[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
U.S. GOVERNMENT PRINTING OFFICE
43-084 PDF WASHINGTON : 2010
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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
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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?
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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.
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\1\ The prepared statement of Senator Lieberman appears in the
Appendix on page 119.
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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.
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\1\ The prepared statement of Senator Collins appears in the
Appendix on page 120.
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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.
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\2\ The charts submitted by Senator Collins appear in the Appendix
on page 124.
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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\
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\1\ The General Motors Press Releases submitted by Senator Carper
appear in the Appendix on page 128.
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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.
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\2\ The prepared statement of Mr. Siegel appears in the Appendix on
page 153.
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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.
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\1\ The prepared statement of Mr. Babcock with an attachment
appears in the Appendix on page 156.
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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.
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\1\ The prepared statement of Mr. Beckmann appears in the Appendix
on page 162.
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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.
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\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.
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\1\ The chart referenced by Senator Sununu appears in the Appendix
on page 126.
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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.
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\1\ The prepared statement of Mr. Masters appears in the Appendix
on page 191.
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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\
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\1\ The chart referenced appears in the Appendix on page 137.
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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.
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\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.
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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.
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\1\ The prepared statement of Mr. Steil appears in the Appendix on
page 212.
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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.
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\1\ The prepared statement of Mr. Buis appears in the Appendix on
page 219.
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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.
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\1\ The chart referenced by Senator Levin appears in the Appendix
on page 135.
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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.
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\2\ The chart referenced by Senator Levin appears in the Appendix
on page 136.
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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.
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\1\ The graphic referenced by Dr. Steil appears in the Appendix on
page 217.
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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.
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\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.
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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.
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\1\ The prepared statement of Mr. Quinn appears in the Appendix on
page 264.
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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.
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\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.
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\1\ The prepared statement of Mr. Greenberger appears in the
Appendix on page 278.
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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
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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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