator Pryor. OK. Thank you, Mr. Chairman.
    Chairman Lieberman. Thanks very much, Senator Pryor. 
Senator Levin.
    Senator Levin. Thank you, Mr. Chairman.
    I quoted before the analyst for Oppenheimer and Company who 
said ``. . . speculators have seized control and it is 
basically a free-for-all, a global gambling hall, and it won't 
shut down unless and until responsible governments step in.''
    The president of Marathon Oil Company said that ``$100 oil 
is not justified by the physical demand in the market. It has 
to be speculation on the futures market that is fueling this.''
    The oil analyst for Citigroup said that the larger supply 
and demand fundamentals do not support a further rise and are, 
in fact, more consistent with lower price levels.
    At a joint hearing with Senator Dorgan's Subcommittee on 
Energy we held last December at the Permanent Subcommittee on 
Investigations, a man named Edward Kraples, who is a financial 
market analyst, testified, ``Of course, financial trading 
speculation affects the price of oil because it affects the 
price of everything we trade. It would be amazing if oil 
somehow escaped this effect.''
    So there is a whole lot of expert opinion in terms of the 
role of speculation, and the best estimate we had, Senator 
Pryor, when you asked the question: What percentage of the 
price of oil could be attributed to speculation? Our 
Subcommittee reached a conclusion, when oil was $70 a barrel, 
that about $20 of that $70 was the result of speculation.
    Senator Pryor. That is why I asked that question.
    Senator Levin. In supply and demand, that is where crude 
oil stocks are, right smack in the middle of the historical 
level of inventory for crude oil.
    As a matter of fact, since December 2007, crude oil 
inventories have gone up. At the same time, the price continues 
to go up. So if supply and demand were working, as the supply 
went up, the price would go down. But the price since 2007 has 
gone up--I had the figure here--from $90 a barrel to $127 a 
barrel. So you cannot just point to supply, shortage of supply, 
when our inventories are going up.
    We have a chart, which I want to put in front of our 
witnesses, that has to do with the amount of speculation.\1\ 
This is the amount of speculative purchase of future contracts, 
contracts for future delivery of crude oil, since 2000. I 
think, Mr. Harris, you would probably say, well, that is no 
proof that there is any relationship to the price of gasoline, 
but it sure has accompanied the increase in the price of 
gasoline.
---------------------------------------------------------------------------
    \1\ The chart referenced by Senator Levin appears in the Appendix 
on page 135.
---------------------------------------------------------------------------
    You may say, well, the first people who buy are the 
commercial folks, and then the speculators the next morning buy 
at last night's commercial price. Well, it is also true that 
tomorrow, then, the commercial people will be following the 
speculators' purchase today. I mean, your solution to the 
chicken-egg problem here is that the speculators are the ones 
that follow rather than support and sustain the commercial 
purchases, the real hedgers. And I do not think there is any 
more logic for your argument than there would be for mine, the 
reverse.
    What we do know is that the amount of speculation has gone 
up dramatically along with the price of oil and that there is 
an awful lot of experts out there who say that it is 
speculation which has been a significant cause.
    I could not agree with you more that currency differences 
are a cause. Of course, it is a cause. The value of the dollar 
going down is a cause. But to say that does not mean that 
speculation is not the cause. It just means there are other 
causes. And there are other causes.
    Mr. Erickson, I think you talked about some upward push 
from speculation. Have you put a dollar amount on that push?
    Mr. Erickson. I have not, no.
    Senator Levin. All right. Mr. Masters, you really have 
pointed out very effectively and dramatically the role of 
additional funds into the market in terms of the price of oil. 
Are you able to estimate how much of the $125-a-barrel price 
for oil is the result of either the hedge funds or the index 
funds, particularly the index funds, coming into the market? 
Have you been able to put a dollar amount on that?
    Mr. Masters. I think that is a tough question to answer. I 
think the answer is nobody really knows specifically. But I 
would say that when we talk to refiners and other industry 
contacts, they consistently come back to us and say, net of 
speculation, oil would probably be in the $65-$70 range today. 
They are the ones that make gasoline so I am going to rely on 
their judgment.
    Senator Levin. Another chart that I want to show to our 
witnesses shows the increase in the amount of speculative 
purchases since 2000.\2\ The bottom line there is the amount of 
future contracts. It has gone up about double. The top line is 
the amount of speculative purchasers of future contracts. It 
has gone up about 1,100 percent. And, by the way, the bottom 
line includes the index funds, so that if you put the index 
funds where they belong, which seems to me is logically in the 
speculative category, that lower line would probably be totally 
flat; and that upper line, which is the amount of speculation, 
would be even more dramatically going up.
---------------------------------------------------------------------------
    \2\ The chart referenced by Senator Levin appears in the Appendix 
on page 136.
---------------------------------------------------------------------------
    So, Mr. Harris, you are CFTC. You are supposed to be the 
cop on the beat here. You are supposed to be regulating 
excessive speculation, and I do not think you even recognize 
its existence. I do not mean you personally, I mean the agency.
    Mr. Harris. Right. Well, I would say exactly the opposite. 
The agency has been engaged with this particular development 
for years.
    Senator Levin. Engaged?
    Mr. Harris. Yes. We started studying----
    Senator Levin. I do not mean studying. I mean doing 
something about it.
    Mr. Harris. Well, I cannot speak to enforcement cases we 
have. We could give you a briefing on some of those. But we do 
have enforcement cases in this particular market.
    Senator Levin. In excessive speculation in oil?
    Mr. Harris. Well, I am not privy to everything there, but 
we could arrange for you to talk to----
    Senator Levin. Well, do you know whether or not there has 
been enforcement against excessive speculation in oil? This is 
oil trading I am talking about.
    Mr. Harris. We do not have, I believe, any public----
    Senator Levin. I am not asking for the names. I am just 
asking you if you know of any enforcement action.
    Mr. Harris. Strictly based on excessive speculation? Not 
exclusively on that, that I know of.
    Senator Levin. Strictly, not exclusively?
    Mr. Harris. Right.
    Senator Levin. You sound like a hedger.
    Mr. Harris. Well, mainly because one of the things we do is 
segment my fundamental economic research from the Enforcement 
Division.
    Senator Levin. But you could still know whether or not----
    Mr. Harris. Well, I would say our Department of Market 
Oversight (DMO), and our put-together office monitor this. We 
have updated these studies.
    Senator Levin. You monitor, you update, you study. You do 
not do a darn thing about it. That is the problem. You are 
supposed to be the cop on the beat. You are our regulator. The 
reason we closed the Enron loophole was to get a regulator. 
There was no regulator when it came to electronic trading, so 
we wanted a regulator there. We want a cop on the beat. You do 
not see the problem. You do not act against that incredible, 
dramatic increase in speculation, as far as I can tell, indeed 
you do not even recognize it. Your studies cannot even find a 
relationship between--we had a case involving a hedge fund, 
Amaranth. They held 70 percent of the natural gas market on the 
NYMEX. Winter natural gas prices went up dramatically. We had a 
CFTC witness in front of us at the Permanent Subcommittee on 
Investigations who said they could not find any role of 
speculation in that. This was a firm that had 70 percent, I 
believe, of the NYMEX natural gas market. Even then the CFTC 
saw no evil, heard no evil, spoke no evil, and did nothing.
    So I am just telling you, to me, unless the CFTC is going 
to act against speculation, we do not have a cop on the beat. 
No matter how hard we try to close the loopholes, without a cop 
to enforce it our efforts are not going to succeed.
    I went over. I apologize for going over, and I should not 
close without giving our witness a chance, but that is up to 
the Chairman if he wants to----
    Chairman Lieberman. To Mr. Harris?
    Senator Levin. Yes.
    Chairman Lieberman. Do you want to respond, Mr. Harris?
    Mr. Harris. Well, I think we are on record as having a 
record number of enforcement cases. I think Amaranth was an 
instance where----
    Senator Levin. On oil?
    Mr. Harris. On natural gas in particular, where we were not 
getting the information. I am fairly certain at this stage that 
we are getting information from all the traders in the oil 
market. There is an over-the-counter market that exists for 
these products that we do not see. That is entirely unknown to 
us.
    Senator Levin. Thank you.
    Chairman Lieberman. Thanks, Mr. Harris. Thanks very much, 
Senator Levin. Excellent questioning. Senator McCaskill.

             OPENING STATEMENT OF SENATOR MCCASKILL

    Senator McCaskill. Thank you.
    I am curious, Mr. Harris. If we have oil company folks up 
here and they raise their hand to take an oath and testify that 
speculation is accounting for anywhere from $30 to $50 a barrel 
for the price of oil, it seems weird to me that you say we do 
not think it is having any impact. I mean, how come they know 
it and you do not know it? If you are supposed to be in charge 
of regulating this, how come they can say it, how come Mr. 
Masters can talk about it from the refinery capacity, but you 
say you cannot tell us what the oil companies can tell us? 
Shouldn't you know that? And if you do not know it, what tools 
do we need to give you so you can figure it out?
    Mr. Harris. Well, I think we have some tools. One of the 
things we pointed out in my testimony is increased staffing and 
budgetary concerns that we have in being able to monitor these 
markets. But we have actually inquired to a number of people 
who have looked at that speculative premium, and when oil was 
at $60, we heard it was a premium, and it went to $80 and now 
some people say, again, $95 would be a good price.
    And so we do see that there is a moving target from other 
participants. We have been, like I said, engaged in this 
debate, trying to figure out from the data what is moving 
prices. The other regularity we do find is when commercial 
traders come to the market to buy, they do move the price. So 
we can uncover who does move the price up in a large number of 
instances, and particularly in oil. So we are doing the work to 
try to uncover exactly what is going on.
    Senator McCaskill. Well, I think any specificity you can 
come with as to what you need to get the data--I mean, if you 
have got the data on commodities but you do not have it on oil, 
the people of America are about to take up pitchforks, and we 
are feeling the heat here in Congress--as we should. It is our 
job to feel the heat. And I think that what Senator Levin was 
trying to communicate to you is that it does not appear that 
our cop on the beat feels the heat like we do. And, there seems 
to be a sense of urgency in these halls about this topic, and I 
know that part of this as your job is to be careful, cautious, 
and modulated. But I think we are all frustrated because it 
appears that you basically are saying, no harm, no foul. And, 
clearly, that line should worry you.
    Mr. Harris. I think clearly it does, and one thing I would 
welcome actually being here is to convey that message, that we 
are monitoring these markets on a daily basis. We are updating 
studies. We are referring different instances in particular 
cases to our Enforcement Division, and we do have an active 
engagement with both the commodities in agricultural and energy 
space.
    Senator McCaskill. Well, I think the more you can do and 
the more aggressive you can get--I mean, if you were Popeye, I 
would give you a can of spinach right now. I think it is time 
to muscle up here and get busy, because if you do not do it, we 
are going to figure out some way in Congress to impose it. And 
sometimes that has unintended consequences that probably most 
of the people at this table are worried about. But the pressure 
is real, and something is going to have to give.
    Mr. Buis, I wanted to ask you from the farmer capacity, 
what impact are the current market forces having on the plans 
of farmers for crop planting for the next couple of cycles? I 
am interested from a pragmatic standpoint, these incredibly 
high commodity prices, what impact is that having on my 
producers in Missouri as to their planting cycles?
    Mr. Buis. Well, I think the prices are doing a couple 
things. One, if you can capture the prices--which we have been 
precluded from capturing markets beyond this crop year. I think 
almost everyone has shut off offering hedge contracts for in 
the future. But you do see farmers follow the price. For 
example, 2 years ago, corn prices started to go up. Last year, 
farmers produced the biggest corn crop by far in history, 
almost 3 billion bushels more, which gave us a 13-billion-
bushel crop. That is unheard of.
    This year, I think you are seeing a shift back to 
soybeans----
    Senator McCaskill. Because beans got so high.
    Mr. Buis. Because bean prices came up. You saw more acreage 
go into wheat. With the higher rice prices, I think you are 
going to see it. But farmers are like any other business. They 
want to make a profit. And for a very long time, we have not. 
We welcome the higher prices, but the problem is we are not 
being able to necessarily able to capture them. And at the same 
time, we have these skyrocketing input costs because of energy.
    President Kennedy once said farmers are the only people 
that buy retail, sell wholesale, and pay freight both ways. It 
needs to be updated today because we also pay fuel surcharges 
both ways. We are price takers, not price makers. We have no 
ability to pass that on. We are at the mercy of the 
marketplace, and when the marketplace does not work, regardless 
of what the charts show, it is not working for farmers out 
there right at the moment. Action needs to be taken.
    Senator McCaskill. And the irony is that when I go to the 
Board of Trade in Kansas City, the pitch I get is how important 
that market is for the farmers in terms of predictability. Now, 
the irony of this situation is now we have these futures 
markets that are supposed to be helping the farmers, and they 
are not being able to access them.
    Mr. Buis. Absolutely.
    Senator McCaskill. Now, something is really wrong here, 
that the very ability to be able to forward contract is being 
cut off to the people who need them the most.
    Mr. Buis. Absolutely, and if you look at wheat, for 
example--and we do have a shortage of wheat. The wheat stocks 
are at record lows. But wheat prices got very high in February 
and March when farmers did not have it and many were shut off 
from being able to forward contract that wheat for delivery 
after harvest. Now they are getting ready to harvest in States 
like Oklahoma and Texas, and prices are down to under $8 a 
bushel, almost half of what it was in those high times when 
they were shut out.
    Senator McCaskill. There is certainly an irony there. Thank 
you, Mr. Chairman.
    Chairman Lieberman. Thank you, Senator McCaskill. Senator 
Carper.

              OPENING STATEMENT OF SENATOR CARPER

    Senator Carper. Thank you, Senator Lieberman.
    To our witnesses, we are grateful to you for being here. I 
said to Senator Lieberman and Senator Collins, when I was in 
for a short period of time earlier in the hearing, that we just 
concluded a markup in the Senate Banking Committee on a couple 
of important issues, and I have been detained there, but I am 
glad to be here before you have left, and we appreciate very 
much your testimony and responses to our questions.
    While I was here for a little bit earlier, one of the 
things that I heard in the conversation was that among the 
primary factors that are driving run-ups in the commodity 
prices for oil and other commodities is the drop in the value 
of the dollar, and that certainly is understandable. And I once 
studied economics a little bit, and so I believe in the law of 
supply and demand. As we see demand increases in places like 
China and India for oil products, that certainly would have 
some effect.
    But I sense from a little bit of what you have said, and 
what I have read and heard elsewhere that there is more than 
just a drop in the value of the dollar; there is more than just 
a change in supply and demand. There is more going on here than 
that. And I would just ask you, is there any consensus from 
this diverse panel as to what beyond those two factors has 
caused the price of a barrel of oil to go from, about a year 
ago, roughly $60 or $70 to, today, $120 or so? What else is 
going on here? And what, if anything, should we in Congress do 
about it? And what, if anything, should the Executive Branch of 
our government do about it?
    I am happy to start with Mr. Harris, if you do not mind.
    Mr. Harris. Well, I guess from my perspective, the 
fundamental change in the market was highlighted by Dr. Steil. 
I mean, that particular underlying fundamental factor, interest 
rates and using commodities as a portfolio hedging tool is the 
driving force here.
    We have been searching for behavior in our markets and 
behavior across markets, and like I mentioned in my testimony, 
we see market prices falling in live cattle and hog markets, 
where the percentage of index traders is actually greatest. 
Almost half those markets is participation by index traders, 
and yet those prices are falling. So from the market operations 
standpoint, we do not see where there is a lot of regulation 
that is going to be beneficial.
    I think the other related topic is that we do have farmers 
that we are hearing from that are having issues with margin 
calls. One of the proposals has been to raise margins. Well, we 
already know what happens when people have higher margins to 
meet. It drives small elevators and grain dealers out of 
business. And so that gets at the wrong end of the problem, I 
believe.
    So I guess my personal feeling, after looking at all this 
data perpetually for the last 9 months since I have been in 
this job, is that there are fundamental reasons in the broad 
economy and worldwide that move these prices.
    Senator Carper. And the second half of my question was what 
advice do you have for us, if any, as to what we should be 
doing in the Congress to respond to the run-up in the prices, 
particularly the food commodities, but especially oil for my 
interest. And what advice do you have for us? What advice do 
you have for the Administration?
    Mr. Harris. Well, I think the chairman of the CFTC would 
probably like me to be a little bit more tenuous in those 
recommendations on policy. But I would focus on those broad 
economic consequences and broad economic policies rather than 
trying to pinpoint behavior necessarily in the marketplace.
    Senator Carper. All right. Thank you. Mr. Masters.
    Mr. Masters. Sure. I believe your question, Senator, was--
--
    Senator Carper. I am looking for some advice. I am trying 
to find out what else is going on here other than the two 
factors we have mentioned and what advice do you have for the 
Legislative and Executive Branches.
    Mr. Masters. All right. Well, we are really focused on 
index speculators, as we have described in our testimony. We 
think that is the primary or one of the primary drivers here.
    It is interesting that everybody on the panel talks about 
fundamental factors and whatnot. What we are talking about is 
participants. Fundamental factors do not drive prices. 
Participants acting on the perception of those fundamental 
factors drive prices. There is a key difference. It takes 
people to drive prices.
    So, clearly, we feel like index traders or index 
speculators are a group that really have no place in the 
commodities futures markets and their practices should be 
excluded.
    Senator Carper. Excluded by whom?
    Mr. Masters. By Congress, either through ERISA or through 
some other legislation. So that would be one solution.
    The other solution we offered earlier in our testimony was 
to close the swaps loophole which allows effectively unlimited 
speculation by that category of participant and others. And, 
again, whether or not it is in the contract month is really 
immaterial. What is important is that they have an impact on 
price. They are never going to take delivery, so having a 
restriction on them in the spot month that prevents them from 
taking delivery is not really a restriction. The key issue is 
to not allow the practice to begin with, because that is where 
the price behavior starts.
    Senator Carper. Good. Thanks very much. Mr. Erickson.
    Mr. Erickson. Thank you. I guess I would maybe step back a 
little bit and look at, again, the fundamental of supply and 
demand. In the agricultural sector, we are looking at 60-year-
low supplies for wheat. We are at 35-year or 40-year lows in 
global stocks for other commodities. And, I think the markets 
generally are crying for supply, and I think that may be in 
energy as well.
    The International Energy Agency a week or two ago came out 
with its ``sobering finding.'' It said, that if the world gave 
up all biofuels production tomorrow, we would have to find 
another million barrels of crude oil every day.
    So I think the market is responding to a sense, a 
perception of scarcity across the board, in addition to other 
fundamental factors.
    Senator Carper. Thank you, sir.
    Mr. Steil, I heard some of what you said, but if you want 
to add anything to that, please do.
    Mr. Steil. On page 6 of my written statement,\1\ I included 
a graphic showing the changes in correlations between the U.S. 
dollar and specific commodities, and it is quite interesting. 
The correlation between the gold price and the price of the 
dollar has always been very tight, because historically, 
whenever the dollar has depreciated, people have bought gold.
---------------------------------------------------------------------------
    \1\ The graphic referenced by Dr. Steil appears in the Appendix on 
page 217.
---------------------------------------------------------------------------
    What is new specifically since last year is the huge 
increase in the correlation between dollar depreciation and the 
prices of other commodities. This is brand new. Or at least we 
have not seen it since the 1970s.
    For example, the correlation between wheat prices and 
dollar depreciation has become really quite remarkable. So it 
is clear that what is going on in the market is that people 
have been reacting to what the Federal Reserve has been doing 
very aggressively since last summer--that is, cutting interest 
rates, now for good reasons, with good motivations, in order to 
try to forestall a recession. But I would argue that some of 
the problems that they have tried to address with monetary 
policy--for example, the horrible interbank credit crunch--
could be better dealt with, as I call it, on balance sheet with 
specific targeted programs that Congress could run that are 
explicitly funded.
    For example, in December, in the Financial Times, I wrote 
an op-ed supporting the creation of a new Resolution Trust 
Corporation that would offer to buy up subprime mortgages at 
very deep discounts, which I believe would induce banks to get 
these mortgages back on their balance sheet once they had a 
watertight price at which they could mark them and would induce 
other financial institutions in the industry to buy these 
things up knowing that there is a floor to the price.
    Now, by doing something like that, we take the burden off 
the Federal Reserve, the burden off monetary policy, and stop 
inducing people to buy commodities as a substitute for the 
dollar.
    Senator Carper. All right. Thanks so much. My time has 
expired. For our last witness, very briefly do you have 
anything you would like to add?
    Mr. Buis. I would just add one thing. The most immediate 
relief is what you guys did last week in suggesting that the 
President quit filling the Strategic Petroleum Reserve. I would 
suggest you dip into that. And as far as the prices for farm 
commodities, I just remind everyone this is a country that has 
never had food shortages. We continue to produce. And as an 
elderly farmer once told me, ``The best cure for high commodity 
prices is high commodity prices. It will attract more 
production.''
    We have been in a decade of low prices, and we are just now 
coming out, and I think you will see the productive capacity of 
farmers respond to higher commodity prices.
    Senator Carper. Thank you for those words of wisdom. Thank 
you. Mr. Chairman, thanks so much.
    Chairman Lieberman. Thank you, Senator Carper.
    Mr. Buis, I was just thinking, if I am not mistaken, at the 
end of the Clinton Administration I believe President Clinton 
did go into the Strategic Petroleum Reserve and move some of 
what was there out into the market, and it did have an 
immediate short-term effect on prices. So it is something for 
us to think about, although, obviously, that is not the answer 
to the problem. But it is a form, at least, of temporary 
relief.
    Mr. Harris, I think in having you here as the Chief 
Economist of the CFTC, we have also, based on the direction of 
the testimony and the interest of the Members of the Committee, 
made you into a spokesperson for the Commission overall, 
probably an unfair thing to do to you, but you happen to be the 
person here.
    I have talked to Senator Collins, and I think that we would 
like to do another hearing here and have the chairman of the 
CFTC, and perhaps some others from the Administration, who 
design economic policy to respond to some of the specific 
recommendations that have been made here.
    But pending that, and understanding that, and understanding 
your role, am I hearing you correctly in saying that for you 
personally, there is no additional statutory authority, that 
you would like to see the U.S. Commodity Futures Trading 
Commission have to deal with the run-up in commodity prices?
    Mr. Harris. Yes, that is right, I think we have engaged 
with that process. We are happy, I think, with the closing of 
the Enron loophole that is in the farm bill right now. We are, 
as I mentioned in my testimony, hearing what is going on in the 
marketplace in agricultural and energy space, and we do have, I 
think, forthcoming fairly shortly some policy changes, and some 
of the issues there I do not think require statutory changes. I 
think this issue about whether index trading is visible in all 
commodity products is an issue we have been engaged with to try 
to figure out how can we be more transparent there.
    We can get estimates of that type of trading in some 
markets but not all, and I think those types of things I think 
we could probably handle internally without legislative input.
    Chairman Lieberman. Am I correct that you cannot handle 
internally what Mr. Masters has called the ``swaps loophole''? 
Or can you? Would that require legislation?
    Mr. Harris. I think we can handle that ourselves, yes.
    Chairman Lieberman. You do? And actually closing the swaps 
loophole?
    Mr. Harris. Well, typically the CFTC does not set position 
limits, first of all, so we do not set the speculation limits, 
but we work closely with the markets that we oversee to make 
sure that the markets recognize that they are properly 
functioning correctly in our eyes. So I think we would have 
some moral persuasion and some other ways of actually engaging 
with the industry to say here is what we see going on.
    Now, part of that issue is uncovering something that we see 
that is detrimental in our markets, so that is something that 
we have had a proposal from our agricultural market, for 
instance, to have a moratorium on commodity index trading, to 
have other types of things that we could execute within the 
Commission.
    Chairman Lieberman. Well, I hope you will take back with 
you the sense of urgency and, frankly, the favorable response 
that I believe most Members of the Committee have had to what 
Mr. Masters had said, understanding that is not the whole 
problem, that the other response here is that we understand 
that the weak dollar, which is in part the fault of government 
policy, is a part of the problem. In fact, perhaps it is a 
significant part of the motivation for the speculative 
activity. I hope you will go back to the Commission on that, 
and I would look forward, when we call the Chairman, to hearing 
what more the CFTC can do to deal with this problem because I 
think the current status of the response is unacceptable to us. 
And, believe me, we are speaking in rational Senate language. 
Our constituents are less diplomatic because they are hurting, 
and that is what it is all about.
    I do want to ask you about one kind of authority you have 
now, which is, as was referenced, the authority to address 
excessive speculation. And as I understand it, the Commission's 
use of this authority has been limited and has applied 
primarily to trading dates or certain types of contracts and 
certain types of traders. But I wonder whether any of the kind 
of behavior--and this is perhaps a stretch, and if it is, we 
ought to know because we may want to change the law to give you 
more clearly defined authority--whether some of the kinds of 
activities that Mr. Masters particularly has pointed to of 
index speculation in the markets comes under that statutory 
power that you have now to deal with excessive speculation. Do 
you have an opinion on that?
    Mr. Harris. Yes, I would agree that defining and 
determining what excessive speculation is is difficult.
    Chairman Lieberman. How would you define it?
    Mr. Harris. Usually we look for a connection, and the way 
we are looking at that, is any one group of trader or type of 
trader moving prices in response to their trading? So is there 
a real reason for the trading? And does that trading move 
prices in any way to the detriment to the rest of the market? 
That is precisely the types of analyses we are doing. We are 
doing it on a daily basis. We are aggregating it up to a weekly 
basis. We are looking at different time horizons, different 
intervals.
    Chairman Lieberman. Right.
    Mr. Harris. Believe me, we are actively engaged in----
    Chairman Lieberman. Sure. And are you looking for an effect 
on the integrity of the markets or on the price?
    Mr. Harris. A little bit of both. We determine market share 
of each individual trader, for instance, to make sure that 
there is no one group or one set of market participants in 
addition to each individual market participant not having a big 
market share. And then we try to connect changes within each 
individual trader or types of trader groups. We aggregate up to 
the commercial/non-commercial. We have been looking at moving 
the swap dealers into the non-commercial. We have been looking 
at different combinations of each subgroup of types of traders 
that we have in an effort to try to connect either their 
trading behavior with the price movements or their trading 
behavior with some excessive amount of participation in the 
market. And that is where we really come to the conclusion that 
since each trade involves a buyer and a seller, somebody is 
speculating and someone is hedging, despite the fact that there 
is this separation between hedgers and speculators, the amount 
of volume in our markets reflects a large degree of hedging in 
our market as well.
    Chairman Lieberman. As a baseline, do you believe that 
there can be such a thing as too much speculation in the 
commodity markets?
    Mr. Harris. Yes, and that is, in fact, why we are updating 
our study on a weekly basis. We are looking at the numbers as 
they come out each week. We get a daily report. We have been 
running the thing. And one of my concerns is exactly that, we 
want to make sure we are at the cusp or we are in touch with 
the fact when prices seem to deviate from what we would expect 
to be happening in the marketplace.
    Chairman Lieberman. OK, thanks. My time is up. Senator 
Collins.
    Senator Collins. Thank you.
    Mr. Harris, my question is along the same lines. 
``Excessive speculation'' seems to be a very vague term. You 
have talked a lot about studying the different movements in the 
markets, the players, and I guess the frustration that some of 
us have is it sounds very academic when we are dealing with oil 
prices at $127 a barrel. And it sounds very academic when our 
constituents cannot afford to heat their homes or fill their 
gas tanks.
    What we are trying to get a better understanding of is not 
only the factors that are pushing up the prices, which seemed 
unrelated to some extent to normal supply and demand, as Mr. 
Masters has said, but also whether the Commission has the 
authority and the resources to do this job, to police these 
markets. So let me end by asking you a couple of questions.
    First of all, in my opening statement I referenced what the 
chairman of the Commission told me about the staff declining by 
12 percent over the past 30 years, and yet the volume of trade 
soaring by 8,000 percent. Do you believe that the Commission 
has adequate resources to monitor what is an increasingly 
complex market with new players?
    Mr. Harris. I think we are doing the best job with what we 
have. I mean, one of the things we can do is use technology to 
leverage up and so if we have a market that is reporting 100 
trades or 100,000 trades, basically our same analysis can run a 
couple nanoseconds slower. But I think it is a well-known fact 
that we are at record low staffing levels, that our budgets 
have been operating on a stilted budget for the last 2 or 3 
years, that reauthorization is in the farm bill so we have 
plans already to do a technology upgrade to try to connect 
better with our marketplace, to try to make the transition from 
the data into the analysis smoother, that we have the people 
there that when we flag illicit behavior or suspect behavior in 
our markets, that we have the enforcement staff to go after 
those people.
    So is there more we can do? Obviously. I think there is 
always more you can do in these markets.
    Senator Collins. Well, let me ask you a second question, 
and that is about your authority. How would you define 
``excessive speculation''? There is a definition of fraud. You 
can probably identify price manipulation when you see it. But 
``excessive speculation,'' what does that mean?
    Mr. Harris. Well, I would say I think we have been looking 
at this problem exactly that way. In the futures market, when 
two buyers show up, you are bidding on the same actual item in 
the futures market, you could each have a contract, and if a 
third person shows up in the market, we could write a third 
contract.
    One of the areas that we are looking at is that mechanism 
and whether we can find some aspect of the writing of these 
contracts leveling off while prices continue to go up so that 
there does not seem to be liquidity added into the system, and 
yet prices still rise.
    So those are the types of analyses we are trying to get our 
hands on.
    Senator Collins. Well, Senator Levin showed you what I 
thought was a very compelling chart that shows the increase of 
speculative trades. Does volume determine whether you are 
finding excessive speculation?
    Mr. Harris. I would caution against using volume as a 
proxy. One of the things that came out of that that we did not 
address is that one of the things we are finding is that we 
know, for instance, in the oil and energy space, there was a 
very well developed, large, over-the-counter trade going on. 
One of, I think, the positive developments of the last 5 years 
as partially reflected in those charts is the fact that more 
and more of these over-the-counter trades are based on whether 
it is credit concerns or other concerns that they have about 
counterparties are moving more of that trading onto our 
markets. So part of that increase reflects, I believe, trades 
that would have happened prior to this, over the counter with 
the traders on their trading desks without reporting to the 
authorities.
    We think or we are fairly certain that a large degree of 
that is trades that we are seeing now that 5, 10 years ago we 
were not seeing. So in that regard, that is also consistent 
with the fact that our reported volumes are higher.
    Now, we have talked with people on Wall Street who say that 
you can still contract in oil out to 2023, so if you want to 
get a 15-year oil contract, you cannot get it at the NYMEX but 
you do that over the counter. So there is still a large, over-
the-counter market that we are not seeing, but I think part of 
the positive sign of that chart was that we are seeing more 
people in the organized exchanges, where we can see them, where 
we can monitor them; and when we see them acting in a way that 
is not beneficial to the rest of the market participants, we 
can step in.
    Senator Collins. What would be your assessment of the 
impact on the markets if we were to adopt Mr. Masters' 
recommendation and somehow either amend ERISA or take other 
actions to limit or even prohibit large institutional investors 
from trading on the commodities market?
    Mr. Harris. I think it is related to what I just said. One 
of the things we do know is that there is a large over-the-
counter market for a number of these products, at least in the 
energy space.
    Senator Collins. So you think that it would just go to the 
over-the-counter markets?
    Mr. Harris. That would be part of the shift, I believe, 
yes.
    Senator Collins. Mr. Masters.
    Mr. Masters. I think that if you eliminated the practice 
through ERISA or some other regulation, they would not be able 
to go on the other markets. If it is a prohibited practice, 
they cannot do it, period. So whether it is traded on the CFTC 
exchange markets or it is over the counter, no pension trustee 
is going to do something that is blatantly illegal. They are 
just not going to do that.
    Senator Collins. Right.
    Mr. Masters. So, clearly, if you change the practice or 
prohibited them, it would make their decision much easier. They 
just would not do the practice.
    Senator Collins. Mr. Harris, I am trying to get at a more 
fundamental issue, and that is, would it harm the commodities 
markets?
    Mr. Harris. One concern we have--well, I guess generally 
speaking markets are most healthy when you do not have 
artificial limitations on who can participate. We have seen 
that when people are limited to the commodity space or futures 
in particular, they will transfer their trading to the options 
market. Or we noticed in the Minneapolis Grain Exchange, when 
their wheat contract went way up, a large degree of that 
trading went to the Chicago Board of Trade wheat contract, 
which really is not the same underlying product, but people 
were looking for an asset that is related.
    So I think in some respects, you would be diminishing the 
effectiveness of hedging. We do not know how much information 
would not get to the market if that were the case.
    Senator Collins. OK. Thank you, Mr. Chairman.
    Chairman Lieberman. Thanks very much, Senator Collins.
    I do not want to go on too much longer at all, but, Mr. 
Masters, I appreciated your answer to the question about if we 
just tell pension funds they cannot do this kind of speculation 
and index speculation in commodities, that they will not be 
able to do it anywhere. And that would have a significant 
effect on the problem you are describing, but what about others 
who we would not cover with that, who might either go to the 
over-the-counter or even overseas markets in commodities? Is 
there an answer for that?
    Mr. Masters. I do not think that you can prohibit every 
investor from ever doing anything.
    Chairman Lieberman. Right.
    Mr. Masters. We are in a large, interconnected world. That 
being said, it is extremely unlikely that the investment 
consultant community is going to recommend to university 
endowments, sovereign wealth funds, other pension funds, 
especially on this politically charged issue, to engage in 
index replication strategies when you have banned it for one 
group. I think that it is likely that many of those groups 
would probably get the message that this is not the kind of 
behavior that we like to see from our institutional investors.
    Chairman Lieberman. OK. This has been a very productive 
morning, and I thank all of you for the time and expertise you 
have brought. This is a wonderfully diverse panel. We had a 
good exchange of ideas. I think we learned a lot.
    My own thought, just to provoke us to the next stage and 
try to focus the question, is that we might try to--and I am 
going to ask my staff to work with you, Mr. Masters. We might 
try to at least outline legislation in the two areas that you 
mentioned--limitations on index speculating by large 
institutional investors and closing the swaps loophole--and 
then bring in another panel of witnesses, including the 
chairman of the CFTC, and perhaps some others, and essentially 
ask them why not do this; or why, if they agree that we should. 
And that may focus the discussion.
    My own conclusion is that index speculators are responsible 
for a significant part of commodity price increases that are 
really hurting a lot of individuals, a lot of businesses, and 
we ought to see if we can do something about it. Again, it is 
not illegal behavior. It is the old line from that old book. 
This was an alleged, slightly fictional New York City political 
boss at the beginning of the 20th Century: ``I seen my 
opportunities, and I took 'em.'' And the reasons, as Dr. Steil 
has said, come back to the rest of the work we have to do to 
strengthen the dollar. But sometimes in the public interest we 
have got to limit the opportunities that people have to 
maximize their profits because the rest of us end up paying 
through the nose as a result, including a lot of people who 
really cannot afford to pay through the nose.
    So that will take us to the next step, but I thank you very 
much. We are going to keep the record of this hearing open for 
14 days. That is to allow any of you who want to add anything 
to your testimony to do so. You may get some questions. I know 
Senator Coleman, for one, had another hearing he had to go to, 
but he will file questions for the witnesses because he is very 
interested in this subject.
    Again, I thank my colleague Senator Collins, and I thank 
all of you.
    The hearing is adjourned.
    [Whereupon, at 1:03 p.m., the Committee was adjourned.]


 ENDING EXCESSIVE SPECULATION IN COMMODITY MARKETS: LEGISLATIVE OPTIONS

                              ----------                              


                         TUESDAY, JUNE 24, 2008

                                     U.S. Senate,  
                           Committee on Homeland Security  
                                  and Governmental Affairs,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:30 a.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Joseph I. 
Lieberman, Chairman of the Committee, presiding.
    Present: Senators Lieberman, Levin, Carper, Pryor, 
McCaskill, Collins, Coleman, and Warner.
    Also Present: Senator Isakson.

            OPENING STATEMENT OF CHAIRMAN LIEBERMAN

    Chairman Lieberman. Good morning. The hearing will come to 
order. Welcome to this Committee's third hearing on the subject 
of skyrocketing food and energy prices.
    In the last two hearings, we focused on the role of 
financial speculators to determine if their increasing 
participation in the commodity markets is a cause of rising 
food and fuel prices. Evidence presented to this Committee has 
persuaded me that speculators are, in fact, a significant 
contributing factor to the economic distress now being felt by 
American consumers every time they stand in the grocery store 
checkout line or pay for a fill-up at the gas pump. That 
distress, obviously, is being also felt in many ways by 
American businesses, small and large.
    That is why, at the end of our last hearing, Senator 
Collins and I asked our staffs to draft legislation that might 
address this problem. Last week, we made those drafts public, 
posted them on the Committee Website, and solicited public 
comment. Today, we are going to take testimony on these draft 
proposals which we hope and believe can bring relief to 
American family and business budgets.
    Since we initiated this inquiry nearly 2 months ago, a lot 
has happened on this subject and with this problem. The U.S. 
Commodity Futures Trading Commission (CFTC) itself has 
announced at least four new initiatives to address speculative 
activity. And last week, the chief executive of the New York 
Stock Exchange (NYSE) said that investments by large 
institutional investors, particularly pension funds, were 
completely altering the supply and demand for commodities. Our 
colleagues here in Congress have introduced at least eight 
bills on this subject, most of them focusing on market 
transparency. But some go further by seeking to bring foreign 
or over-the-counter markets under Federal regulation.
    Concern about speculation in commodity markets and its 
impact on prices is not confined to the United States. At the 
recent G-8 meeting, a number of our closest allies and trading 
partners, particularly France, Italy, and Japan, raised this 
concern. And, in fact, the final G-8 statement from that 
meeting asks national authorities, ``to examine the functioning 
of commodity futures markets and to take appropriate measures 
as needed.''
    Austria has proposed a European-wide tax on commodity 
speculators, and a report recently released by the 
International Monetary Fund (IMF) concluded that, ``Speculation 
has played a significant role in the run-up in oil prices as 
the U.S. dollar has weakened and investors have looked for a 
hedge in oil futures (and gold).''
    So what we are doing here today is not in isolation and not 
without very credible support. The three draft discussion 
documents Senator Collins and I made public last week would: 
One, extend transparency to unregulated commodity markets by 
closing the so-called swaps loophole; two, create a seamless 
system of speculative position limits that would apply to all 
commodity trading--on the exchanges, over the counter, and on 
foreign exchanges; and, three, restrict commodity investments 
by large institutional investors that invest through index 
funds. And I want to stress that the legislative proposal would 
restrict commodity investments by large institutional investors 
only so far as they invest through index funds.
    I want to be clear that when I talk about financial 
speculators, I am talking about those looking to commodity 
price appreciation or depreciation to generate profits. 
Increasingly left on the sidelines are bona fide hedgers--the 
farmers, the fuel oil dealers, and others for whom the 
commodity markets were originally created as a way to reduce 
their risk by locking in prices on next year's crops or oil 
production.
    Let me also be clear that I understand that some 
speculation in commodity markets helps them function, but the 
speculation taking place now has gone way beyond that. One of 
the public comments we received through the Committee Website 
is, I think, particularly insightful and instructive. It came 
from a commodity broker in Iowa, and it reads like this: ``I 
have seen firsthand the effect that these index funds have had 
on the agricultural markets. My customers are farmers, and they 
are getting tired of not being able to make sense of the 
markets. Although they are happy with the price of grains, 
almost to a man they will tell you that prices are too high. 
With these high prices, the price of their inputs has gone up 
as well, i.e., land, rent, fertilizer, seed, etc. To my 
customers, the fundamentals of supply and demand mean nothing 
anymore. These index funds and exchange-traded funds are not 
living by the same rules that the CFTC set up for speculators. 
They need to be made to come into compliance with the 
speculative limit the rest of the market participants have to 
abide by.''
    That is real common sense from the heartland, and I think 
that voice of that commodity broker from Iowa is one that we 
should keep in mind as we consider what Congress can and should 
do about this legislation and this problem.
    I also want to say--and I think it is important to say--
that speculation in the food and fuel futures markets is not 
illegal. But that does not mean that it is not very hurtful. To 
paraphrase a character in an early 20th Century political 
novel, speculators are just seeing their opportunities and 
taking them. Motivated by the weakness of the dollar and rising 
demand for oil and food, speculators are moving enormous 
amounts of money into commodities markets for the obvious 
purpose of making more money. But in so doing, they are 
artificially inflating the price of food and fuel futures and 
causing real financial suffering for millions and millions of 
people and businesses. The steady upward climb of the cost of 
food and energy in recent months is not simply the result of 
natural market forces at work. Speculation has passed the point 
where it provides stability to the commodity markets. It is now 
excessive and has consequences that are very harmful.
    And that is why I believe our government must step in as 
soon as possible to protect our consumers and our economy 
because against the forces that are raising the cost of food 
and fuel, the average person simply cannot protect himself or 
herself.
    Senator Collins.

              OPENING STATEMENT OF SENATOR COLLINS

    Senator Collins. Thank you, Mr. Chairman, for holding this 
critically important hearing this morning.
    High energy costs are having a devastating impact on our 
economy and on our people, especially people in large, cold, 
rural States like Maine. Truck drivers, small business owners, 
fishermen, farmers, and countless others are struggling with 
the high cost of oil and gasoline. In Maine, where 80 percent 
of our homes are heated with oil, many families simply do not 
know how they are going to cope with the record high cost of 
heating oil this coming winter. For many of them, it is truly a 
crisis.
    The high cost of energy is also taking a toll on businesses 
throughout our Nation. For example, the paper mill in 
Millinocket, Maine, recently announced that it would be closing 
down because it is no longer profitable due to the cost of oil. 
If this occurs, the community will be devastated by the loss of 
more than 200 good jobs.
    What is troubling to me is that the harmful spike in energy 
cost does not appear to be caused solely by supply and demand 
factors, as the Chairman has pointed out. Compelling evidence 
gathered by this Committee suggests that excessive speculation 
in futures markets is also a significant factor pushing up the 
price of oil.
    The increased cost of energy certainly reflects 
fundamentals, including the increased demand from China and 
India and the depreciation of the dollar. But massive new 
holdings of oil futures contracts by pension funds, university 
endowments, and other institutional investors who neither 
produce nor take delivery of oil also appear to be driving up 
prices. Their intentions may be simply to provide good returns 
and investment diversification, but many experts believe their 
activities are distorting commodity markets and pushing prices 
upward.
    I am pleased to be working with Chairman Lieberman once 
again to write legislation that will help our Nation, this time 
by preventing excessive speculation in energy and agricultural 
commodity markets. And I commend the Chairman for his far-
sighted leadership.
    I do have serious concerns about one major provision in the 
draft legislation, and that is the proposed ban on 
institutional investors using index funds to trade in the 
commodity futures markets. While I believe that the influx of 
money from pension funds, university endowments, and other 
institutional investors has had a detrimental impact on prices, 
prohibiting their investment risks harming current and future 
retirees. After all, pension fund managers are investing in 
commodities as a way to diversify their holdings, hedge against 
inflation, and improve returns, all in keeping with their 
fiduciary obligations. In my judgment, an outright ban would 
have unintended consequences for retirees relying on these 
pension funds.
    That does not mean, however, that I do not believe that 
reforms are called for. I do. Senator Lieberman has proposed 
other policy options to address the effects of excessive 
speculation that make a great deal of sense to me. These 
proposals would limit the percentage of total contract holdings 
that non-commercial investors could maintain in any one 
commodity market and would close the swaps loophole that 
currently allows financial institutions to evade position 
limits intended to prevent an investor from cornering a market.
    As we identify and evaluate these and other policy options, 
we obviously must take care not to cripple the usefulness of 
futures markets for the producers, handlers, and purchasers of 
commodities who need to lock in prices, hedge risks, and see 
clues for price trends.
    There are two other issues that are of critical importance 
and concern to me. The first is ``dark markets,'' and the 
second is resources for the U.S. Commodity Futures Trading 
Commission. There are still gaps in publicly available data to 
track the effect of speculation on prices--price manipulation 
that I fear could go undetected in certain markets because they 
lack regulation or because trades are not adequately disclosed 
to regulators. This is why I have called for increased 
regulation and transparency in futures markets to guard against 
excessive speculation and price manipulation. And it is why I, 
along with the Chairman--Senator Levin was a leader on this--
supported closing the Enron loophole for electronic exchanges.
    A related concern is ensuring that the CFTC has the 
resources it needs to collect and analyze data, monitor 
trading, and police markets. The Commission's Chairman recently 
testified that the trading volume of commodities futures 
contracts and options has soared from 27 million back in 1976 
to more than 3 billion contracts last year. Yet today there are 
fewer employees at the Commission than there were in 1976, 
leaving much more work for far fewer staff. With Senator 
Lieberman's support, I hope to include provisions in our 
comprehensive bill that will rectify this resource shortcoming.
    Beyond lacking sufficient resources, I believe the 
Commission has been less than aggressive in using its existing 
authorities. To be fair, the Commission deserves credit for its 
recent investigations into market activity, its stronger data-
sharing agreement with British authorities, and its withdrawal 
of proposed rules to raise speculative position limits on 
agricultural commodities. But I would have felt better if the 
Commission had taken these actions more proactively rather than 
in response to prodding from lawmakers and public opinion.
    As usual, we must perform a careful balancing act, not 
simply for the abstract goal of market efficiency, but for the 
concrete goal of easing hardship for real people who are 
struggling with inflated food and energy costs.
    I welcome our panel of witnesses, and I thank them for 
helping us evaluate our policy options. Working together, I am 
confident that this Committee can develop effective measures to 
curb excessive speculation, guard against price manipulation, 
and protect consumers who are suffering from high food and 
energy prices.
    And, again, Mr. Chairman, thank you for your leadership on 
this vitally important issue.
    Chairman Lieberman. Thanks very much, Senator Collins, for 
that thoughtful statement, even the part in which you disagreed 
with one of my proposals. This is probably good because it will 
prove, contrary to public belief, that you and I do not agree 
on everything.
    Senator Collins. That is true.
    Chairman Lieberman. And we will reason together, as we 
always do, on that. I thank the Members of the Committee who 
are here. I particularly want to, as I did last time, thank 
Senator Levin, who really was way ahead of the rest of us in 
focusing on, this problem that we are focused on now. I think 
Senator Coleman worked with him at some point along the way as 
well, and so their work is a preface to what we have done.
    I also want to welcome Senator Isakson, not a member of the 
Committee but who asked if he could sit in on the hearing, and 
we are delighted to have him here.
    We will go right to the witnesses now. I thank you for 
being here. I believe that there is a vote tentatively 
scheduled for 11:15 a.m., so we will try to move as quickly as 
we can and maybe rotate our departures to vote so we can keep 
the hearing going.
    The first witness is Walter Lukken, Acting Chairman of the 
U.S. Commodity Futures Trading Commission. Mr. Lukken was 
appointed Acting Chairman in June of last year, but has served 
as a CFTC Commissioner since 2002 and currently chairs the 
Commission's Energy Markets Advisory Committee.
    Thank you for being here, Mr. Lukken. We welcome your 
testimony.

 TESTIMONY OF HON. WALTER L. LUKKEN,\1\ ACTING CHAIRMAN, U.S. 
              COMMODITY FUTURES TRADING COMMISSION

    Mr. Lukken. Thank you, Mr. Chairman, other distinguished 
Members. I appreciate being here today to testify on the role 
of excessive speculation in the futures markets.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Lukken appears in the Appendix on 
page 222.
---------------------------------------------------------------------------
    During the last few years, the futures markets have changed 
dramatically in both size and products and complexity, 
experiencing 500-percent growth in both volume and products 
listed. Today's exchanges are technology-driven corporations 
that trade electronically, 24 hours a day, all around the 
globe. Approximately $5 trillion of notional transactions flow 
through these U.S. exchanges every day. This description alone 
would make the oversight of these markets a challenge for 
regulators. But add to it the subprime crisis, record energy 
and commodity prices, the influx of financial funds into the 
futures markets, and historic low staffing levels at the CFTC, 
and it is clear that these are challenging times for this 
agency.
    Recent substantial increases in the price of crude oil have 
put considerable strain on U.S. households. These issues are a 
matter of intense focus at the Commission due to the key role 
that futures markets play in the price discovery of these 
products.
    The CFTC recognizes that these markets and their 
participants have evolved significantly in the last several 
years. Concerns have been raised about the role of speculators 
and index traders in these markets. As prices have escalated, 
the CFTC has pursued an active agenda to ensure that the 
commodity futures markets are operating free of distortion.
    These initiatives fall into five broad categories: one, 
increasing information and transparency; two, ensuring proper 
market controls; three, continuing aggressive enforcement 
efforts; four, improving oversight coordination; and five, 
seeking increased funding.
    The proper oversight of markets requires transparency. 
Market regulators must receive the necessary information to 
surveil the markets, study long-term financial trends, and 
evaluate policy changes as circumstances evolve. The backbone 
of the CFTC's market surveillance program is its large trader 
reporting system. All large traders must file daily with the 
CFTC their futures and options positions in the markets. This 
information enables the CFTC's surveillance economists to 
oversee all traders of size to ensure that no one is attempting 
to manipulate these markets.
    As markets have become electronic and global, the CFTC has 
been working to expand its trade data collection to accommodate 
these trends. On May 29, 2008, the CFTC announced an agreement 
with the U.K. Financial Services Authority to greatly expand 
the trader data already received from IntercontinentalExchance 
Futures Europe on its linked crude oil contract that settles 
off the NYMEX crude oil benchmark, including receiving 
equivalent daily large traders reports on all months traded. 
This cross-border information sharing is unprecedented among 
global regulators.
    The CFTC has also taken action to improve the transparency 
of index traders and swap dealers in the energy markets. In 
late May, the CFTC announced that it would use its special call 
authorities to gather more detailed data from swap dealers on 
the amount of index trading in the markets, and to examine 
whether index traders are being properly classified for 
regulatory and reporting purposes. These information requests 
have been sent, and the CFTC expects in the coming weeks to 
begin receiving more detailed information on index traders in 
the markets that are being conducted through swap dealers.
    After analyzing this data, the CFTC will provide a report 
to Congress by September 15 regarding the scope of index 
trading coming into the markets and recommendations for 
improved practices and controls, should they be required.
    Beginning last fall and finalized last month, the 
Commission worked with Congress to enact legislation as part of 
the Food, Conservation, and Energy Act of 2008 (farm bill) 
requiring exempt commercial markets that trade linked energy 
contracts to provide the CFTC with large trader reports and 
impose position accountability and position limits on these 
products. Congress and this agency believed that these 
authorities were necessary to protect the regulated energy 
marketplace.
    As noted earlier, linkages between contracts are not purely 
a domestic occurrence but happen across borders. Most energy 
and agricultural commodities are global commodities operating 
in a global marketplace, and the U.S. futures markets have been 
facing the challenges of cross-border trading and regulation 
for many years.
    For more than a decade, the CFTC has utilized its mutual 
recognition process for foreign exchanges that allows U.S. 
institutions access to those markets by striking a balance 
between protecting the U.S. regulated marketplace and the 
acknowledgment that increased globalization of commodity 
markets requires international cooperation and coordination 
between governments.
    With this balance in mind, last week the CFTC announced 
modifications to its Foreign Board of Trade process. After 
consultation with the British Financial Services Authority, the 
CFTC revised the access letter of IntercontinentalExchange 
(ICE) Futures Europe to require the implementation of position 
limits and accountability levels on its linked crude oil 
contracts. The CFTC will also require other foreign exchanges 
that seek such direct access to provide the CFTC with large 
trader reports and to impose position and speculative limits on 
those products. This combination of enhanced information data 
and additional market controls will help the CFTC in its 
surveillance of its regulated domestic exchanges while 
preserving the benefits of its mutual recognition program.
    During these turbulent economic times, the environment is 
ripe for those who want to illegally manipulate the markets. In 
late May, the Commission took the extraordinary step of 
disclosing that, since December 2007, its Division of 
Enforcement has launched a nationwide crude oil investigation 
into practices surrounding the purchase, storage, trading, and 
transportation of crude oil products and their related 
derivatives contracts. Strong enforcement is imperative during 
this time.
    Given the CFTC's size and the enormity of the global 
marketplace, the CFTC must also engage others in government as 
we seek to meet our important mission. Two weeks ago, the CFTC 
announced the formation of an interagency task force to 
evaluate developments in the commodity markets, which includes 
staff from the CFTC, the Federal Reserve, the Department of the 
Treasury, the Securities and Exchange Commission (SEC), 
Department of Energy, and the Department of Agriculture. I have 
also invited the Federal Trade Commission (FTC) and the Federal 
Energy Regulatory Commission (FERC) to participate as well, 
given their expertise in these related energy matters. The task 
force is intended to bring the best and brightest minds in 
government together to study these issues so we understand how 
the markets are functioning.
    If it sounds busy, it is--especially given that the 
agency's staffing levels are near record-low numbers. Since the 
CFTC opened its doors 33 years ago, the volume on futures 
exchanges, as Senator Collins mentioned, has grown 8,000 
percent while our staffing levels have decreased 12 percent.
    As the agency embarks on new authorities and initiatives in 
order to respond to changing market conditions, it is 
imperative that these be met with adequate resources. The CFTC 
is in the midst of implementing the new farm bill authorities 
that were led by Senator Levin and others on this Committee, 
which require many programmatic changes in our legislation and 
just plain old hard work from a staff that is already under 
considerable strain. Additionally, the agency's staff is racing 
to implement the measures that I have outlined earlier in my 
testimony. Recall as well that our employees are full-time 
regulators, charged with overseeing these markets each and 
every day. Without proper funding, the agency will not be able 
to sustain this pace for much longer.
    In summary, the Commission shares this Committee's concern 
for the current market conditions in the energy markets and for 
the high prices of crude oil and gas on consumers, workers, and 
businesses. These are difficult economic times, and the 
Commission recognizes the need to respond accordingly to ensure 
that futures markets are working properly for all Americans.
    Thank you very much, and I welcome any questions you may 
have.
    Chairman Lieberman. Chairman Lukken, thanks for your 
testimony. I must tell you that I am disappointed that nowhere 
in your opening statement have you responded to the request 
that Senator Collins and I made in our letter of invitation to 
the witnesses, which is to offer comment on the three draft 
proposals. I am going to ask you about that in the question 
period.
    I also must say that I hear that you have acted against 
manipulation, but I do not hear any recognition from you that 
speculation is a problem. And I understand you are busy, but 
most of the business that you have described sounds to me like 
study instead of action that will bring relief because this is 
a crisis in the real lives of people in this country every day. 
Senator Collins and I happen to both be from New England. We 
are thinking a lot about the cost of home heating oil this 
winter, and I just think the Administration and Congress have 
to get together and decide where the problem is and act quickly 
because the problem is urgent. And I believe that we have the 
power to offer relief, and shame on us if we do not. So I will 
come back to that in the question period.
    The next witness is James E. Newsome, President, CEO, and 
member of the board of NYMEX Holdings, parent of the New York 
Mercantile Exchange, which is the main American exchange for 
trading in oil futures. He has been at NYMEX since August 2004. 
Prior to that, Mr. Newsome served as Chairman of the CFTC, 
beginning in December 2001, and before that was a CFTC 
Commissioner. In addition, Mr. Newsome serves on the board of 
the Dubai Mercantile Exchange, the Canadian Resource Exchange, 
the National Futures Association, and the Institute for 
Financial Markets.
    Thanks for being here, Mr. Newsome. We welcome your 
testimony now.

  TESTIMONY OF HON. JAMES E. NEWSOME,\1\ PRESIDENT AND CHIEF 
            EXECUTIVE OFFICER, NYMEX HOLDINGS, INC.

    Mr. Newsome. Thank you very much, Mr. Chairman.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Newsome appears in the Appendix 
on page 232.
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    NYMEX is fully regulated as a derivatives clearing 
organization and a designated contract market, which is the 
highest and most comprehensive level of regulatory oversight 
for a trading facility. My comments today in this oral 
testimony are only as it relates to NYMEX markets and not to 
foreign boards of trade or over-the-counter markets.
    The ever increasing cost of energy touches all aspects of 
our daily lives, and today it is quite possibly the most 
important issue facing both global and domestic economies.
    The Commodity Futures Modernization Act of 2000 (CFMA) 
ushered in a period of phenomenal growth in derivatives 
markets. The CFMA has proven to be the gold standard of U.S. 
financial policy. For the most part, the value and success of 
the CFMA holds true today. However, neither the Congress nor 
the conference possessed a crystal ball, and it was impossible 
at that time to determine how some markets would develop. In at 
least two instances, markets have developed differently than 
anyone could have anticipated at the time.
    First, an over-the-counter natural gas contract trading on 
an unregulated exempt commercial market could mirror an 
exchange-traded natural gas contract, and the two contracts 
could become very closely linked. Ultimately, the over-the-
counter contract began to serve a price discovery function. 
Market participants could and did easily move positions from 
the regulated exchange to the exempt commercial market to avoid 
regulatory requirements such as position limits. This scenario 
was investigated by the Senate Permanent Subcommittee on 
Investigations chaired by Senator Levin and was addressed 
effectively in an amendment to the recently adopted farm bill.
    Second, foreign boards of trade began offering futures 
contracts with U.S. delivery points to U.S. customers pursuant 
to CFTC no-action letters. Historically, foreign exchanges were 
permitted to offer direct access to their markets to U.S. 
customers based on a determination by CFTC staff that the 
foreign regulatory regime governing foreign boards of trade was 
comparable to that of the CFTC.
    This approach worked very effectively until a foreign board 
of trade listed the look-alike of the NYMEX West Texas 
Intermediate (WTI) Crude Oil Futures contract without the level 
of transparency and market surveillance controls such as 
positions limits that are require on U.S.-regulated markets. It 
was never anticipated that the no-action process would be used 
in this manner.
    NYMEX has suggested for 2 years that foreign boards of 
trade offering linked products should be required by the CFTC 
to provide the same level and quality of data and at the same 
frequency that U.S. exchanges provide to the CFTC.
    In addition, we believe that no-action letters for foreign 
boards of trade offering contracts with U.S. delivery points 
should be conditioned to impose position limits and/or 
accountability levels. And we appreciate the fact that the CFTC 
announced last week to do just that.
    Much has been said recently regarding the role of 
speculators in energy markets. Speculative activity on U.S.-
regulated futures exchanges is managed effectively by position 
limits. For the NYMEX WTI crude contract, the position limit 
during the last 3 days of the expiring delivery month is 3,000 
contracts. Breaching that position limit can result in 
disciplinary action being taken by the exchange.
    Many believe that speculators, particularly index funds and 
other large institutional investors in our markets, are 
responsible for the high price of crude oil. Data from NYMEX 
confirms non-commercials are relatively balanced between long 
and short open positions for NYMEX crude oil futures. Thus, 
non-commercials are simply not providing disproportionate 
pressure on either the buy side or the sell side of the crude 
oil market. In fact, since October 2007, swaps dealers in the 
NYMEX crude oil markets had been holding overall net short 
positions. Thus, any price impact attributable to swaps dealers 
would be to lower prices, not to raise them.
    Questions are being raised as to whether hedge exemptions 
for swap dealers are being used by index funds and other 
institutional investors as a means of circumventing speculative 
position limits. The full extent of participation by swaps 
dealers as well as what, if any, influence they are having on 
current market prices and volatility cannot be determined 
without accurate data. NYMEX believes that more precise data 
are needed to better assess the amount and impact of this type 
of trading, and NYMEX fully supports the further delineation of 
this data in the CFTC large trader report.
    In addition, we continue to believe that market 
fundamentals are the most important factor in the current 
market. Uncertainty in this jittery, very tight global crude 
market regarding geopolitical uncertainty, refinery and 
deepwater well sabotage and shutdowns, decreasing production by 
non-OPEC producers and increasing global demand, as well as 
devaluation of the U.S. dollar, are clearly having an impact on 
the assessment of market fundamentals.
    In futures markets, margins function as financial 
performance bonds and are used to manage financial risk and to 
ensure financial integrity, not to control volume flow. 
Adjusting margin levels significantly upward will not change 
the underlying market fundamentals, but instead will force 
trading volume away from the regulated and transparent U.S. 
exchanges into less regulated or even unregulated opaque 
markets.
    A number of legislative initiatives have been proposed that 
are intended to respond to perceived problems of excessive 
speculation in the markets. NYMEX reiterates that it is 
important to collect the data in order to accurately assess the 
activity and influence of speculative activity before adopting 
a legislative solution. Futures markets, like NYMEX, are 
messengers carrying price information from the energy industry 
to the public. It would be contrary to the public interest to 
adopt legislation that impairs the important price discovery 
function of these markets.
    Another legislative proposal would prohibit certain 
institutional investors such as pension funds from investing in 
agricultural and energy commodities on U.S. futures exchanges, 
foreign exchanges, or over-the-counter markets. NYMEX believes 
that prohibiting investment opportunities of institutional 
market participants effectively substitutes the judgment of 
Congress for the judgment of trained financial investment 
professionals. Moreover, we believe that the case has not yet 
been made to support a finding that institutional investors are 
contributing to the high price of crude oil. It would be 
premature to adopt a legislative solution for an unproven and 
unsubstantiated problem.
    Mr. Chairman, while we may not be in agreement on all the 
issues before this Committee, we are in complete agreement that 
there is a need for full transparency in a competitive 
marketplace, and we are also firm believers that position 
limits should be used across the marketplace in order to 
control speculative activity.
    Chairman Lieberman. Thanks, Mr. Newsome.
    Incidentally, Senator Collins and I invited witnesses who 
we assumed would be against some of the proposals because we 
want to air them out as we have a sense of urgency about 
actually introducing these as legislation sometime after the 
recess for the 4th of July next week. So this is really your 
opportunity, positively or negatively, to influence what we 
want to do.
    Our next witness is Michael Masters, here for his second 
command performance before this Committee. Mr. Masters is an 
accomplished hedge fund founder and manager who has researched 
the effect of speculators, particularly those operating in 
over-the-counter markets outside the scope of the CFTC's 
jurisdiction. And I will just say that I did not know Mr. 
Masters before we asked him to testify. I have a friend who 
sent me an e-mail and said, ``I met this guy Masters, Michael 
Masters, and he is smart. He understands financial markets, and 
he really feels strongly that speculation in the commodity 
markets is a big part of the reason for the increase in the 
price of fuel and food. You ought to meet him.'' That is how it 
started, and I appreciate what you have brought forth, and we 
look forward to your testimony now.
    Mr. Masters, go ahead.

    TESTIMONY OF MICHAEL W. MASTERS,\1\ MANAGING MEMBER AND 
       PORTFOLIO MANAGER, MASTERS CAPITAL MANAGEMENT, LLC

    Mr. Masters. Thank you, Senator. Thank you, Chairman 
Lieberman, Ranking Member Collins, and Members of this 
Committee, distinguished guests, for the opportunity to testify 
today. I especially want to thank the two of you for your 
exemplary bipartisan leadership on this issue. I very much 
appreciate your balanced approach of taking the time to 
thoroughly understand these issues and then acting in a 
decisive manner to solve them.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Masters appears in the Appendix 
on page 246.
---------------------------------------------------------------------------
    Commodities futures exist solely for the benefit of bona 
fide physical hedgers, not for speculators. The futures markets 
provide physical hedgers with two vital functions: Price 
discovery and risk hedging. If we lose one or both of these 
vital functions, then physical hedgers will abandon the futures 
markets, and they will become little more than high-stakes 
casinos. In my written testimony, I discuss at length the 
mechanics of the price discovery function and the threat that 
excessive speculation poses to the commodity futures markets.
    Turning now to solutions, the time for studies is well 
past. Studies should be attempted prior to the adoption of new 
financial techniques, like the FDA does with new medicines, not 
after approval has been granted. ``First, do no harm,'' part of 
the Hippocratic Oath, is a concept that market regulators 
should take to heart.
    I have read the discussion drafts introduced by Senators 
Lieberman and Collins on June 18, and I believe they represent 
a substantial step in the right direction. I note that your 
three proposed pieces of legislation correspond generally to 
the first three steps that I am outlining here today. To the 
extent that they differ, please accept these differences as my 
suggestions on how to improve on these proposals.
    As a first step, I recommend that Congress convene a panel 
composed exclusively of physical commodity producers and 
consumers for every commodity. This panel will set reasonable 
speculative position limits in the spot month as well as in all 
other individual months, and as an aggregate across all months. 
For commodities such as crude oil where real limits, except for 
the last 3 days in an expiring contract have been replaced by 
accountability limits, effective real limits must be re-
established.
    The commodities futures markets exist solely for the 
benefit of bona fide physical hedgers, so they are best 
qualified to set the limits. These physical market participants 
understand the benefits of liquidity and will do nothing to 
jeopardize their ability to hedge. The key here is that 
reasonable speculative limits allow the commodities futures 
markets to function properly.
    As part of this first step, speculative position limits 
must apply to every market participant whether they access the 
futures markets directly or trade in the over-the-counter 
markets through swaps and other derivatives. This means 
effectively closing the swaps loophole and ensuring that 
position limits look through the swap transaction to the 
ultimate counterparty. It is essential that swaps dealers 
report all their positions to the CFTC so that positions can be 
aggregated at the control entity level for purposes of applying 
position limits.
    It potentially makes sense to require that all over-the-
counter transactions clear through the appropriate futures 
exchange. This makes monitoring and enforcement of limits much 
easier and would have the added benefit of strengthening the 
current system and making it more transparent.
    As a second step, Congress should instruct the same panel 
to define numerically exactly what constitutes excessive 
speculation based on a percentage of open interest. As an 
example, physical crude oil producers and consumers may decide 
that the crude oil futures markets should never be more than 35 
percent speculative on a percentage of open interest basis.
    Next, the CFTC should be instructed to establish circuit 
breakers that adjust individual speculative position limits 
downward in order to prevent any commodity futures markets from 
reaching the overall limit established by the panel. These 
adjustments to individual limits should happen in a gradual 
fashion to minimize the impact on markets.
    The third step is to eliminate the practice of investing 
through passive commodity index replication. Because of the 
nature of passive indexing, index speculators have no 
sensitivity to supply and demand in the individual commodities. 
The practice should be prohibited because of the damage that it 
does to the price discovery function. Congress should use any 
and all available means to do so. One potential avenue may be 
ERISA. Another avenue may be found in the Commodities Exchange 
Act which states, ``two or more persons acting pursuant to an 
expressed or implied agreement or understanding'' should be 
subject to the speculative position limits of a single person. 
Since index speculators are all acting in express agreement by 
following the exact same index trading methodology, they should 
all be collectively subject to the speculative position limits 
of a single speculator. The CFTC could enforce this law 
tomorrow, and if they did, the amount of money allocated to 
index replication strategies would have to drop from roughly 
$260 billion to approximately $4 billion.
    Finally, Congress should actively investigate the practice 
of investors buying physical commodity inventories. It has come 
to my attention that some Wall Street banks are offering 
commodity swaps based on actual physical commodities. This is a 
distressing development because it means that investors are 
directly competing with American corporations and American 
consumers for limited natural resources.
    Before I conclude, let me say that many of the people who 
are profiting from the practices outlined in my testimony will 
try to scare you into believing that futures trading in U.S. 
commodities will simply move offshore. This is an empty threat. 
The United States is the largest consumer of energy in the 
world and the largest producer of food in the world. U.S. 
corporations and their non-U.S. trading partners are going to 
prefer U.S.-regulated contracts with physical delivery points 
inside the United States. Today, without the critical mass of 
volume that the United States provides, it is very unlikely 
that any of the existing U.S. contracts would be able to 
successfully migrate overseas.
    The implementation of the solutions outlined in this 
testimony will greatly increase the confidence of market 
participants around the world that our futures contracts' are 
an accurate reflection of true supply and demand fundamentals. 
This will lead to greater participation and, ultimately, 
further volume.
    This concludes my testimony.
    Chairman Lieberman. Thanks again, Mr. Masters. Very 
helpful.
    Next is William F. Quinn, Chairman of American Beacon 
Advisors, which manages approximately $60 billion in pension 
assets and short-term cash assets on behalf of American 
Airlines and others. Previously, he served as President of 
Beacon Advisors since its founding in 1986.
    Mr. Quinn, thanks for being here and bringing your unique 
perspective to this important question.

   TESTIMONY OF WILLIAM F. QUINN,\1\ CHAIRMAN, COMMITTEE ON 
             INVESTMENT OF EMPLOYEE BENEFIT ASSETS

    Mr. Quinn. Thank you, Mr. Chairman, Ranking Member Collins, 
and other Members of the Committee. I am here today as the 
chairman of the Committee on Investment of Employee Benefits 
Assets (CIEBA), and I thank you for providing us an opportunity 
to testify. We have submitted written testimony for the record, 
but in the interest of time, I will summarize the key points of 
that testimony.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Quinn appears in the Appendix on 
page 264.
---------------------------------------------------------------------------
    Chairman Lieberman. Mr. Quinn, excuse me. Why don't you 
just indicate--I failed to do it--what CIEBA is.
    Mr. Quinn. Yes. The Committee on Investment of Employee 
Benefit Assets is the voice of the Association for Financial 
Professionals on employee benefit plan asset management and 
investment issues for ERISA-governed plans. As the chief 
investment officers of most of the country's largest corporate 
pension plans, CIEBA members manage more than $1.5 trillion of 
defined benefit and defined contribution plan assets on behalf 
of 17 million plan participants and beneficiaries. According to 
Federal Reserve data, the $966 million managed by CIEBA members 
in defined benefit plans represents 50 percent of all private 
defined benefit plan assets.
    The pension system has served millions of Americans for 
over half a century. We owe it to working Americans and their 
families to ensure that any contemplated policy changes, no 
matter how well intentioned, do not undermine retirement 
security.
    The record prices for food and energy in the United States 
and abroad are of great concern to all of us. We are sensitive 
to the need to investigate this critical problem. We need to 
understand the supply-demand imbalances, concerns over supply, 
the impact of the weaker dollar, and the impact of speculative 
investors. Nonetheless, we are deeply concerned about the 
prospect of any legislation that would bar pension plans from 
investing in certain types of assets.
    Congress has long recognized that direct government 
regulation of pension plan investments is ill-conceived. ERISA, 
the primary law that regulates the investment of pension 
assets, takes a very different track. Rather than requiring or 
prohibiting specific investments, ERISA imposes rigorous 
fiduciary responsibilities on the persons that manage pension 
plan assets. These rules require a plan's fiduciary to act 
prudently and to diversify plan investments so as to minimize 
the risk of large losses. In addition, ERISA requires that a 
fiduciary act solely in the interest of plan participants and 
beneficiaries and for the exclusive purpose of providing 
benefits to plan participants.
    Today, private pension plans invest in a wide range of 
different asset classes, equities, fixed income, emerging 
markets, real estate, private equity, and natural resources. 
Plan fiduciaries use a variety of investment techniques and 
tools, including derivative instruments, to mitigate risk and 
enhance returns.
    Other countries have taken different approaches to the 
investment of pension plan assets. Historically, some U.S. 
public funds and some European defined benefit plans had rigid 
investment guidelines, prohibiting certain types of investments 
while requiring others. Many of these rigid investment rules 
were eventually discarded because of the negative impact such 
guidelines had on investment returns and thus on employees' 
retirement security. Put simply, mechanical approaches do not 
work as well as the American approach of investment flexibility 
paired with strict fiduciary responsibilities.
    It is critical that pension plans have the ability to 
invest in accordance with modern portfolio theory and pursue 
the best investment strategies available. The investment 
marketplace is constantly changing, and pension plans need to 
adapt and evolve accordingly without having to comply with a 
list of permitted and impermissible investments.
    Our concern is both with specific restrictions on pension 
plan investments in commodities but also with the precedent 
that action will set for allowing the Government to intrude on 
pension investments. Today, commodities investments are not a 
significant part of most private sector pension plans. Our 
preliminary results of three 2007 surveys of CIEBA members 
shows that less than 1 percent of assets are invested directly 
in commodities and a similar amount in natural resources. Based 
on numbers that were given in testimony of commodity indexes of 
$260 billion, our members' investments represent about 1 
percent of that total. So it is a very small amount.
    We firmly believe that commodities may be part of a 
prudent, well-diversified investment portfolio by providing a 
hedge against inflation and minimizing volatility, but our 
primary concern is with the principle that the government 
should not micromanage pension plan investments.
    Pension plans are long-term investors, not speculators. The 
most successful plans do not chase returns; rather, they have 
disciplined strategies for minimizing risk and enhancing 
returns so that the plan sponsor can fulfill the promises they 
make to their employees. In fact, most plans will rebalance 
their investments periodically to assure they stay within their 
guidelines and not inadvertently get overexposed to a single 
asset class. Thus, we sell when prices are high and buy when 
they are low.
    Political temptation to intervene in pension fund 
investments is not unprecedented. Congress in the past has 
considered legislation that would bar plans from investing in 
particular investments or, conversely, would mandate particular 
investments. There are numerous instances where there has been 
a first instinct to require pension plans to make investment 
decisions with a view of promoting a particularly social or 
political goal.
    Congress, however, has consistently rejected legislation 
that would subjugate the retirement security of millions of 
Americans and their families to other social or political 
concerns, no matter how worthy. In fact, when asked about the 
economically targeted investments, the Department of Labor 
interpretation said that a fiduciary must not subordinate the 
interests of participants and beneficiaries to unrelated 
objectives.
    Moreover, the case for limiting pension investments in 
commodities has simply not been made. As others, including the 
U.S. Commodity Futures Trading Commission, have testified, it 
is far from clear that institutional investors in the commodity 
markets are driving the surge in prices. Before acting, it is 
imperative that Congress step carefully and allow the CFTC to 
analyze the commodities markets and gather data.
    Regulating pension fund investments would make it difficult 
to adequately diversify investments to hedge against market 
volatility and inflation and, consequently, would put at risk 
the retirement funds of the very workers the proposal is 
intended to help. In effect, such a proposal would be a case of 
robbing Peter to pay Paul.
    Again, thank you for this opportunity to testify, and 
please let us know if there is any additional information you 
would need.
    Chairman Lieberman. Thanks, Mr. Quinn.
    Our next witness is James J. Angel, Associate Professor of 
Finance at the McDonough School of Business at Georgetown 
University. Dr. Angel's area of research focuses on the 
structure of financial markets, including the micro structure 
of trading, so he is well prepared to assist us in our 
deliberations today.
    Thanks for being here.

TESTIMONY OF JAMES J. ANGEL, PH.D., CFA,\1\ ASSOCIATE PROFESSOR 
OF FINANCE, MCDONOUGH SCHOOL OF BUSINESS, GEORGETOWN UNIVERSITY

    Mr. Angel. Good morning, Mr. Chairman. It is a great honor 
to be here. We are in the midst of an economic crisis brought 
on by high energy and food prices. The potential for economic 
and social disruption is major, and it is very important that 
we deal with the problem. And I am pleased that this Committee 
is looking at several of these proposals.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Angel appears in the Appendix on 
page 268.
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    We can tell a couple of stories about the currently high 
energy prices now. One story is that we are in the midst of a 
speculative bubble, that the same forces that brought us the 
dot-com and housing bubbles have turned on to commodities, and 
now we see a food, energy, and metal price bubble.
    On the other hand, maybe the markets are right. Maybe we 
have reached a point of peak oil and maybe the markets are 
telling us that the value of another barrel of oil to our 
society really is $135 per barrel. Maybe. Maybe not. The point 
is markets have an incentive sooner or later to get to the 
right number. But if we are in the midst of a bubble, we have 
to ask ourselves, is there something in the design of our 
financial markets or in our Government policies that is making 
the bubble worse? And what, if anything, should we do about it?
    I have been asked to look at the three proposals that have 
been put forth.
    The first two proposals basically extend the authority of 
the U.S. Commodity Futures Trading Commission into the over-
the-counter market. Now, there exist a lot of close substitutes 
for the regulated contracts that trade on our regulated 
markets, and I think it makes good common sense to extend CFTC 
authority into this area because these ``substitutes'' for the 
exchange-traded contracts do spill over into the regulated 
market.
    However, we have to be careful in how we do this because 
the devil is in the details. Fortunately, I have a lot of 
respect for the CFTC and their capacities, and if we give them 
the resources they need, I think they will be able to exercise 
this new authority in a judicious manner.
    The third proposal is to ban institutional investment. Now, 
I would like to point out that there are some good, legitimate 
economic reasons why institutions may wish to invest in 
commodities. Quite simply put, there is a historical tendency 
that when stocks go up, commodities go down, and when 
commodities go up, stocks go down. So by putting some 
commodities into your portfolio, you can smooth out returns. 
This is very good for the pension plans and other investors who 
are trying to reduce the volatility for the workers who depend 
on their pensions. And, indeed, if you use a standard asset 
allocation model with some plausible assumptions, you can come 
up with numbers of maybe 3 to 5 percent easily as a reasonable 
investment in commodities.
    Now, however, we need to be careful with the regulation 
because these are global markets, and the threat of foreign 
substitutes is real. I have visited over 50 stock and 
derivative exchanges around the world, and the foreign markets 
have, as you know, invested heavily in technology. They are 
looking for new products, and they would just love the 
opportunity to snare business away from us. So if we do not 
impose new regulations in a judicious manner, if we do 
something crude and clumsy, all we will do is reduce the 
effectiveness of our markets and push the bad activity offshore 
into places that are less transparent and less easy to 
regulate. So we need to be very careful in how we do this.
    However, let's not get our hopes up. These proposals alone 
will not fix the problem. Energy markets have always gone from 
supply to glut with highly volatile prices. This has happened 
for over a century in the energy markets. And these proposals 
will not stop a global frenzy in commodity prices. What will 
bring prices down is a credible action by the United States 
that signals to the rest of the world that we are serious about 
transitioning away from imported petroleum. If we can send a 
message to the rest of the world that we are going to move away 
from insecure polluting fuels and become energy independent, 
then the producers of oil will have a going-out-of-business 
sale and the prices will drop. However, we have to adopt 
credible energy policies that demonstrate to the rest of the 
world we are serious about moving away from petroleum.
    Those are my basic comments. I have more technical comments 
about the proposals in my prepared statement, and with that, 
once again I would like to thank you for asking me to testify 
today.
    Chairman Lieberman. Thanks very much, Dr. Angel. I will 
state for the record that the prepared statements of all the 
witnesses will be printed in the record as if they were read in 
full. And thanks to you for using a minute and 37 seconds less 
than you were allotted.
    Our final witness is Michael Greenberger, Professor of Law 
at the University of Maryland, who was Principal Deputy 
Associate Attorney General at the Justice Department during the 
Clinton Administration. Before that, he was Director of the 
Division of Trading and Markets at the CFTC, where he was 
responsible for supervising exchange-traded futures and 
derivatives.
    Thanks for being here, Mr. Greenberger.

STATEMENT OF MICHAEL GREENBERGER,\1\ PROFESSOR, SCHOOL OF LAW, 
                     UNIVERSITY OF MARYLAND

    Mr. Greenberger. Thank you very much, Chairman Lieberman.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Greenberger appears in the 
Appendix on page 278.
---------------------------------------------------------------------------
    This is a market that I study a lot, and I think there have 
been three seminal events that have taught me an awful lot 
about it. Two of those events were the reports issued from the 
Senate Permanent Investigations Subcommittee, one in June 2006 
when Senator Coleman was Chairman and Senator Levin was Ranking 
Member, and then one in June 2007 when the positions were 
reversed. I said at the time when I testified on the June 2007 
report that if you want to understand these markets, you must 
read that report.
    The third was the hearing Chairman Lieberman held on May 
20, 2008, which I think has become a turning point in 
convincing people that speculation in these markets is a 
problem and that we need to address it. I will tell you I 
thought I knew a lot about these markets, but Mr. Masters' 
testimony on May 20 educated me and, I think, a lot of people 
with his analysis of the treatment of commodity index funds.
    I would say from the outset--and I mention this in my 
testimony--I am perfectly prepared to discuss this, and I am 
not going to assert it as a conclusion, but my view is that 
agricultural index funds are barred by the Commodity Futures 
Modernization Act. That statute clearly said we are going to 
deregulate everything, but not agricultural futures. I do not 
see how you can have agricultural index funds. There may be an 
argument that they are swaps, but my reading of that statute--
and I am perfectly prepared to have a discussion about it--is 
swaps can not be agricultural instruments. You can have energy 
swaps because energy was deregulated by the Enron loophole. And 
I believe that there are many State Attorneys General and 
people who can bring private right of actions who are looking 
at that very question as to whether these agricultural index 
funds are proper.
    Second, there are many legislative proposals, and I want to 
congratulate you and the Ranking Member for your three options. 
I want to address the issue about fiduciaries. Before the 
passage of the Commodity Futures Modernization Act, all energy 
futures had to be traded on a regulated exchange unless 
expressly exempt by the CFTC. That meant when an endowment or a 
pension fund, or anybody else for that matter, traded energy 
futures, whatever their fiduciary obligations, they had to meet 
the speculation limits of that exchange. Speculation limits 
were not a substitute for fiduciary responsibility. Fiduciaries 
had to satisfy speculation limits. Why is that? As Mr. Masters 
said, these exchanges are not betting casinos. They were 
designed for commercial hedgers. The commercial hedgers cannot 
use these markets anymore. But they were intended for 
commercial use. Your heating oil dealers cannot use these 
exchanges. I am sure they have told you that. They cannot 
hedge. Exxon cannot hedge anymore on these exchanges.
    Now, the reason that endowments or anybody else has 
speculative limits was to avoid unhinging these commercial 
exchanges from supply-demand principles. In fact, there has 
been little discussion about the fact that the Commodity 
Exchange Act provides CFTC with emergency powers to intervene 
when the markets do not reflect supply-demand principles to set 
speculation limits and take other corrective measures.
    One of the problems we have is because we have freed up so 
much of this market from the CFTC's jurisdiction, CFTC cannot 
protect the entirety of the market meaningfully because they 
only control NYMEX. My view is that I think there are a lot of 
important tools that can be used to reregulate excessive 
speculation. I think speculation limits are probably, if you 
had to pick one, the most important tool. And I think the 
beauty of your option, No. 1 is that you do not look to see 
whether the trading is done on a regulated exchange or on an 
over-the-counter market or an unregulated index fund. As I 
understand that legislation, someone who is not a true 
commercial hedger has an aggregate speculation limit for both 
regulated and unregulated markets. Speculators can use it any 
way they want. They can use it all in an index fund. They can 
use it all in over-the-counter markets. Or they can use it all 
in NYMEX in the case of energy or the Chicago Board of Trade in 
the case of food. But just like we have a Federal taxpayer 
identification number, people who want to speculate in these 
markets, which are supposed to be principally for commercial 
use, will have limits across the board.
    So your option one does not require people to worry about 
what is over the counter, what is regulated, what is in London. 
As I understand it, if you are a U.S. citizen or trading in the 
United States, you would have an aggregate speculation limit 
for trading in any and all markets.
    Option two has each market impose speculation limits on 
each contract, as I understand it, setting the amount on each 
contract that would be open to speculation. And I think that 
would be a very therapeutic approach, but this is the question 
you have to ask yourself: Is Goldman Sachs going to create a 
speculation limit on energy index funds? Those funds have many 
speculators. So I am worried that when you say a contract 
market, are the index funds a contract market? Will Goldman 
Sachs or the CFTC be assigning to Goldman Sachs for their 
agricultural index funds a speculation limit? If you do, I 
mean, you are essentially undercutting the very purpose of the 
index fund markets. Revert back to option one. If everybody 
wants to use their speculation limits to go with an index fund, 
great. You then preserve the concept of index funds.
    So as I see option one and option two, option one gives the 
trader an aggregated speculation limit across all markets; 
option two requires the market to say how much of the market 
will be speculative. Option three is the absolute flat bar on 
pension funds in terms of what they can do in the futures 
markets. Also, if you have over $1 billion in net worth, you 
cannot invest in an index fund. I am slightly troubled by that. 
I think that is going to be a very arbitrary thing to impose.
    In that vein, I am quite sympathetic to what the endowments 
are saying. You might have $1 billion and need a certain amount 
to hedge, and then you have got a market closed off to you. But 
I think these are all very interesting proposals. They cause me 
to think very hard. I would look to option one as the way to 
go. I would also encourage you possibly to require the CFTC, 
while option one is being taken care of--because everybody 
agrees we are in an emergency--to use their emergency powers 
wherever they can on regulated exchange and over-the-counter 
markets pertaining to energy and food. The principal over-the-
counter market here is the ICE, which is all over the United 
States. The CFTC has jurisdiction over it. The CFTC could go in 
with its emergency powers and set speculative limits 
temporarily to deflate the speculation, assuming they agree 
that there is speculation. Thank you.
    Chairman Lieberman. Thanks very much. Very interesting, 
helpful testimony. I think in light of the wide interest in 
this subject on the Committee, I am going to ask that we take a 
recess--Senator Collins and I agree--and ask the witnesses not 
to go far. We will try to get over to the floor, vote, and come 
back real quickly. And then we will begin the questioning.
    Thank you. The hearing stands in recess.
    [Recess.]
    Chairman Lieberman. The hearing will reconvene.
    We will do a 7-minute round of questions for each of the 
Senators. I want to thank you again for being here, and I 
thought the opening panel was very helpful.
    Chairman Lukken, as I said before, we specifically want to 
invite your reaction to these three proposals, or any others 
you would make legislatively, and I will give you that chance 
now, unless you do not think we should do anything until, as 
Mr. Newsome said, there is further study. But we have proposed 
extending transparency to unregulated commodity markets, 
essentially by closing the so-called swaps loophole; creating a 
seamless system of speculative position limits, that apply to 
all commodity trading; and the third is the restriction on the 
investments of large institutional investors through index 
funds.
    Do you have an opinion you want to offer us about any or 
all of those three at this point?
    Mr. Lukken. Well, I think everybody can agree that there 
has been a large influx of index money coming into the markets. 
There is a wide range of what that might be, anywhere from 
estimates of $140 to $260 billion coming into the markets. So 
we are trying to get our arms around that, but, unfortunately, 
this comes through swap dealers, which are not directly 
bringing this money onto the market. They are offering swap 
contracts to these participants, netting these instruments, and 
bringing the residual risks to the market. So for us to 
understand exactly how much is coming into the market is very 
difficult. We are reaching beyond the futures markets to get 
this information, which traditionally we have not done.
    And so we are using our ``special calls'' to get this 
information. We are trying to unwind what these positions might 
be in terms of futures contracts. But I can tell you right now 
that swap dealers as a class are actually ``flat the market'' 
or virtually flat the market. They have as many positions 
betting the markets will go down as would benefit from the 
markets going up. So we are trying to better understand this 
before we make hard and fast conclusions.
    I would say, though, conceptually on your proposals, you 
have tried to address information needs and position limits 
where points of entry may come into the market, which is 
helpful. We have done this with exempt commercial markets, with 
the farm bill provisions, and recently took steps to do this 
with foreign boards of trade markets. And we are looking into 
the swap dealer exemption to see whether we need to do this and 
position limits into these traders as well.
    Chairman Lieberman. Since the law has established 
speculative position limits per entity, wouldn't you agree that 
these so-called swaps effectively end-run that limit and, 
therefore, that they are frustrating the intention of a 
previous Congress to try to limit the speculative positions of 
anybody speculating in the commodities markets?
    Mr. Lukken. Well, this has been a policy of the CFTC to 
give exemptions to swap dealers since 1991. There was something 
in our reauthorization of 1986 that Congress urged us strongly, 
I think was the term, to look at exempting these types of risk 
management from speculative limits.
    Chairman Lieberman. I understand the history here, but 
isn't it true that the sheer size of the trading and investing 
through this loophole has grown enormously in recent years? I 
mean, all the evidence we have seen says that. Doesn't that cry 
out for some kind of remedy? I am focusing on this first 
recommendation of ours because to me it just looks like people 
are seeing their opportunities and taking advantage of them. 
There is nothing illegal that I can see about it, but it is 
frustrating what was clearly the intention of Congress.
    Mr. Lukken. Well, certainly we are looking into it to see 
what is coming through swap dealers, and I think we are going 
to find a lot of commercial business. Legitimate hedgers are 
also coming through swap dealers. So we do not want to punish 
those people who are looking to manage risk in the markets. But 
if people are purposely evading speculative limits--if they 
could have gone directly to the markets and would have hit 
these limits and they are purposely going through swap dealers, 
this is something we will have concern about and will take 
action against.
    Chairman Lieberman. Let me ask you for a quick response to 
questions two and three, that is, the coverage of all the 
speculative position limits, a kind of aggregative position 
limit that we would give you the opportunity to set.
    Mr. Lukken. Well, I think it would be difficult, just 
talking to staff, of how we would police that. I mean, I 
understand the intent of trying to find optimal levels of 
speculation in the market.
    Chairman Lieberman. The intent is to try to protect the so-
called commercial traders, the physical traders, the farmers, 
the fuel oil dealers, for whom these markets were created so 
they are not crowded out as they are now down to about a 
quarter of the volume on the markets.
    Mr. Lukken. Well, certainly I understand the intent. For 
us, I am not sure how we would police that, whether we would 
force people out of the markets every day that exceeded certain 
limits. So I think it is difficult to determine what the 
optimal level would be; and, how would you police these without 
government really putting a footprint on these markets. And so 
I think this would be difficult.
    I think the current authority of allowing position limits 
and accountability levels has been effective and would probably 
be a preferable method, in my view.
    Chairman Lieberman. Let me ask you a final question, and if 
I have time, I will ask Mr. Masters something. Do you think 
there is such a thing as excessive speculation? Because in your 
testimony you focus on the power of the CFTC to deal with 
manipulation, but we are not really alleging that here. We are 
saying that speculation has become so dominant in the markets 
that it is having an artificial effect that is disastrous and 
raising consumer prices. So is there such a thing as excessive 
speculation?
    Mr. Lukken. I think you have put your finger on it. Our 
mission has primarily been in the past to prevent illegal 
manipulation. This is a relatively new market structural issue 
that has developed over the last couple years that we are 
trying to get our arms around. But I think theoretically, 
certainly if markets are being artificially driven higher, 
sure, excessive speculation can lead to that. I am not sure 
that case has been proven, but it is certainly possible.
    Chairman Lieberman. OK. I am glad you acknowledge that. I 
am surprised at your answer that you are not sure there is 
excessive speculation.
    Let me ask Mr. Masters in the minute I have left, yesterday 
before the House Energy and Commerce Committee you and two 
other witnesses--Fadel Gheit, Managing Director and Senior Oil 
Analyst at Oppenheimer and Company, and Edward Krapels, a 
special adviser at the consultant Energy Security Analysis--all 
said that if greater regulation over the speculation in energy 
prices actually was adopted by Congress, implemented by the 
CFTC, there would be significant drops in crude oil prices, and 
the retail price of gasoline that is now obviously over $4 a 
gallon would follow suit. You indicated, ``prices would 
probably drop over a reasonably short period of time, back to 
somewhere closer to the marginal production cost of oil, $65 to 
$70, as compared to the $130-plus now. And I think gas prices 
would reflect that in a relatively short order.''
    Mr. Gheit said prices could come down to a range of $45 to 
$60 a barrel, and Mr. Krapels said, ``I don't think it would 
take 30 days after the President signed such a bill. It would 
happen more quickly than that. As soon as Congress passed it, 
commodity funds would withdraw their positions.''
    Now, of course, that sounds great to not only us but people 
who are suffering the consequences of the unbelievable, 
unprecedented run-up in prices. Why do you assert that with 
confidence, Mr. Masters, that there would be that significant a 
drop in retail prices if we regulated the speculative behavior 
in the commodity markets?
    Mr. Masters. Thank you, Senator. I was referring, when I 
was testifying yesterday, to implementing the solutions that I 
described. If you take away one thing from the testimony today, 
I would take away the following suggestion, and that is, money 
moves prices, money moves markets. And so if you want to 
understand why markets are moving, follow the money.
    The key here is that there is no question that 
institutional investors in the capital markets have infiltrated 
the commodity futures markets through long-only strategies to 
the tune of new inflows of almost $170 billion, as of my 
testimony May 20, when I testified about the $260 billion, that 
also included some price participation. But, effectively, those 
new inflows of actual dollars have impacted the price, 
especially when you think about the fact that in 2003, the 
total open interest of all commodity futures was $180 billion.
    So you have had approximately the same amount of money that 
has come into the commodity futures markets than you had total 
open interest in 2003. So we are not arguing that index 
speculators are the only reason that prices have gone up, but 
we are suggesting that they have greatly amplified a positive 
price trend, and they have contributed to greatly higher 
prices. And so what you have got here is supply and demand, and 
also financial investor demand. So it makes a lot of sense to 
us if you take away that financial demand that you are going to 
bring down prices because you are going to bring down total 
demand. And that is why we made the statement we did yesterday.
    Chairman Lieberman. Thank you very much. I am over my time. 
Senator Collins.
    Senator Collins. Thank you, Mr. Chairman.
    Mr. Newsome, you indicated that the development of an 
overseas look-alike to the NYMEX West Texas Intermediate Crude 
Oil contract had made about a third of that market non-
transparent to the CFTC and ``permitted an easy avenue to 
circumvent position limits designed to prevent excessive 
speculation.''
    Two questions for you. First, do you think that the changes 
that the CFTC recently announced addressed that problem 
adequately of the lack of transparency? And, second, do you 
believe that excessive speculation did, in fact, occur because 
of the lack of transparency in those markets?
    Mr. Newsome. Senator, the answer to the first question is 
yes, we do believe that the actions the CFTC has taken 
adequately address our concerns. At the same time, we are 
certainly not opposed to the Congress codifying those actions.
    Second, with regard to whether or not that activity did 
lead to price increases through speculation, I do not know the 
answer to that, and that is why we wanted those markets made 
transparent so those positions could be seen and that 
determination made.
    Senator Collins. Professor Greenberger, some experts have 
estimated that excessive speculation in the futures market has 
driven up the price of oil by as much as a third. Do you have 
an estimate of what you think the impact has been?
    Mr. Greenberger. Well, I do have an estimate, but I am not 
an economist, and I was a regulator. In my bones, I know that 
these things are happening in the ICE, which you have referred 
to, is overseas, and I believe in the U.S. exchange. They have 
all their indicia in the United States, and I think we make a 
terrible mistake to keep calling it a British exchange when it 
is run in Atlanta, has trading engines in Chicago, and 30 
percent of the competitive contract that NYMEX has. So in my 
bones I know not only there is excessive speculation--and I 
know you said you are not addressing manipulation. But I can 
tell you even in the regulated markets, we worry about 
manipulation.
    I would guess that is 25 to 50 percent, but the people I 
would look to are the people who testified in the first panel 
in the House yesterday who are mostly trained economists or 
experts in these oil markets. And if I remember, the thesis 
there is at a minimum it would go back down to $80 a barrel. 
That is what OPEC estimates it should be at. It is $135 now. 
Saudi just announced they are going to put more in. Oil went up 
yesterday.
    Senator Collins. Thank you.
    Just so I am clear, I can assure you that we are all 
concerned about price manipulation as well as excessive 
speculation. One thing that I would hope that everyone ought to 
be able to agree on is that there should be transparency on all 
the markets. I agree with you that if anyone is going to have 
access through our commodities and our markets, the same rules 
should apply that should be effective and even oversight by the 
Commission.
    Mr. Lukken, I want to ask you about the thesis that Mr. 
Masters has put forth that speculators are creating a virtual 
demand for the product that drives up prices. I was struck in 
looking at Mr. Masters' testimony by a table that he has that 
has a 1998 versus 2008 comparison of speculative long positions 
in heating oil, and the chart shows that index speculators held 
only 10 percent of those positions back in 1998, but today hold 
47 percent.\1\
---------------------------------------------------------------------------
    \1\ The chart referenced by Senator Collins appears in the Appendix 
on page 256.
---------------------------------------------------------------------------
    What is your reaction to that data?
    Mr. Lukken. Well, I am not sure how Mr. Masters got the 
information on the energy markets because we currently do not 
report that, and that is why we are trying to get better data 
from the swap dealers on how much of that money is flowing in. 
We certainly get it for agricultural markets--we have very good 
data on index traders. Where we see large positions, large 
index trading flowing into certain commodities, where some of 
the highest levels--in fact, cattle and hogs have some of the 
highest levels of index participation, and they have some of 
the weakest prices currently in commodities. There are other 
markets in wheat, Minneapolis wheat, that have no index money 
at all, but some of the highest run-ups in prices.
    So certainly we are trying to find the causations that you 
are after, that Mr. Masters is trying to find, and we are 
looking to do that. We are trying to get better data on the 
energy commodities in order to make those determinations. But 
currently it is difficult to find a smoking gun saying that 
index trading is leading to higher prices across the board 
because we certainly have instances where that has not been the 
case. And, in fact, we have been tracking this very closely on 
agricultural products over the last 3 months. We are seeing a 
slight decrease in index funds coming into those markets over 
the last 3 months during this price run-up in a lot of other 
agricultural commodities.
    So, again, we are looking for the smoking gun. We are going 
to get better data on the energy side and hopefully can give 
hard, fast conclusions.
    Senator Collins. Mr. Masters, could you tell us the 
derivation of your data for that chart where you show the 
holdings of the index speculators going from 10 percent 10 
years ago to 47 percent today?\1\
---------------------------------------------------------------------------
    \1\ The chart referenced by Senator Collins appears in the Appendix 
on page 256.
---------------------------------------------------------------------------
    Mr. Masters. Sure. I will answer that, Senator, and just 
before I answer it, if you will indulge me, I will just respond 
to Mr. Lukken's suggestions.
    One of the reasons why lean hogs and a couple of other 
commodities in the indexes have not moved due to the effects of 
index speculators is their settlement procedures are much 
different. So I think in actuality he is making our point for 
us here.
    Lean hogs are cash-settled based on a nationwide index of 
spot prices, and so the effect of index speculators is greatly 
muted by having this particular settlement procedure because it 
brings prices back down to an actual fundamental spot index.
    With regard to the Minneapolis wheat issue, that can be 
explained pretty easily by something that economists call the 
cross-elasticity of demand or the substitution effect, in which 
prices of one commodity go up when another commodity that is a 
close substitute goes up. So, for instance, to use a car 
example, if I wanted to buy a Ford and the price went up too 
much, maybe I would buy a Chevy instead. And so that is the 
basic tenet.
    But to answer your question, we derive our numbers directly 
from the CFTC Commodity Index Traders Reports. We then 
extrapolated out our numbers for energy because they are not 
currently provided. But the math is relatively easy. For 
instance, if wheat is 2 percent of the index and you know the 
position of wheat is $2 billion, then you can just do the math 
and figure out that if it is 2 percent of the index and that is 
$2 billion, then 100 percent of the index is $100 billion. And 
since these index replicators are all doing something exactly 
specific to the index, if you know that the index in heating 
oil is 5 percent, say--I am just making that number up--then 
you can easily figure out that the input into heating oil is $5 
billion. So that is effectively the way the numbers work out.
    Senator Collins. Thank you.
    Chairman Lieberman. Thanks. Very interesting. Senator 
Levin.

               OPENING STATEMENT OF SENATOR LEVIN

    Senator Levin. Thank you, Mr. Chairman. Thanks to the 
panel.
    One of the legislative options that has been discussed is 
to impose position limits in the over-the-counter market, and I 
believe, Mr. Masters, you have supported that option. I am 
interested as to, first of all, what your position is on that, 
Mr. Newsome. Second, I would like to know how it will work. How 
do you get to the over-the-counter market as a practical 
matter?
    So, first, Mr. Newsome, do you support that particular 
recommendation or option?
    Mr. Newsome. Well, in theory, coming from the regulated 
exchange component where we have position limits, we would love 
for all the market participants that we compete with to have 
position limits. But I think with the second component, you get 
to the heart of it. I have no idea how you would do it and make 
it work.
    Senator Levin. All right. But you would like, if we could 
make it work, to get it done.
    Mr. Newsome. Yes.
    Senator Levin. Yes. OK. Mr. Masters, as a practical matter, 
it seems to me there are a lot of pluses in this. There is no 
doubt in my mind--and we have put out this material before in 
our Permanent Subcommittee on Investigations as showing the 
1,200-percent increase in the number of crude oil futures 
contracts held by speculators over the last 5 or 6 years, 
whereas the number of crude oil futures contracts held by 
commercial traders have only gone up 200 percent. There is not 
much doubt in my mind that speculation has played a critical 
role, and in our earlier report at the Permanent Subcommittee 
on Investigations, we showed that when oil was $70 a barrel, we 
estimated that $20 of that $70 was from speculation at that 
time, which is about 30 percent of that barrel's cost.
    So, in my mind, there is very little doubt that speculation 
has a significant role in the drive of the price increases of 
oil. But if we want to close some of these other loopholes--we 
think we closed the Enron loophole, and I want to ask you, Mr. 
Lukken, as to whether we did that effectively. But to get to 
the other ``loopholes,'' including the over-the-counter problem 
and including the London problem, how do we practically get to 
over-the-counter transactions?
    Mr. Masters. Well, thank you, Senator. I think the way we 
are suggesting is that you do this at the control entity level. 
For instance, you set up position limits so that a particular 
participant, even though they may trade under five different 
names or five different corporations or whatever, that all goes 
back to the one source. So that is the first thing.
    Senator Levin. But what if it is not on an exchange, if it 
is just literally a telephone conversation between two people?
    Mr. Masters. Well, effectively, if they are U.S. citizens, 
the CFTC is going to have jurisdiction over them.
    Senator Levin. So they have an obligation of notifying the 
CFTC----
    Mr. Masters. So they have to report----
    Senator Levin [continuing]. Even it they do not use the 
exchange, the burden would be on them by law to notify somebody 
that they have had this over-the-counter one-on-one 
transaction.
    Mr. Masters. That is my understanding.
    Senator Levin. Do you think that is a practical way to put 
a position limit on these over-the-counter trades?
    Mr. Masters. We actually do that in a lot of areas. We 
certainly do that--if you are a U.S. citizen--I mean, it comes 
back to a lot of money-laundering regulations. But effectively 
you can figure out if they are U.S. citizens, you can make sure 
that they have to comply with laws where there are over-the-
counter swaps and whatnot.
    Senator Levin. Now, if there is not an exchange involved, 
how do you set the position? Would that be by law, the position 
limit?
    Mr. Masters. The way we suggested to set the position 
limits is to convene a panel of physical players only, 
exclusively physical players. So, for instance, in crude oil 
that would be, for instance, the airlines, perhaps Exxon, or 
some of the refiners. Those are just physical players.
    Senator Levin. All right. They would make a recommendation. 
Would that be incorporated by law or would that be the law?
    Mr. Masters. That would be--I think you could do either 
one, but I think the point of the matter is they are the best 
qualified to determine what those position limits are because 
they are never going to sabotage their ability to transact in 
those markets. They want sufficient liquidity, that they need 
to be able to transact. But they do not need so much liquidity 
that they cannot transact.
    Senator Levin. And would that be a recommendation to a 
regulator to then adopt that position limit?
    Mr. Masters. I think you certainly could do that.
    Senator Levin. I do not think you could delegate that to a 
private group, that decision, could you?
    Mr. Masters. I think you could delegate it to a private 
group and then have the regulator, follow the----
    Senator Levin. Adopt it.
    Mr. Masters. Adopt it.
    Senator Levin. Or not.
    Mr. Masters. Right. Again, the reason for that is you have 
the exchanges which are paid on a per contract basis, and you 
have investment banks that also have an incentive to see more 
transactions. So really you have some conflicts of interest 
there you need to address.
    Senator Levin. All right. Now, you have indicated, Mr. 
Masters, in your testimony that if you follow the money, you 
can see how the demand has increased the ultimate price for 
oil. And here, Mr. Newsome, I want to ask you a question. Even 
though you have not concluded yet that this is accurate, you 
are not sure in the chicken-egg problem, which is the chicken, 
which is the egg. Would you not agree that the demand--put 
aside the ultimate product, oil, but the demand for futures 
contracts, if it has a huge increase, that the increased demand 
for the contracts would drive up the price of the future 
contract? Would you at least go with me that far--before I trap 
you? [Laughter.]
    Mr. Newsome. And I know you are very good at that.
    If it was increased demand from commercial participants who 
had the ability to trade through expiration when the price is 
determined, then they would have the ability, and that is how a 
market works.
    Senator Levin. No, try the non-commercial participants. If 
you really believe that supply and demand works, if suddenly 
you have a huge influx of money for the contracts--put aside 
the product. The contracts. Wouldn't that under the normal 
rules of supply and demand drive up the price for the contract?
    Mr. Newsome. Yes, it certainly could be the case.
    Senator Levin. If that is true, then the question is: What 
is the relationship between the price in the contract and the 
price for the ultimate product? That then becomes the question. 
And if the price for that contract, the delivery of that oil, 
say a week before it is supposed to be delivered is $130 a 
barrel, would you not then take the second step with me then 
that clearly would have a price on the actual product itself? 
Do not do the 3 months out and 4 months out. Just do the week 
out or 2 weeks out.
    Mr. Newsome. Well, the WTI contract at NYMEX works very 
efficiently, and you can determine that by the fact that the 
prices do converge. The futures price and the cash price 
converge into one price at the end. But at the end, you have no 
speculative interest trading. You only have the commercial 
entities that are trading on both sides.
    Senator Levin. But if there is that relationship--and I 
think logically there is. If you are a week out or 2 weeks out 
and something is $130 a barrel, they are going to converge. 
They are not going to go down to $70 in a week. If that futures 
price has an impact on the price of the commodity a week later 
or a month later, then if you believe that supply and demand 
rules generally work, it seems to me it takes two steps, but 
you get to the point where the demand for futures contracts has 
driven up the price of the futures contracts, which I think is 
clear under rules of supply and demand, and then that price has 
an effect on the product itself, particularly when they are 
fairly close a week out or 2 weeks out before delivery.
    Would you agree?
    Mr. Newsome. No, the key price discovery is the spot 
contract at which the price converges. Certainly they will 
trade in the outer months, but the prices of those outer months 
have virtually no impact on the price of the spot market.
    Senator Levin. But the week before or the 2 weeks before, 
would you say that does have an effect?
    Mr. Newsome. It converges in the last 3 days.
    Senator Levin. I am over my time. Could I ask a quick 
question of Mr. Lukken? Have we effectively closed the Enron 
loophole, in your judgment?
    Mr. Lukken. Absolutely.
    Senator Levin. Thank you. Thank you, Mr. Chairman.
    Chairman Lieberman. Thanks, Senator Levin.
    We have the leadership of the Permanent Subcommittee which 
led the way for this Committee into the investigation, which 
really has produced results. As the last answer said, we have 
absolutely closed the Enron loophole. Senator Coleman.

              OPENING STATEMENT OF SENATOR COLEMAN

    Senator Coleman. Thank you, Mr. Chairman, and I compliment 
my Subcommittee Chairman that he has been focused on this, and 
I have been focused on it. But a couple of things still hang 
out there. You have smart people on all sides of this.
    Mr. Angel, you made it very clear. You said that the threat 
of a foreign substitute is real, that if, in fact, we regulate 
in a certain way, that we require certain margin requirements, 
etc., that, in effect, we can drive this trading somewhere 
else. And yet it seems to me that if you have American citizens 
and American operations involved here and they want to trade or 
do things in this country, we should have the ability, 
regardless of the market they are trading on, to require some 
kind of transparency. Is that a fair assessment?
    Mr. Angel. Yes, I am a big proponent of transparency in the 
markets, and I think that giving the CFTC the authority to 
investigate and regulate, where appropriate, the over-the-
counter markets makes sense. I think the CFTC has shown that 
they can regulate intelligently most of the time and that they 
would not go so overboard as to drive the business offshore.
    Senator Coleman. Professor Greenberger, how real from your 
perspective is the sense that if we push too far, we are really 
going to be driving folks offshore to less transparent markets?
    Mr. Greenberger. I do not believe that is the case. I would 
urge you to look at the C-SPAN proceedings yesterday where 
virtually every independent observer and academic observer said 
that would not happen. The reason it will not happen is 
basically the West Texas Intermediate market is in the United 
States. We have NYMEX, and we have ICE. Now, ICE flies the 
Union Jack, but they are in Atlanta; they have Chicago trading 
engines and 30 percent of our market. That is the United 
States.
    When I was at the CFTC, I was besieged by all of these 
foreign exchanges wanting terminals in the United States. Mr. 
Lukken, if I remember correctly, said yesterday, 20 foreign 
exchanges have United States terminals. They cannot build 
liquidity, certainly in U.S.-delivered products, without having 
a presence in the United States.
    Yesterday, the experts testified that the real threat in 
oil is London, but on the U.S. West Texas Intermediate, it is 
delivered in the United States. It is an economic reality that 
the hedgers and the speculators want to be in the country where 
the delivery is taking place.
    Dubai Gold has started a West Texas Intermediate and is not 
asking to come into the United States. My understanding is that 
the contract is not doing well. Dubai Metal has gotten 
permission to come into the United States. The Guardian just 
ran a story. They have not started yet. It is not doing well. 
If they get terminals here, which they have permission to do, 
and trade WTI--which, by the way, will be regulated by Dubai--
they will probably be able to pick up liquidity. You have to be 
here, and, frankly, I think it is a hard thing to tell your 
constituents that we are not going to provide relief because we 
are worried that speculators will go elsewhere. And if you are 
going to weigh out those balances, you have the speculation 
that it will go elsewhere against the reality of $4 gas and 
$135 oil.
    Senator Coleman. Mr. Newsome, do you want to respond? Just 
listening to the exchange with Senator Levin, and Mr. Masters' 
comment about following the money, money moves markets, follow 
the money, on the non-physical side, the pension funds and 
others, looking at the testimony, there is discussion that the 
speculators are buying long, but some are buying short. And so 
I am trying to understand. Is it the volume of the money that, 
in effect, drives it? But if some of that money is betting 
short, does that somehow change the conclusion that this 
massive influx of money is contributing directly to higher 
prices?
    Mr. Newsome. Well, I think we are having somewhat of an 
apples-oranges discussion when we are talking about these 
markets. With regard to the NYMEX markets, the positions of 
swaps dealers since October 2007 have been net short, putting 
downward pressure on prices.
    Now, the scenario that Mr. Masters is talking about with 
the long-only funds, they are buying those funds, and the swaps 
dealers, the banks, are laying off that risk. But the banks 
themselves, at the CFTC hearing 2 weeks ago, admitted that they 
were laying off 90 percent of that risk over the counter. That 
is not coming to NYMEX. That is not reflected in the NYMEX 
numbers. And so I think when you say that it is having this 
long-only effect on the futures market, it is impossible to 
have that effect because you have to trade out of that position 
every months before you can buy the next.
    Now, if you will allow me to go back to Mr. Greenberger's 
comments--and Michael and I have known each other for a long 
time--I respectfully disagree with his comment about driving 
these markets offshore because it has already happened. London 
has 30 percent of the WTI market today. London has 50 percent 
of the Henry-Hub natural gas market today. The over-the-counter 
markets are nine times larger than the NYMEX market today. Not 
only can it happen, it is happening.
    Senator Coleman. Mr. Masters, just to follow up then on Mr. 
Newsome's comments, if, in fact, that $170 billion, whatever it 
is, if it is being laid off short, where is the upward 
pressure?
    Mr. Masters. Thank you, Senator. This is something that is 
thrown around by folks. People say, well, you see, there is a 
buyer for every seller, and so the implication is that prices 
will not move. Let's understand something clearly. There has 
been a buyer for every seller for every transaction ever in 
history. When Yahoo! traded at $120 in 2000, there was a buyer 
for every seller. When it traded in 2001, 1 year later, it 
traded below $10. At that point there was a buyer for every 
seller. So having a buyer for every seller does not mean 
transactions do not occur and markets do not move. Otherwise, 
markets would never move.
    So to what he is saying, the answer is the swaps that the 
index speculators are buying, the dealers may be selling, but 
it does not mean it is not going to have any effect on price. 
Because if you had a neighborhood and five people decided to 
try to buy your house, you are not going to keep the price the 
same. You are going to move up your price. And that is the way 
things work.
    If there is not enough supply at a certain price, the price 
goes higher. And that is what has happened here. The swaps 
dealers are just trying to lay off their risk. What they do is 
an index speculator comes in to them, the index speculator 
buys, the dealer sells, and then they turn around and buy a 
later contract, especially in a market with backwardation 
because they can make that spread. So there is still an impact. 
But the idea that just having a buyer for every seller means 
that prices do not move is, quite frankly, ridiculous.
    Senator Coleman. If I may, Mr. Masters, I think you are the 
only trader sitting up here. You are active in the market. What 
are you telling your clients? Are you buying short or are you 
buying long today?
    Mr. Masters. I do not trade commodity futures. I am a long-
short equity manager, and we have a variety of positions in 
equities.
    Senator Coleman. I mean, where do you see this going?
    Mr. Masters. In terms of?
    Senator Coleman. Long, short? I mean, where do you----
    Mr. Masters. In terms of the price of crude?
    Senator Coleman. Yes.
    Mr. Masters. I really think that if you can pass some 
really good legislation along the lines of our suggestions, 
that will have the effect of, short term, greatly bringing down 
prices. The issue here is what we have is an acute problem 
versus a chronic problem. We have an energy infrastructure 
issue that we have to deal with long term. But on the acute 
side, in the very short term, we have something that we can 
solve through regulation that will restrict institutional 
investors' ability to impact price discovery in the futures 
markets. And so there are differing time horizons. But I think 
over the short term, if you did this, I think that it is very 
likely that prices for food, energy, and commodities would come 
down hard.
    Senator Coleman. Thank you, Mr. Chairman.
    Chairman Lieberman. That is encouraging. I thought for a 
moment there, Senator Coleman, you were asking for a stock tip. 
[Laughter.]
    But this would have been in total compliance with the 
Securities and Exchange Commission Act because it was totally 
open. [Laughter.]
    No insider trading. Senator McCaskill.

             OPENING STATEMENT OF SENATOR MCCASKILL

    Senator McCaskill. Thank you, Mr. Chairman.
    This is a really dangerous time. It is a dangerous time 
because there are millions of businesses out there that are on 
the brink of collapse, and there are millions of families out 
there that are waking up every morning afraid. And what makes 
it even more dangerous is those of us who run for office feel 
incredible pressure to do something. And it is with a great 
deal of trepidation that we should wade into these waters in 
terms of beginning to play with a very heavy hand in the 
market.
    And I got to tell you, Mr. Masters, I think you speak 
plainly and you are very easily understood, and you may be the 
most powerful guy in Washington right now because what you are 
saying is what we all want to hear. What you are saying is that 
if you all will just do this, you are going to be able to, 
short term, move this price. And, frankly, most of the people 
around Washington right now, that is all they want to hear. 
What do we do to get the price down?
    And, unfortunately, I think that there are many of us who 
have not grasped some of the unintended consequences that we 
have to be careful of if we begin doing too much too quickly 
without really thinking this through. And so it is one of these 
really scary times to have a vote, because I am not sure what 
you will be doing a few years from now. I am not sure what oil 
prices will be doing a few years from now. But all of us will 
still be answerable to the same people that are going to be 
very angry if we cannot figure out something to do with oil 
prices or if we make it worse.
    We stopped contributing to the Strategic Petroleum Reserve. 
Prices continued to go up. We closed the Enron loophole. Prices 
continued to go up. China announced no more subsidies. That is 
huge, China announcing no more subsidies, because all the talk 
has been, well, this is Chinese demand, that is what is doing 
this. The prices continued to go up. Saudi Arabia said this 
weekend they are going to produce more. Prices opened up on 
Monday.
    So I am looking at four events that I think if we were in a 
bubble somewhere and it was not really in the news and I asked 
all of you smart people wouldn't all of these things have some 
impact on the price, and clearly they have had no impact on the 
price. You just said, Mr. Masters, that you believe that if we 
do these regulatory issues in terms of limiting institutional 
investors, limiting positions, trying to get back to the 
commercial players as opposed to the index funds and the hedge 
funds, you believe it will have a short-term positive impact on 
the price of crude oil. I want to ask the rest of you, yes or 
no, do you believe the price of crude oil will go down if we do 
this? Beginning with the CFTC, yes or no.
    Mr. Lukken. Not significantly, no.
    Senator McCaskill. NYMEX?
    Mr. Newsome. No, and I have a perfect example. The 
uncertainty that has been created among institutional investors 
over the hearings the last several weeks have forced liquidity 
and open interest out of the NYMEX WTI contract. And while that 
liquidity has been leaving, prices have not gone down.
    Senator McCaskill. Mr. Quinn.
    Mr. Quinn. No. We believe it is more supply-demand 
imbalance. We also think the falling dollar has had a big 
impact because our price increases are much greater than we are 
experiencing in Europe where the dollar has depreciated.
    Senator McCaskill. Dr. Angel.
    Mr. Angel. No. These are technical changes to the edges of 
the market. It really will not break the psychology of the 
market right now.
    Senator McCaskill. Mr. Greenberger.
    Mr. Greenberger. Yes, and I think in 4 years, if you do not 
do what is being suggested today, you are going to be 
criticized. Both Presidential candidates are calling for the 
end of speculation. Senator Obama came out with a very strong 
plan.
    Senator McCaskill. Well, we cannot end speculation.
    Mr. Greenberger. No, I mean----
    Senator McCaskill. That would be a terrible thing to do 
because if we end speculation, my farmers are in big trouble, 
to say nothing of Anheuser Busch and American Airlines that 
need to buy all kinds of commodities in terms of liquidity.
    Mr. Greenberger. One of your premises is we closed the 
Enron loophole. We are still talking about agricultural index 
funds. Why aren't they closed?
    Senator McCaskill. That is a good question.
    Mr. Greenberger. I have the greatest respect for those who 
worked on closing the Enron loophole, but I have testified it 
was not fully closed. And I can elaborate on that, but if it is 
closed, why are we talking about all these pension index funds.
    Now, Mr. Newsome said, if you close it, people will run to 
the ICE because it is British. The ICE is here, in Atlanta. It 
is headquartered in Atlanta, trading engines in Chicago, 
trading West Texas Intermediate, delivered in Cushing, 
Oklahoma, in U.S.-denominated dollars.
    Now, Mr. Newsome tells you, the unintended consequences 
will be that you will drive more to that market. That market is 
unregulated in the United States. Senator Levin is the 
principal author of pending legislation to re-regulate those 
exchanges. So when you say Saudis put more oil in, China has 
reduced its subsidies. George Soros testified in front of the 
Senate Commerce Committee. You could empty the Strategic 
Petroleum Reserve and not affect the price of crude oil unless 
you get a regulatory handle on what has not been closed by the 
Enron and London loopholes.
    Senator Lieberman and Senator Collins have a suggestion, 
that is option one, that I think is very credible. The Saudis 
are playing chicken with us. They know they can announce 12 
million barrels in 3 years, and it is not going to have any 
impact because this has no commercial basis. Saudi Arabia 
announced this great program to increase oil, and yesterday oil 
goes up $1.36. They have no control over it.
    Senator McCaskill, I cited in my testimony yesterday a 1992 
House Agriculture Committee study quoting a wheat farmer in 
your State, or somewhere thereabouts, saying, ``I look out at 
my field, and I do not own my field because some guy in Chicago 
is trading paper and taking my price power away from me.'' That 
is why we passed the Commodity Exchange Act. In 2000, we 
deregulated energy, and now we are hearing, even though we did 
not deregulate agriculture, that there are agricultural index 
funds.
    Of the four premises you have, the one I would go back and 
look at is if you closed the Enron loophole. That was good, but 
today there is not one contract that has been affected by that 
closure. And Mr. Lukken has announced it will affect Henry-Hub. 
That is natural gas. That has nothing to do with oil, gasoline, 
or heating oil.
    Senator McCaskill. I noticed in your written testimony, Dr. 
Angel, that you talked about three things: Is it a bubble? Is 
this really the price? Is it being manipulated? And then you 
talked about your solutions. And I got to tell you that I 
believe that your solution is the solution. The problem is it 
is not quick enough. The problem is it does not help me with 
the literally thousands of phone calls I am getting every day 
and the letters I am getting every day: Why can't you do 
something? And, what you said in your written testimony, I am 
not sure that you had time to emphasize it in your oral 
testimony, so I will do it for you. It is, in fact, our 
commitment to alternative energy that is going to, in fact, 
make the difference. It is, in fact, saying to the oil 
producers, we do not need you anymore, we do not want you 
anymore, we can do this differently.
    Do you believe that the single most important thing we can 
do for oil prices in this country is to, in fact, extend the 
tax credits for solar and wind and to do the kind of investment 
in these technologies and in this kind of alternative energy, 
not just ethanol but a whole lot of other things--cellulosic 
and all of the hydrogen technology? Do you think that is the 
single most important thing that we must do?
    Mr. Angel. Yes. We must adopt credible policies to move 
away from petroleum, that is, policies that the rest of the 
world will see and say, yes, we are going to stop burning 
petroleum, and because of that the stuff we have in the ground 
is eventually going to be worthless. Once that happens, we can 
use the strength of the speculators, like a good martial 
artist, against them. Once the markets see that we are going to 
stop burning petroleum, then there will be a going-out-of-
business sale. The speculators will rush to the exits and start 
shorting petroleum.
    Senator McCaskill. All right. I will tell you that the only 
thing in your testimony--you said we have to make sure that oil 
does not get below $100 a barrel? I hope we have that problem.
    Mr. Angel. And we will.
    Senator McCaskill. Thank you, Mr. Chairman.
    Chairman Lieberman. Thank you, Senator McCaskill. Senator 
Warner, thanks for being here.

              OPENING STATEMENT OF SENATOR WARNER

    Senator Warner. Thank you, Mr. Chairman. I thank you and 
the distinguished Ranking Member for convening this Committee 
for a very important hearing. And, gentlemen, you were 
challenged with one of the more extraordinary chapters of my 
contemporary life here in the Senate of some now 30 years. This 
is a very volatile issue, and we want to be extremely cautious 
not to, through testimony or otherwise, elevate the hopes and 
aspirations of a public that is grievously suffering that there 
is a quick fix for bringing down gas prices.
    I support the measures that my colleague from Missouri 
talked about. Certainly we can go to the alternatives and so 
forth. But that is going to take time. I am a sponsor of 
offshore drilling, and I think maybe there is a chance now that 
can be done, certainly for natural gas. But that is going to 
take time. So we are struggling with what we can do now to 
impact this situation, and I hope that we do so with the 
greatest of caution.
    Now, speaking for myself, I come out of the old school that 
this Nation, when the Founding Fathers put it together, was 
predicated on the principles of a free market system, and there 
is a fairly clear definition of what a ``free market system'' 
is. And it served this Nation quite well, except in times of 
war and other periods when we have had to take extraordinary 
measures.
    So my first question to you is that I am heavily inclined 
to support the Chairman and Ranking Member on their principles, 
but I would just like to ask each of you a simple question. If 
this were to become law, would this alter in any way the 
concept that we have had these many years about the free market 
system? And if so, does it strengthen the free market system or 
change it? So that is the question. We will just go down the 
line.
    Mr. Lukken. The devil is in the details of what this 
legislation----
    Senator Warner. That is a standard answer.
    Mr. Lukken. This would put controls on free market 
activity. So it would hinder it. And we already have controls 
in place in our law that allows certain limitations on 
speculative activity. So depending how it is crafted, it could 
be effective. But we want to make sure that it is not driving 
business overseas, that the markets are working effectively to 
discover prices. And that is the key. Are they discovering the 
right prices? And that is what we would be looking for.
    Senator Warner. So there is a potential that this could be 
interpreted or written or rewritten in such a way as to really 
impair the concept of a free market system?
    Mr. Lukken. It would put controls on free market--the 
movement of capital, certainly.
    Senator Warner. All right. Mr. Newsome.
    Mr. Newsome. Free competitive markets operate best and most 
efficiently when they are completely transparent, and that is 
the focus of our----
    Senator Warner. Well, that would be my second question when 
I come around. We may as well incorporate it in this. I really 
believe in every step that we can take to make things more 
transparent, or in simple language, let the sunshine and the 
light come in so that each person that wishes to follow this 
can see it. So you think it achieves that. And what was your 
response to the free market system?
    Mr. Newsome. Well, I think certainly transparency is 
beneficial to the free market system. Position limits are 
something that we have in use today to control speculators in 
the regulated marketplace, and in our opinion, it works very 
effectively.
    Senator Warner. All right. Mr. Masters.
    Mr. Masters. Thank you, Senator. I would just say that free 
markets, just like free society, require rules. In society, we 
do not allow assault and battery. Nobody argues that makes any 
of us less free. In this case, having some rules in our markets 
does not make our markets less free. In fact, I would argue 
that they actually make them more free.
    It is important to note that for bona fide physical 
hedgers, the actual prime constituency of the commodity futures 
markets, they presently have no restrictions, no position 
limits on their activities, and we are not promoting that they 
should. They will still be completely free without position 
limits to act as they would like to, and I mean bona fide 
physical hedgers.
    More importantly, speculators in the commodity futures 
markets, because they are not capital markets--they are 
commodities futures markets and, therefore, a different 
purpose--have always had limits, and that served everyone very 
well, because in this case what we want is we want some 
speculation----
    Senator Warner. Do you feel that this will strengthen the 
concept of the free market system?
    Senator Warner. How about transparency? Do you feel it 
enhances transparency?
    Mr. Masters. I absolutely do.
    Senator Warner. Good. Thank you. Mr. Quinn.
    Mr. Quinn. Three quick points. Transparency, we would be 
very favorable for. We think it would enhance the free market 
system. I think putting on specific limits, we would be 
concerned about how they allocate those limits to legitimate 
investors, and that would, therefore, limit the free market 
principles that you refer to. And certainly proposal three, 
banning pension funds, would have totally the opposite affect 
on free markets. It would be taking active investments and 
decisions out of the free market system.
    Senator Warner. Out of the free market system.
    Mr. Quinn. Yes.
    Senator Warner. Thank you. Dr. Angel.
    Mr. Angel. Markets work well most of the time, but every 
once in a while they make mistakes. And because of that, we 
found that with some light regulation, markets work even 
better. And I think some of the ideas proposed here will help 
the markets work better. I do not think they are a panacea. 
They are not going to solve the crisis. But we definitely need 
better transparency, and we definitely need to understand what 
is going on in the over-the-counter market.
    Senator Warner. And this, in your judgment, enhances the 
transparency.
    Mr. Angel. Yes.
    Senator Warner. Thank you. Mr. Greenberger.
    Mr. Greenberger. I agree it enhances transparency, and it 
helps, does not hurt, the free market. Bear in mind as the 
discussion papers that accompany Senator Lieberman and Senator 
Collins' legislation makes clear, this is premised on the 1936 
Commodity Exchange Act. These speculation limits were imposed 
because farmers were being killed in what was then essentially 
an only-agricultural futures market. There were too many 
speculators, so they put speculation limits. From 1936 to 2000, 
nearly every energy and food futures contract had speculation 
limits. The energy futures markets were deregulated in 2000. 
The speculation limits went away for those deregulated markets. 
What Senator Collins and Senator Lieberman want to do is return 
to something that has been done since 1936 and is still done in 
the regulated exchanges: Limit the participation of 
speculators.
    Option three bars certain trading--let's leave option three 
to the side. Option one and two limit so that the commercials 
who need these markets are not overwhelmed by speculators. We 
will have a better futures market. I am sure you are going to 
be hearing from your industrial users of energy and your 
farmers that for them to have a better competitive free market, 
they need these speculation limits on speculators, not to bar 
them from the markets, but to bring them under control.
    Senator Warner. All right. Thank you. That concludes my 
time.
    Chairman Lieberman. Thanks very much, Senator Warner. I 
appreciate the question, and it is a question that Senator 
Collins and I asked ourselves as well.
    My own view of this is--and I will say it very briefly, 
because I think it has been touched on--that the act adopted in 
the 1930s did set speculative position limits because the 
Congress then was worried about speculation creating a problem 
for the farmers and the fuel oil dealers who the market was 
created for. And the way we see certainly our first two 
proposals is as simply updating that reasonable exercise of 
congressional authority to protect public safety, make sure the 
markets operate freely because of things that have happened 
since then, some of which were just referred to by Mr. 
Greenberger; but also so much business now occurs in commodity 
futures off the exchanges in these over-the-counter markets. 
And then we have this swaps loophole that people have taken 
advantage of that also is an end run around the speculative 
position limits.
    So I share your admiration for markets, but I personally 
see these two proposals as essentially an updating and response 
to real events to try to bring the law up to where the life out 
there is.
    Senator Warner. We do not want to overregulate what we have 
got here in this country to the point it is all driven 
overseas. I mean, the rest of the world is going to sit back, 
look at our hearing, and say, well, that is fine if they want 
to do it in America, but we are going to do it our own way over 
here. We are at risk of seeing that happen.
    Chairman Lieberman. Yes, I share that. You know what I 
think? There has been some testimony on this, and I want to get 
to Senator Carper. But, interestingly, I think if we take some 
action here, the foreign markets may follow us. In fact, the G-
8, when it met in the last 2 weeks, adopted a resolution 
calling on each of their individual governments to take a look 
at regulating more actively in the commodities area because of 
their specific concern that this is a factor in the run-up in 
oil prices, which is obviously affecting them all, in some 
cases not as much as it is affecting us and poorer nations, but 
it is certainly affecting them. Thank you, sir, for that 
contribution. Senator Carper.
    Senator Carper. Thank you, Mr. Chairman.

              OPENING STATEMENT OF SENATOR CARPER

    Senator Carper. Gentlemen, welcome. I think we may be close 
to the end. I am not sure. But our caucus luncheon meeting 
starts in about 5 minutes, and so we will probably be out of 
your hair by then.
    I have been privileged to sit in on a couple of Committee 
hearings that deal with the issue of speculation, and I think 
in the Commerce Committee we have had some hearings as well. We 
discussed in a meeting over in the Capitol this morning 
legislation, I think, Senator Dorgan is introducing today to 
deal with this matter. And I think legislation that the House 
of Representatives might try to pass, I think as many as three 
pieces of legislation, as early as today.
    Are any of you aware of the content of any of the three 
pieces that the House expects to move? And can you comment on 
them favorably or not for us at this time?
    Mr. Greenberger. I was at a meeting last night where that 
issue was discussed among many of the House members who were 
concerned, and, I cannot swear to this, but I think there is a 
view that they need more time to digest what they are going to 
do, and they may not be moving as quickly as they thought they 
were moving yesterday afternoon.
    But there are different pieces of legislation that are 
being considered. Again, this idea that there is a London 
market that we do not have control over, we can debate whether 
it is London or the United States, and I have strong views 
about that, but, nevertheless, as Chairman Lieberman is saying, 
our actions may affect other countries. Chairman Lukken has 
just gotten the major exchange, which operates under the Union 
Jack, I believe wrongly, to agree that they should apply 
position limits for purposes of ``London.''
    I think Senator Levin and Senator Durbin have similar 
legislation on the Senate side. There is other legislation that 
wants to tighten the closure of the Enron loophole in the farm 
bill in the following way: The farm bill Enron loophole 
provision now puts the burden on Mr. Lukken to prove that a 
contract should be regulated. People want to go back to the 
status quo ante before the Commodity Futures Modernization Act 
and say every energy futures contract should be regulated the 
way it was on December 19, 2000, and let those who are 
regulated prove the need for deregulation. And then I think 
there are others who are suggesting that they do not believe 
that this major British exchange, ICE, is, in fact, British. 
They have 30 percent of our crude oil market. They are not 
operating under the same rules Mr. Newsome is operating under, 
even if the adjustments are made, and Mr. Lukken has been 
trying to do that. So there is legislation pending that says if 
you have U.S. trading terminals trading U.S.-delivered 
commodities, you must register as a full U.S.-regulated entity, 
as Mr. Newsome is. And that legislation would avoid trying to 
regulate through the foreign countries. So those are the three 
pieces of legislation.
    I think there is a dialogue going on, on one part of that, 
and that is, whether we continue to principally defer to 
foreign regulators while ratcheting up our controls over them 
for these U.S. trading terminals, or whether we deem those U.S. 
trading terminals to be U.S. terminals and they have to be 
regulated in the United States.
    In other words, these people have come to our country. 
There are about 20 foreign exchanges here. They have their 
trading terminals here. The biggest problem right now for 
energy is the ICE, which is trading 30 percent of Mr. Newsome's 
market. Mr. Newsome used to trade 100 percent of that market. 
People are debating whether to regulate ICE by going through 
the British or to say, no, these people are really in the 
United States, they should register as a U.S. exchange. And I 
am sure you will be part of that debate in the Senate.
    But those are the three different things that are going on.
    Senator Carper. Good. Thanks very much. Dr. Angel.
    Mr. Angel. I respectfully disagree with Mr. Greenberger. It 
is so easy to trade anywhere in the world these days. I can go 
to any Internet-connected computer right now and trade futures 
contracts on a variety of exchanges that, for all I know, do 
not even have terminals in the United States. So the fact that 
an exchange has a terminal here means that they have at least 
some degree of oversight from the CFTC. But modern 
communications make it so easy for anybody to trade anywhere 
anytime that our ability to regulate the activities of foreign 
markets is rapidly slipping away. And it is not just London 
that we need to be concerned about. It is Shanghai, it is 
Singapore, it is Hong Kong, and it is Dubai. It is many other 
places on the planet.
    Senator Carper. Let me go back to my original question and 
look to the others on the panel, and let me modify it just a 
little bit. In addition to asking for any reflections you have 
on the legislation that may or may not move in the House this 
week, or if you have heard anything about the legislation that 
Senator Dorgan introduced today, any comments on it one way or 
the other, I would appreciate hearing that, too. Please, 
anyone?
    Mr. Newsome. Senator, I have not heard specifics about what 
he introduced today. I know the bill that he was on with 
Senator Levin, Senator Durbin, and others is being discussed by 
the House Agriculture Committee. And that bill supports the 
transparency that we have been speaking about, supports the 
position limits that we have been speaking about, additionally 
supports further delineation of the swaps dealer information, 
and we support all those components with regard to that 
legislation.
    Senator Carper. All right. Thank you. Anyone else? Yes, Mr. 
Lukken?
    Mr. Lukken. I have not seen what Senator Dorgan introduced 
today, but in regards to the Durbin legislation, which he was a 
part of, that is promoting transparency, trying to codify some 
of the things the CFTC has been doing about getting more 
information from foreign boards of trade, which is extremely 
important, and imposing position limits on foreign boards of 
trade, that is imperative.
    I would respectfully disagree with Mr. Greenberger. We have 
to recognize that this is a global marketplace. New York Stock 
Exchange and Euronext have merged, those markets in London, 
Paris, and New York. And we have to engage foreign regulators 
to try to harmonize and write standards. This has allowed us to 
do that, and it has given us a transparent view into those 
markets to see the markets we would not normally see unless we 
had this process in place. And that is what we want to do, is 
bring these into the sunshine.
    Senator Carper. All right. Thank you. Mr. Masters, do you 
want to add to that?
    Mr. Masters. Sure. I would respectfully disagree with the 
Chairman. I do not think the Durbin bill would be that 
effective. I think it is more of a Swiss cheese bill, if you 
will. There are too many ways to move around it. I think a much 
stronger bill is necessary.
    I just want to make one other point. One of the issues 
here, I think, is that people from the capital markets tend to 
impute their biases on the commodity futures markets. The 
commodity futures markets have a physical delivery 
functionality in the United States, and I just want to read 
what Senator Levin said earlier: Today, any futures contract 
that cash-settles against a U.S. contract with physical 
delivery provisions is also automatically subject to CFTC 
regulation unless specifically exempted. If not exempted, then 
no person inside the United States may lawfully trade that 
contract.
    So without that exemption granted to ICE, which 60 percent 
of their volume is U.S. participants, ICE would have never 
gotten off the ground. So, going back and looking at some of 
these exemptions, removing some of these exemptions, closing 
the swaps loophole, could be a great way of making sure that 
these transactions occur on U.S. shores.
    Senator Carper. All right. Thank you.
    I have one more question. I am just going to ask it for the 
record and just ask you to respond in writing, if you would. 
But we have gone through some of the short-term options of 
correcting the challenge that we face, and it occurs to me that 
there are some long-term issues here that are not likely to be 
resolved overnight. I think you would agree with that.
    What do we, as Members of the Senate, need to be looking 
at, not in the short term but over the long term, to help bring 
about some real and needed changes? So I will be asking that 
one for the record.\1\
---------------------------------------------------------------------------
    \1\ CFTC's response to Senator Carper's question for the Record 
appears in the Appendix on page 360.
---------------------------------------------------------------------------
    Mr. Chairman, thank you all, and thank you very much.
    Chairman Lieberman. Thanks, Senator Carper.
    We will do a second round of 5 minutes each for Senator 
Collins and myself. I cannot resist asking you, Mr. Masters, if 
you think that the other piece of legislation you referred to 
is like Swiss cheese, would you say that the proposals Senator 
Collins and I are making are more like solid New England 
cheddar? [Laughter.]
    You do not have to answer. You can give your answer for the 
record.
    Mr. Masters. I think your proposed bill is much better, and 
it does a lot more to solve the problem.
    Chairman Lieberman. Thanks.
    Let me go back to a line of questioning that Senator 
McCaskill raised. Part of why we are focused on speculation in 
the markets as a source of the run-up in fuel and food prices 
is because we cannot see any other rational place where it is 
coming from. So, we know that the demand for oil--and food, but 
let me focus on oil for now--has risen over the last year, but 
by a small percentage of the increase in the price of oil 
futures contracts and in the price of gasoline at the pump. So 
it does not seem like the normal rules of supply and demand are 
working.
    But I want to come back--because it really perplexes me, 
and it is just this week. If the normal rules of supply and 
demand are working, why didn't the announcement by Saudi Arabia 
that they are going to increase their output of oil daily--
what, 700,000 barrels did they say? And then if that is not 
enough, that they are willing to go up 2 million above where 
they are now by the end of the year--I mean, that is really the 
futures market. Why has the price of the barrel of oil 
continued to rise after the Saudis did that if there were any 
normal laws of supply and demand going on here? Dr. Angel.
    Mr. Angel. Well, the media pundits put forth two proposals.
    One, on the same day as the Saudis made their announcement, 
there were also news reports of further turmoil in Nigeria of 
pipelines being blown up and supply disruptions there.
    At the same time, in the last year we have a number of 
political jitters with regard to Iran and their activities that 
are also causing fears in the oil market that there may be even 
more serious supply disruptions to come.
    Chairman Lieberman. This is something that has bothered me 
about the futures markets from the 1990s when the Committee 
last did an investigation of the run-up in fuel prices, because 
I understand that there has to be some place for psychology 
here, but so much of this is psychology, and here is the 
difference: The concern about Iran and the crisis there, that 
is still iffy. It is speculation. Whereas, the Saudi 
announcement to put this enormous increase in oil into world 
markets every day is real. So I do not understand why it is not 
bringing the price of gasoline down. Mr. Newsome.
    Mr. Newsome. I could give a couple of comments, Mr. 
Chairman.
    One, typically when we look to supply and demand in oil, it 
has been driven very hard by the supply function. Today, when 
we look at market fundamentals, it is being driven by the 
demand function. And the demand function information is much 
more difficult to put together, particularly when you are 
talking about China and India.
    With regard to the Saudi announcement, two things I would 
add--and I am not an oil market analyst, but as someone who is 
very involved in these markets--first of all, the production 
that they are talking about adding to the market right now is 
very sour. It is very costly to refine and is having little 
impact with regard to the kind of oil that refineries actually 
want.
    With regard to their longer-term projections--and I think 
it is OPEC in general--we have heard lots and lots and lots 
from OPEC in the past, and the market usually does not move 
until they actually see it put in place.
    Chairman Lieberman. So you are hopeful by the end of that 
answer that once the Saudis really begin to pump more oil that 
we will see some reduction?
    Mr. Angel. Yes. The market will wait for them to actually 
do it before it moves.
    Chairman Lieberman. Well, that is at least hopeful.
    Mr. Greenberger, do you want to add something?
    Mr. Greenberger. The materials I have read on this 
demonstrate that OPEC and the Saudis believe that increased 
production will not reduce the price in this market. I think 
they are saying we are going to show you that is the case.
    Chairman Lieberman. Right.
    Mr. Greenberger. And the reason is either you accept or you 
do not accept that the speculation is driving this market away 
from supply-demand fundamentals. I was shocked yesterday when 
there was no price rise on uninsured interests of Saudi supply. 
I thought at least temporarily something would get done 
lowering prices.
    Chairman Lieberman. Right.
    Mr. Greenberger. But the whole burden of the testimony that 
you had on May 20, and yesterday in the House, is the market is 
unhinged from supply-demand fundamentals. That is not to say we 
do not have a supply-demand problem. But the oil experts who 
testified yesterday are independent consultants. I do not think 
they have a political agenda. They are all saying, and OPEC is 
saying, and Exxon Mobil is saying, and Sunoco is saying, at the 
highest, oil should be $80 a barrel.
    Now, with regard to Dr. Angel, who says he could go 
anywhere to trade a futures contract, he could go anywhere to 
execute a trade. I hope he can get out of the trade. You have 
got to have liquidity. That is why people are not going to Oman 
to trade West Texas Intermediate. The whole concept and the 
reason we want speculators in the market is to create 
liquidity. Frankly, I get a lot of e-mails every day from 
somebody in Nigeria who wants to give me $20 million. I would 
suggest, Dr. Angel, treat those offers with prudence.
    Chairman Lieberman. All right. My time is up. I would say 
that I hope Mr. Newsome is right, that when the Saudis actually 
do raise their daily production, 500,000, 700,000 barrels of 
oil, that the price of gasoline and home heating oil will go 
down. If it does not, then watch out because I think this 
Congress is going to say there is only one explanation for this 
disastrous run-up in oil, gasoline, home heating fuel prices, 
and that is speculation. And there is going to be regulation.
    Senator Collins.
    Senator Collins. Thank you, Mr. Chairman.
    Mr. Newsome, in my opening remarks I talked about the 
soaring cost of home heating oil, which is my constituents' No. 
1 concern, especially since the vast majority of them rely on 
home heating oil to stay warm. And they are truly frantic about 
what is going to occur this winter.
    A home heating oil dealer in Maine discussed with me a 
concern that he has with NYMEX's heating oil contract. What he 
told me is that although home heating oil and diesel are 
similar products, they are not identical because of differing 
levels of sulphur. Yet on NYMEX, they are traded together, he 
says, under the HO symbol.
    His theory is that by combining those two products, the 
cost of home heating oil is being driven higher than it 
otherwise would be. He points out this is summertime, the time 
when demand is lowest, and yet the cost of home heating oil is 
very high. He believes it is being traded with diesel for which 
the demand is high.
    Could you comment on this issue? This is a major home 
heating oil dealer in Maine with a lot of experience, and he 
does believe this is another factor exacerbating the price of 
home heating oil.
    Mr. Newsome. I am more than happy to, Senator. Obviously, 
it is a derivative product from crude oil, as is gasoline. We 
list a heating oil contract, and it is listed and traded as 
heating oil. Other market participants, however, manage their 
risk through hedging our heating oil contract against their 
needs for diesel and against their needs for jet fuel, which 
are both relatively similar to heating oil. And then there is a 
basis difference between the cost of heating oil and whether it 
is diesel or jet fuel.
    So NYMEX lists it as a heating oil contract. We trade it as 
a heating oil contract, other market participants use to hedge 
diesel and jet fuel risk.
    Senator Collins. But if you separated it on your futures 
markets, would it be advantageous for the purchasers of home 
heating oil?
    Mr. Newsome. I do not believe so. It is a relatively small 
contract now, and we recognize that others trade it. It helps 
provide liquidity in that contract that is beneficial to all 
who need to hedge. If we separate it out, the participants who 
need it only to trade jet fuel or who need it only to trade 
diesel, then it would become a very small illiquid contract on 
its own.
    Senator Collins. Thank you.
    Professor Angel, I want to talk to you about the swaps 
loophole. I know that you are not enthusiastic about two of the 
three proposals that are being discussed for legislation, but 
it does seem to me, based on my reading of your testimony, that 
you do believe the proposal to close the swaps loophole and 
give the CFTC more authority does have some merit. Is that 
accurate? And if so, could you elaborate on that? If I am not 
correct, then you do not need to elaborate on it.
    Mr. Angel. Certainly. Yes, that is accurate. The swaps 
loophole basically says that swap dealers are treated as 
hedgers, and, indeed, that is legitimate in that they have an 
exposure on one side in the over-the-counter market, and they 
hedge that position in the regulated futures market.
    Now, the problem is that provides a direct conduit between 
the unregulated over-the-counter market and the regulated 
markets so that the unregulated markets are providing 
substitutes that feed back into the regulated market. And I 
think it makes sense to give the CFTC some authority to 
regulate that.
    Senator Collins. Thank you.
    Mr. Quinn, do you have any objections to closing the swaps 
loophole?
    Mr. Quinn. We are not really technical experts on that, but 
I think we would be in favor of the transparency aspects as 
well. And that is exactly what I think the professor explained, 
being able to see what is happening on both sides. So we would 
be supportive of it.
    Senator Collins. Mr. Newsome.
    Mr. Newsome. Yes, we support the full transparency.
    Senator Collins. Is there anyone on the panel who does not 
support that provision?
    Mr. Lukken. Can I just mention one thing?
    Senator Collins. Mr. Lukken.
    Mr. Lukken. As we look at the information that we will be 
getting from swap dealers, we want to make sure, as the 
proposal, I think, talks about greater transparency in looking 
through to those markets. I just want people to be mindful, 
too, that we want to give these investment banks opportunities 
to manage their risk in the regulated marketplace, that as we 
think through proposals, that we are not cutting off a 
regulated avenue for them to come onto markets where there is 
transparency. Certainly Bear Stearns and other examples 
recently, we have seen where they----
    Senator Collins. Not a great example.
    Mr. Lukken. They have been off from regulated marketplaces. 
So we want to make sure they have a transparent avenue onto 
those markets when we consider all these proposals.
    Senator Collins. Thank you, Mr. Chairman. I also recognize 
that we do not have investment banks represented at this panel, 
which might have a different view, although I think any 
observer of this hearing would commend the Chairman for having 
a panel with so many diverse views. So thank you, Mr. Chairman.
    Chairman Lieberman. Thank you, Senator Collins. I thank the 
witnesses. It has been a very constructive morning from my 
point of view and I think a healthy exchange of ideas. As we 
indicated last week, Senator Collins and I are now going to sit 
back and consider what has been said here and elsewhere. And 
our strong intention is to introduce legislation after the 4th 
of July recess, which would be the week of July 7, hopefully. 
And, again, I think this is urgent enough--and I hope this is a 
case where the bipartisan interest in doing something about the 
run-up in fuel and food prices is not limited to this 
Committee--that we can get a bipartisan willingness to devote 
some floor time in the Senate and House to this before we break 
certainly this fall. So we are going to push forward with what 
we believe will be a reasonable and constructive package after 
the recess.
    I thank all of you very much. We are going to leave the 
record of the hearing open for 15 days so that you can add 
anything you would like to your testimony. And if Members of 
the Committee have additional questions they want to ask, we 
would ask you to respond to them in that time frame.
    Thank you very much. The hearing is adjourned.
    [Whereupon, at 1:16 p.m., the Committee was adjourned.]
                            A P P E N D I X

                              ----------                              


    OPENING PREPARED STATEMENT OF SENATOR LIEBERMAN FOR MAY 7, 2008
    Good morning and welcome to our hearing today. This is the first of 
at least two hearings this Committee will hold to examine the rapid 
increase in the price of food occurring here in the United States and 
across the globe, and to consider actions the Federal Government should 
take or change to alleviate the pressure these high prices impose on 
American families. I want to thank Senator Collins for her suggestion 
that we hold these hearings on an issue of such real concern to so many 
Americans.
    The specific issue we will examine today is the effect of Federal 
Government subsidies for ethanol on the current food crisis. In a 
couple of weeks, we will ask whether speculators are driving up 
commodity prices. According to the USDA Economic Research Service, food 
prices in the United States will increase 4 to 5 percent this year, the 
largest annual increase since 1990, with the increase 
disproportionately affecting low-income consumers whose food 
expenditures make up a larger share of their total expenditures. 
Overall, U.S. households spend 12.6 percent of their income on food, 
while low-income households spend 17.1 percent on food.
    The World Bank reports that global food prices have increased by 83 
percent in the last 3 years, a devastating rate of inflation when you 
understand that Nigerian families spend 73 percent of their budgets on 
food, the Vietnamese spend 65 percent, and Indonesians spend half their 
incomes on food. People have already died in food riots in Somalia, 
World Bank President Robert Zoellick warns that 33 other nations are at 
risk of unrest, and one billion Asians are at risk of hunger or 
malnutrition.
    So how did this crisis come to be? In a complex global economy, the 
domino effect began with lower than expected wheat harvests in the 
United States and Europe last year, prolonged drought in Australia and 
Eastern Europe, and poor weather in Canada, Western Europe, and the 
Ukraine. As supplies waned, prices rose, and some major grain 
producers, such as Argentina and Ukraine, barred exports to control 
costs at home, further reducing supplies and driving prices even 
higher. At the same time, global food consumption is increasing as 
developing nations develop. A rising middle class in India and China is 
causing increased demand for meat, which requires more feed grains. The 
record high price of oil increases food production, processing, and 
transportation costs. And finally, a weak dollar has increased the 
purchasing power of other countries' currencies that are stocking up on 
relatively cheap U.S. food exports.
    Then, late last year--in an effort to promote American energy 
independence and help reduce the greenhouse gas emissions that are 
causing global warming--Congress required a fivefold increase in 
renewable fuels, which in turn led to an increase in demand for corn, 
and a further decrease in supplies of wheat and soybeans as farmland 
that traditionally was used to grow these crops has been converted to 
the more profitable corn crop.
    This confluence of events has had a dramatic impact on food prices 
as events spin off one another, creating a cycle of rising demand, 
dwindling supplies, and unstable prices. If you are poor, the effects 
can be deadly.
    The question is how we in Congress can help bring some relief. 
First, and probably foremost, Congress can and should consider 
strengthening the food assistance programs on which those Americans who 
are most at risk rely. Second, Congress is now in the midst of heated 
debate on a number of policies that will affect future food prices. The 
Food, Conservation, and Energy Act of 2008 (farm bill), for example, 
now in conference, would reduce subsidies for ethanol producers. The 
current 54-cents-per-gallon tariff on foreign imports of ethanol used 
as fuel is set to expire at the end of Fiscal Year 2009 and Congress 
could take action to lower it. And third, the Renewable Fuel Standard 
imposed in last year's energy bill could be reduced.
    This Committee has the unique ability to look across the Federal 
Government to assess the range of policies that influence the price and 
availability of ethanol in the marketplace. The policies we discuss 
today have the potential to shape future debates on the best way for 
Congress to respond to this global food crisis, and I am glad to 
welcome our witnesses who will help us better understand this issue.
    Andrew Siegel is the owner of When Pigs Fly Bakery, in York, Maine. 
He will discuss how rapidly rising commodity prices have negatively 
impacted his business. Rev. David Beckmann, President of Bread for the 
World, an organization that works to end world hunger, will talk about 
how rapidly rising food prices have led to a global food crisis. Bruce 
A. Babcock is an agro-economist from Iowa State University, who 
contends that passage of the expanded Renewable Fuel Standard was the 
tipping point in a number of factors that have caused unstable food 
markets. And Mark W. Rosegrant is Director of the Environment and 
Production Technology Division of the International Food Policy 
Research Institute. He will discuss the impact of global biofuels 
policies on food prices. Gentlemen, thank you in advance for your 
testimony.

                               __________
         PREPARED STATEMENT OF SENATOR COLLINS FOR MAY 7, 2008
    Today we consider whether a change in American agriculture policy 
aimed at reducing our reliance on imported oil may be having serious, 
unintended consequences for food supplies and prices.
    According to the World Bank, global food prices have increased by 
83 percent in the past 3 years. Here in the United States, an analysis 
of April 2008 prices shows even more remarkable one-year increases:

      wheat, up 95 percent,
      soy beans, up 83 percent,
      corn, up 66 percent, and
      oats, up 47 percent.

    Such increases in basic commodities naturally work themselves 
through the food-supply chain. According to the U.S. Department of 
Agriculture, consumer prices for all foods increased by 4 percent in 
2007--the highest annual rate since 1990--and the Department projects 
continued increases.
    The consequences reach far beyond data cells on some spreadsheet. 
They affect families who are forced to cut back on bread, meat, and 
dairy purchases and to apply their economic-stimulus checks to their 
grocery bills. The nutritional threat, especially to lower-income 
families with children or to senior citizens with limited incomes, is 
clear. The high prices and shortages also hurt small businesses like 
the Maine family bakery whose future is less secure due to escalating 
costs.
    The global consequences are also grim. As World Bank President 
Robert Zoellick warned last month, ``33 countries around the world face 
potential social unrest because of the acute hike in food and energy 
prices. For these countries, where food comprises from half to three 
quarters of consumption, there is no margin for survival.'' The impact 
of rising prices, food shortages, and export restrictions has 
devastating consequences for the billion people around the world living 
in dire poverty.
    We need a clearer view of how biofuel policies shape this troubling 
picture. So I am pleased that the Chairman has agreed to have the 
Committee carefully examine this issue.
    Subsidies for ethanol production, tariffs on ethanol imports, and 
mandates for ethanol use have certainly had an impact on the U.S. corn 
crop. In 1997, only 5 percent of the corn harvest was used for ethanol 
production. That portion grew to 20 percent of the 2006 harvest. The 
Department of Agriculture estimates that 24 percent of last year's corn 
crop is currently being used for ethanol, and that ethanol's claim on 
the 2008 harvest will climb to 33 percent.
    Not surprisingly, increased demand for corn-based ethanol has 
diverted acreage from crops like wheat and soybeans to corn and has had 
ripple effects on the cost of feed for livestock.
    The USDA's Long-Term Projections, released in February, note that 
the strong expansion of corn-based ethanol production affects virtually 
every aspect of the field crops sector, from domestic demand and 
exports to prices and allocation of acreage among crops. After 2008, 
the USDA believes that the high returns for corn crops will lead to 
still further reductions in wheat and soybean planting. As our witness 
from a Maine bakery will attest, such changes in the use of distant 
croplands can have profound local effects.
    Certainly, American and European policies that promote corn or 
other food crops for ethanol are not the only factors in the sharp 
increase in food prices. Other factors include higher food demand in 
developing countries, higher energy and fertilizer costs, and weather 
events like the drought in Australia.
    Many of these factors are beyond the control of mankind, much less 
governments. By contrast, however, biofuel subsidies and mandates are 
within the control of governments. And the International Food Policy 
Research Institute estimates that, globally, biofuels development may 
account for a quarter to a third of the increased costs of food. We 
must therefore examine the impact that American biofuel policy is 
having on the global food crisis and whether our policy needs to be 
adjusted to mitigate unintended consequences in the United States and 
elsewhere.
    This is not an abstract matter of public policy. It affects the 
poorest people in our country and our world. It affects our bakeries, 
markets, restaurants, and family kitchens here and around the world. I 
look to today's witnesses for assistance in helping us better 
understand the trade-offs inherent in our current biofuels policy.

                               __________
        PREPARED STATEMENT OF SENATOR MCCASKILL FOR MAY 7, 2008
    As we will hear today, there is no singular cause to the rising 
cost of food. Among the contributing factors are higher energy costs 
that increase transportation, processing, and retail costs; low global 
food grain and oilseed supplies due to drought and poor harvests; 
changing eating habits due to rising incomes in large, rapidly emerging 
economies; demand for corn for ethanol competing with food and feed 
acreage; and increased U.S. exports as a result of a weakening dollar. 
What we are certain of though is that the high cost of food 
disproportionately affects our lower income citizens and the backbone 
of our economy, small businesses.
    It is imperative as we move forward in understanding and in 
responding to the rising cost of food that we do so in a measured and 
reasoned manner. Our solutions should balance not only the immediate 
needs to reduce the costs of food, but also the nation's long term 
energy needs and carbon reduction objectives. It is important to note 
that any change in existing energy policy involving corn-based ethanol 
will not have an effect for at least two years, given 2008 crops are 
already in the ground and the harvest for 2009 will not be reaped until 
late in that year.
    Short term fixes such as waivers to Renewable Fuel Standards (RFS) 
have been proposed to reduce demand on corn--argued to reduce corn 
being diverted to ethanol production and freeing up acreage used 
currently in corn production for wheat production. The RFS requires the 
blending of 9.0 billion gallons of renewable fuel in transportation 
fuels in 2008, increasing to 36 billion gallons in 2022. Although 
increased ethanol production has contributed to the increase in food 
prices, the overall cost of crude oil and labor, coupled with increased 
global demand and reduced harvests also are principal causes of 
increased food prices. Studies indicate ethanol has kept fuel costs up 
to $0.40 cents cheaper in some parts of the U.S., as we face gasoline 
prices over $3.50 per gallon.
    Energy costs affect all levels of the food production sector. 
Recent record crude oil prices in excess of $120 per barrel affect 
costs throughout the marketing chain. Some of these costs are passed on 
to consumers in the form of higher prices. In 2005, the most recent 
year for which data are available, direct energy costs and 
transportation costs accounted for roughly 8 percent of retail food 
costs.
    Clearly the $0.40 reduction in the price of fuel is a positive 
outcome of the RFS. We may learn today that the market will demand this 
cheaper alternative to fossil fuels and continue to refine corn into 
ethanol regardless of the RFS and other incentives. I believe corn-
based ethanol and biodiesels are components of the long term solutions 
to the nation's varied energy needs; however, I believe we need to 
broaden our scope beyond food commodities to alternative sources.
    Specifically, cellulosic sources such as corn stover and 
switchgrass can be a viable option for replacing some of the feed 
stocks currently occupied by corn. There are positive indications that 
with additional research and technology advancements, cellulosic 
biofuels can be a viable fuel option. Incentives that help the 
development of these types of advanced biofuels will not only allow us 
to diversify our fuel options but will also relive many of the 
sustainability concerns around corn based ethanol. At a time when we 
are facing unprecedented fuel costs and increasing inflation, I think 
the best policy is to invest in these untapped sources of cellulosic 
energy.
    I look forward to the testimony we are to hear before this 
Committee today.
                               __________
        PREPARED STATEMENT OF SENATOR STEVENS FOR JUNE 24, 2008
    Thank you Chairman Lieberman and Ranking Member Collins, and to our 
distinguished panelists for your attention to this critical issue.
    Today, the average price of a gallon on gas is $4.08. In some parts 
of Alaska, the price of a gallon of gas is over $8.00.
    There are not many immediate solutions but I am certain that this 
hearing--and related legislation--will help. The disruption in supply 
from the attack on Shell's platform in Nigeria last week reminds us 
that oil prices are volatile enough without allowing speculators to run 
unregulated.
    With the Fourth of July bringing the peak of summer travel next 
week, Congress should act on this energy crisis before we all travel 
home while other Americans cannot afford to do so due to fuel costs.
    Most foreign producers believe Americans will pay any price for 
oil. Congress validates this belief each day that we fail to implement 
a comprehensive energy strategy.
    Americans are being taken advantage of not only by OPEC, but by 
speculators who are exempt from regulation by the U.S. Commodity 
Futures Trading Commission. When speculation in oil markets does occur, 
I believe there should be a legitimate reason for it.
    I would certainly define legitimate speculation to encompass the 
physical market for oil. Anytime an entity has the business need and 
capacity to make or take delivery of the product, their ability to buy 
futures contracts is necessary.
    But Congress must recognize that speculators who are not consumers 
of oil are hijacking the market, they are just trading paper barrels, 
not physical volumes of oil.
    There should be a limit on the extent to which investors in 
petroleum futures can increase their positions in this important 
commodity market. It should be a crime when speculators knowingly 
manipulate oil prices and drive up the price of fuel at the expense of 
the American family.
    Such actions undermine our country's energy stability and energy 
security. Even major institutional investors have taken up oil futures 
markets as a major asset class in their financial portfolios.
    In the last 5 years, investments in commodity index funds jumped 
from $13 billion to $260 billion, and this increase is mainly comprised 
of oil futures. Excessive speculation in oil futures is causing our 
economy to decline.
    Our domestic oil crisis has combined with our economic instability 
and excessive oil speculation to become a vicious cycle. As energy 
prices continue to cripple our economy, inflation rises and the dollar 
weakens.
    One of the few places that investors see a safe bet is in energy 
markets because they know oil demand will continue to increase. I 
recently stated on the Senate floor that IEA predicted world oil demand 
to increase from 85 million barrels per day to 116 million barrels per 
day.
    That is the reality and that is the future of oil. Therefore, more 
investors want to increase their positions in oil futures. Immediately, 
the CFTC needs to conduct a review to examine where unregulated trading 
in oil futures has most impacted the market. There must be full 
disclosure from anyone taking part in the oil speculation game. Last 
year Senator Feinstein and I worked across party lines to pass CAFE, 
which is the first Federal increase in vehicle fuel efficiency in three 
decades.
    Now, we work together again on S. 3131, the Oil Speculation Control 
Act of 2008. This bill requires the CFTC to identify and crack down on 
the oil commodity futures markets that have spun out of control.
    I would also like to point out what I am sure most if not all of 
our panelists will confirm: That oil speculation is driven by 
expectation. We can and should address part of high fuel costs by 
clamping down on the unfair exemptions in commodity markets.
    But so long as Congress fails to address the supply side of this 
issue we will not solve the problem. I have predicted higher oil prices 
many times simply due to my recognition that relying on unstable 
foreign sources of oil creates the potential for disruption and abusive 
pricing of our supply.
    Speculators also recognized that and therefore have been able to 
make a killing buying up futures contracts. It would be an 
understatement to say America needs a comprehensive approach. America 
needs a full court press against our energy crisis.
    This must include powerful signals to the world market that we will 
produce more, conserve more, research more alternatives and, when 
absolutely necessary as it is today, regulate more.
    Speculators and competing world oil suppliers would take notice of 
this approach the moment Congress approves it.
    The fact is that the prospect of more supply coming online, 
together with conservation measures such as CAFE and investment in 
renewable energy, will combine to give speculators less to speculate 
about.
    Again I thank the Chairman and the Ranking Member and look forward 
to the testimony.


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