[Senate Hearing 110-459]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 110-459
 
       NON-COMMERCIAL INSTITUTIONAL INVESTORS ON THE PRICE OF OIL 

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

                                HEARING

                               before the

                              COMMITTEE ON
                      ENERGY AND NATURAL RESOURCES
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                                   TO

EXAMINE THE INFLUENCE OF NON-COMMERCIAL INSTITUTIONAL INVESTORS ON THE 
                              PRICE OF OIL

                               __________

                             APRIL 3, 2008


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               Committee on Energy and Natural Resources

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               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                  JEFF BINGAMAN, New Mexico, Chairman

DANIEL K. AKAKA, Hawaii              PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota        LARRY E. CRAIG, Idaho
RON WYDEN, Oregon                    LISA MURKOWSKI, Alaska
TIM JOHNSON, South Dakota            RICHARD BURR, North Carolina
MARY L. LANDRIEU, Louisiana          JIM DeMINT, South Carolina
MARIA CANTWELL, Washington           BOB CORKER, Tennessee
KEN SALAZAR, Colorado                JOHN BARRASSO, Wyoming
ROBERT MENENDEZ, New Jersey          JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas         GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont             JIM BUNNING, Kentucky
JON TESTER, Montana                  MEL MARTINEZ, Florida

                    Robert M. Simon, Staff Director
                      Sam E. Fowler, Chief Counsel
              Frank Macchiarola, Republican Staff Director
             Judith K. Pensabene, Republican Chief Counsel














































                            C O N T E N T S

                              ----------                              

                               STATEMENTS

                                                                   Page

Barrasso, Hon. John, U.S. Senator From Wyoming...................     6
Bingaman, Hon. Jeff, U.S. Senator From New Mexico................     1
Book, Kevin, Senior Analyst and Senior Vice President, FBR 
  Capital Markets Corporation, Arlington, VA.....................    25
Burkhard, James, Managing Director, Cambridge Energy Research 
  Associates, Cambridge, MA......................................    33
Cino, Victor J., President, Pyramid Oil Marketing................    72
Cota, Sean, Co-Owner and President, Cota & Cota, Inc., President, 
  New England Fuel Institute, Bellows Falls, VT..................    37
Domenici, Hon. Pete V., U.S. Senator From New Mexico.............     3
Dorgan, Hon. Byron, U.S. Senator From North Dakota...............     5
Eichberger, John, Vice President, Government Relations, National 
  Association of Convenience Stores, Alexandria, VA..............    43
Emerson, Sarah A., Managing Director, Energy Security Analysis, 
  Inc., Wakefield, MA............................................    18
Harris, Jeffrey, Chief Economist, Commodity Futures Trading 
  Commission.....................................................     7
Salazar, Hon. Ken, U.S. Senator From Colorado....................     2

                                APPENDIX

Responses to additional questions................................    77


       NON-COMMERCIAL INSTITUTIONAL INVESTORS ON THE PRICE OF OIL

                              ----------                              


                        THURSDAY, APRIL 3, 2008

                                       U.S. Senate,
                 Committee on Energy and Natural Resources,
                                                    Washington, DC.

    The committee met, pursuant to notice, at 9:35 a.m. in room 
SD-366, Dirksen Senate Office Building, Hon. Jeff Bingaman, 
chairman, presiding.

OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW 
                             MEXICO

    The Chairman. Ok. Why don't we get started here? I think 
there will undoubtedly be things that try to interrupt us as we 
go forward. I thank the witnesses for joining us.
    Today's hearing will be about an issue that we've been 
debating in Congress for a number of years. That is how 
increased speculation in financial energy markets is 
contributing to recent record setting oil prices. Certainly 
there's a broad recognition that the fundamentals of supply and 
demand explain much of the current oil price.
    We see increased oil demand especially in developing 
economies such as China and India. We've seen OPEC oil 
production policies successfully manage U.S. and global oil 
inventory levels keeping global commercial stocks low. This 
adds to market tightness and upward price pressure. At the same 
time we see frequent small scale oil supply interruptions, 
which in the last week included sabotage of energy 
infrastructure in Iraq, Ecuador, Nigeria, which are all OPEC 
members.
    We also have a misguided, in my view, policy with regard to 
continued filling of the Strategic Petroleum Reserve. Senator 
Dorgan has consistently pointed out this and has been trying to 
do something about it, which I support. This removes more oil 
from the marketplace than the small-scale disruptions. Clearly 
there are fundamental factors that are very important, but as 
we heard from Guy Caruso, the Administrator of EIA, these 
market fundamentals could explain perhaps as much as $90 of the 
current price of a barrel of oil.
    In addition to these factors there have been a number of 
important developments in financial markets in recent years. 
These trends include a dramatic increase in the volume of 
trading in oil derivative markets, the participation of new 
classes of traders in those markets. These trends are 
exacerbated by the historic weakness of the dollar, which 
encourages non-commercial investors to seek commodity 
investments in order to protect against inflation risk.
    According to a GAO report issued last fall, the average 
standing contract volume for crude oil traded on the New York 
Mercantile Exchange increased by 90 percent between 2001 and 
2006. In addition, GAO noted the average daily number of non-
commercial participants in crude oil markets included hedge 
funds and large institutional investors more than doubled from 
2003 to 2006. So taken together, it seems that just as the 
demand for physical barrels of oil has grown with the global 
economy there is also an increased demand for oil purely as a 
financial asset.
    Untangling whether and how these dual sources of demand may 
be operating in concert and potentially impacting all prices is 
complicated. Certainly, I think, it's accurate to say there's 
growing suspicion on the part of many Americans that at the 
very least Wall Street's geo-political judgments may be serving 
to increase current pricing trends. To my mind, unraveling 
these issues is made more difficult to the extent that we're 
confronted with the lack of reliable and comprehensive data 
across these markets.
    There's a notable lack of reliable information with respect 
to global oil reserves; a lack of transparency related to 
certain corners of financial markets. It seems to me that 
markets operate best on the basis of complete and reliable 
information. In the absence of such information the probability 
increases for prevailing market prices to become untethered 
from the fundamental supply and demand consideration. In 
addition, I think it's also important for us to better 
understand the degree to which energy commodities in a purely 
financial sense have become an attractive investment given the 
state of the overall U.S. economy.
    Today we have a very distinguished panel of witnesses, and 
I look forward to hearing from each of them on these 
complicated issues. I thank them for being here.
    Let me defer to Senator Domenici for any opening statement 
he'd like to make.
    [The prepared statement of Senator Salazar follows:]

         Prepared Statement of Hon. Ken Salazar, U.S. Senator 
                             From Colorado
    Thank you Chairman Bingaman and Ranking Member Domenici for holding 
today's hearing on the influence of speculators and non-commercial 
investors on the price of oil. Today's hearing should shed light on the 
economic and market forces that determine the price of oil. Global 
demand for this resource grows stronger daily. This demand now comes in 
two varieties: demand for the physical product itself, and demand for 
oil as an investment commodity--so-called ``paper barrels.'' In an 
increasingly uncertain global financial climate, many investors are 
seeking to lock their capital into commodities. At the same time, 
consumers and businesses are powerless as gasoline prices skyrocket.
    We are all aware that the price of oil hit an all-time inflation-
adjusted high last month. Some are projecting that we'll have $4 per 
gallon gasoline this summer. Many analysts have suggested that 
speculation in the crude oil market has played a determining role in 
the price surge. The recent increase in trading volume on energy 
commodities markets highlights the rising significance of investors' 
and speculators' behavior. It is reasonable to suspect that this 
behavior plays a significant role in determining the price of oil, and 
therefore the price of gasoline. If this is in fact the case, consumers 
are paying the price for investors' priorities.
    Many people are also worried that the crude oil derivatives markets 
are susceptible to manipulation. We know from the Enron scandal that 
without adequate oversight and regulation, market manipulation is 
possible--and that the consequences can extend far beyond the bottom-
lines of the investors involved and their share-holders to affect the 
lives of individual consumers. The new Energy Independence and Security 
Act explicitly prohibits manipulation of crude oil, gasoline and 
petroleum distillates wholesale markets. I am particularly interested 
to hear our panelists' assessments of whether the regulatory structures 
exist to properly enforce this new statute.
    In the bigger picture, oil prices are still largely a function of 
OPEC's supply-and price-setting whims. The U.S. consumes 25 percent of 
the world's oil, but produces only 3 percent. Given our limited 
domestic supplies of crude oil, it is wrong to suggest that drilling in 
the Arctic or even offshore would have any impact on world prices. At 
the end of the day, we are still captive to OPEC's preferred oil price.
    Ensuring a rational and open crude oil market is a matter of 
national and economic security. Because of strong leadership from this 
Congress, our country is on the verge of a clean energy revolution that 
will reduce our oil consumption. However, as we continue to rely on 
foreign oil in our transportation sector, it is imperative for us to 
understand the forces that affect the oil market. We must do everything 
we can to shield consumers from oil price shocks. I look forward to 
discussing these issues with our witnesses today, and I thank them each 
for participating.
    Thank you, Mr. Chairman.

   STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR FROM NEW 
                             MEXICO

    Senator Domenici. Thank you very much, Mr. Chairman. Thanks 
to all of you for coming.
    Mr. Chairman I might say that I listened carefully to your 
statement. Rather than deliver a detailed statement I would say 
for the record that I agree with everything Senator Bingaman 
said except two things that we already know we disagree on. One 
is SPR. I think it has an impact but I think the risk we're up 
against instead of having an extreme shortage justifies us 
having SPR and even perhaps even having it bigger than it is.
    Other than that I agree with his comments and observations. 
I'm very concerned about whether we can ever find out the 
facts. But I hope that today we at least begin to understand 
the extent to which oil is becoming a commodity, in that it is 
being used to a much larger extent in the market for oil and 
what is the impact of that.
    Now I think we know a few answers there. Commodity trading 
is growing dramatically: the part that is observed and readily 
seen is growing dramatically, and so is the over-the-counter 
market.
    All that means, in my opinion, is that rather than buying 
the commodity, oil permits itself to be traded by all kinds of 
instruments that can be invented and used by those who trade 
for commodities. That oil comes closer and closer to being a 
commodity rather than being a good that is sold and bought on 
the market.
    I concur with the Senator, the chairman, that there are 
various reasons that stand right out and indicate why the price 
is going up so much. It is obvious that the demand for oil is 
incredible. As compared with 10 years ago, the new users in the 
market including China and India are having an absolutely 
dramatic effect.
    In addition the United States, with everything we do, is 
still unable to reduce its importation. We are using less, but 
at the same time our own production is going down. As a result, 
we are importing more.
    We are net importers. So we belong in that same category 
with China. We have a dramatic impact on the world market. Much 
of our capital goes into $100 a barrel oil, even with our 
dollar devaluing which the chairman spoke of. All of those are 
real impact of our current.
    But some people say it is the speculators using these 
various commodity instruments, that are influencing high oil 
prices. Some say their actions add 10&rcent impact, some say 50 
percent. I think we did right on this committee to try and find 
out, as best we can, what that percentage is. But I'm not sure 
we're going to find out.
    We're going to hear opinions. But again, I'm not sure we're 
going to find an exact answer. Instead, I think sooner or later 
we will get to the point of knowing enough to see if we have to 
change the way things are done or not.
    Right now I wouldn't know how to change it without having 
people claim we're taking a risk that we shouldn't take, 
because we don't know enough. But I'm not averse to letting it 
be known that this Senate committee is serious about looking at 
the commodity trading of crude oil because we are concerned 
about whether or not that's having an unreasonable impact, a 
speculative impact, on the price of oil.
    Thank you to the witnesses. I wish to hear from you. Thank 
you, Mr. Chairman.
    [The prepared statement of Senator Domenici follows:]

    Prepared Statement of Hon. Pete V. Domenici, U.S. Senator From 
                               New Mexico
    Welcome. I want to thank our panel of witnesses for taking time out 
of their busy schedules to join us today. Your testimony will be 
invaluable as we look into the role of non-commercial investors in the 
crude oil market.
    In previous hearings, and discussions with others, we've heard 
everything from ``speculators have little or no independent impact on 
the price of oil'' to ``they've driven up the price an additional $50 
dollars or more.'' I commend the chairman for convening this hearing to 
attempt to shed more light on the true impact of these markets.
    This is a useful discussion, and we must pay close attention to 
energy trading because of it clearly is a significant component of our 
energy markets. I am very concerned that it will deflect us focus from 
the factors that we KNOW threaten our energy security. I'm afraid that 
some may find that it is easier to blame nameless ``oil speculators'' 
for all our troubles rather than face the reality of fundamental 
problems with how we produce and consume energy in the United States 
and the world.
    What are the factors that we know are driving up oil prices? First, 
higher demand. Despite a dramatic 60% increase in oil prices over the 
last year, the Energy Information Administration (EIA) projects that 
world oil consumption will continue to increase this year. This strong 
increase in demand, despite rising prices, is the result of economic 
growth in China, and India. Even despite a slower economy, consumption 
in the U.S. is expected to grow, as well.
    In addition to an increase in global oil demand and a reduction in 
supply, geopolitical instability in Nigeria, Iraq, Iran, and Venezuela, 
and the weakening of the dollar have driven oil prices higher.
    How has the depreciation of the dollar affected crude oil prices? 
Most oil price contracts are denominated in dollars and since 2002 the 
dollar has decreased in value by 30% against major currencies. This 
means that American consumers are more affected by the price of crude 
oil then consumers from other countries who have a stronger currency, 
such as the Euro or the Yen, because the prices of imports have gone 
up.
    With high prices and growing consumption worldwide, we must find 
ways to increase domestic supplies. U.S. crude oil production is 
projected to decline 10,000 barrels a day in 2008. This, combined with 
projected increases in U.S. petroleum consumption, will require this 
country to rely even more heavily on foreign oil imports and continue 
to ship nearly $400 billion annually overseas to import oil.
    Mr. Chairmen, I appreciate your willingness to examine the role of 
non-commercial investors in the crude oil market. But we must also 
recognize that while non-commercial investors may contribute something 
to high oil prices, it is just one piece of a very large puzzle. I look 
forward to hearing from today's witnesses, and, going forward, to 
working with the members of this Committee to resolve all of the major 
obstacles to our Nation's energy security.

    The Chairman. Thank you. Senator Dorgan wanted to make a 
statement here. Let me call on him.

 STATEMENT OF HON. BYRON DORGAN, U.S. SENATOR FROM NORTH DAKOTA

    Senator Dorgan. Chairman, thank you. I wanted to make a 
comment. I had requested, among others, that this hearing be 
held. I think this is very important.
    The last 24, 36 hours, 2 airlines have shut down. We see 
news reports about truckers deciding that they can't continue 
trucking. They're going to slow down. They can't afford to buy 
the fuel. These energy prices are having significant 
consequences.
    I'm not very generous with respect to the notion that it's 
just supply and demand that is driving these energy prices. I 
don't think pure supply and demand describes why the price of 
oil has gone from $50 to $100 in a relatively short period of 
time. I think the evidence is pretty substantial.
    There's an orgy of speculation in the futures market. We've 
got people buying what they'll never get from people who never 
had it. I understand these markets and the reason for the 
markets and the need for liquidity in markets. But I think 
there has been an unbelievable amount of speculation.
    We've not sat in this room before when hedge funds were 
neck deep in the oil and commodities futures markets. We've not 
sat in these rooms before when investment banks were actually 
buying oil storage so they could speculate and actually take 
oil off the market and put it in storage away before the price 
of oil goes up. There's an unbelievable amount of speculation, 
in my judgment.
    Twenty times more oil is sold every single day in these 
markets than exists. Think of that. Now we've had testimony 
before this committee, Mr. Chairman, by some pretty respected 
analysts, top analysts for Oppenheimer and Company says there's 
no justification for the price of oil to be where it is.
    It's about $20 to $30 above where it ought to be because 
this is a 24/7 casino with unbelievable speculation. I believe 
it's our job, and not to simply say well it's supply and 
demand. It's our job to ask tough questions.
    We have a margin requirement here of what, 5 to 7 percent. 
You can control $100,000 worth of oil with a $5,000 or $7,000 
investment. You can't do that on the stock market. We ought to 
increase the margin requirements in this country and get the 
speculators out of this system.
    So, I feel very strongly about this. The consequences of 
what's happening with the price of oil are all around us. I 
understand the Indians are going to drive more cars. I 
understand the Chinese are going to drive more cars. I 
understand the future fundamental issues. I don't understand 
the current price, relative to the fundamentals, that exist 
today in these markets. I think there's an orgy of speculation 
that we ought to be deciding to do something about.
    The Chairman. Let me ask if any other Senator wishes to 
make a statement.
    Senator Barrasso.

         STATEMENT OF HON. JOHN BARRASSO, U.S. SENATOR 
                          FROM WYOMING

    Senator Barrasso. Yes. Mr. Chairman, thank you very much.
    Mr. Chairman, the message that I heard loud and clear 
during the most recent recess was that record prices at the 
pump are hurting the wallets of Wyoming families and American 
families. High oil prices hit consumers in States like Wyoming 
particularly hard, but it's just not Wyoming. It's Colorado. 
It's North Dakota. It's New Mexico. This committee is well 
represented with folks who are from States where people travel 
long distances to go to work, to run errands, and to see 
friends and family.
    Mr. Chairman, I understand that the Research Director with 
Greenpeace was quoted earlier this week as saying that his 
organization wasn't inherently against high gas prices. I want 
to be very clear, Mr. Chairman, I'm very concerned about the 
prices at the pump. I'm pleased that this committee is holding 
this hearing.
    There are multiple contributors to today's price of oil. 
Some relate to the fundamentals of demand and supply and 
growing world economies. Others relate to the geopolitical 
tensions, the weakness in the dollar, environmental regulations 
and the like. But in markets with very little available excess 
supply, marginal contributions to supply and demand seem 
particularly influential.
    I don't believe that the American oil producers and 
refiners and distributors or the corner service stations are 
solely responsible for today's high gasoline prices. In that 
context the world economy, America's producers are generally 
price takers, not price makers. Free markets and competition 
serve to keep prices in check, but at a minimum I strongly 
believe government policies should not drive oil prices higher. 
This is true when it comes, in my mind, to deposits into the 
Strategic Petroleum Reserve, any calls for higher taxes at the 
pump or government mandates.
    There are some short and long term policy proposals, which 
I believe warrant congressional attention. I am compelled by 
the GAO's recommendations that we begin dollar cost averaging 
in purchasing heavy oil for the Strategic Petroleum Reserve. 
These steps are simply sound, financially responsible measures.
    I think Senator Dorgan's call for a temporary suspension of 
deposits into the Strategic Petroleum Reserve until the price 
is below a certain level have merit and should be debated. I 
believe high prices at the pump will ultimately encourage 
consumers to seek out individual ways to conserve and to invest 
in more efficient transportation. But these responses may not 
provide the immediate relief that the consumers need.
    Congress has more tools that can and should be on the 
table. Part of a comprehensive solution must incorporate a 
vision for the future and expanded domestic production. There 
are areas throughout America that have vast potential for oil 
development and serious consideration must be given in how we 
manage these lands and deep seas.
    Another component is technology. America must capitalize on 
existing opportunities and continue to invest in emerging 
energy technologies. One technology to me that is especially 
interesting is in the terms of domestic transportation fuel: 
coal to liquids. With respect to market excessive speculation, 
Congress needs to explore the extent to which price 
manipulation is occurring and to what extent the impacts can be 
minimized.
    I appreciate the chairman's efforts in calling this 
hearing. In this global economy will more regulation result in 
America losing its leadership in financial markets? Or can 
stepped up efforts, to root out excessive speculation and 
manipulation, ultimately help American consumers?
    I'm also increasingly compelled by concerns over our trade 
deficit. As America expends more and more of our hard earned 
money to purchase foreign oil of particular interest to the 
activities of the sovereign wealth funds. These funds, often 
supported national oil profits, can serve as a self-reinforcing 
mechanism pushing oil future prices up higher than they 
otherwise would have been.
    So with that, Mr. Chairman, I look forward to today's 
informative discussion. Thank you for holding these hearings.
    The Chairman. Thank you very much. Unless other members 
have just some burning need to speak at this point, I would 
prefer to go ahead and hear from our witnesses. Why don't we do 
that?
    Let me introduce the six distinguished witnesses we have, 
and just have them testify in this order if they would. Jeffrey 
Harris is here from the Commodity Futures Trading Commission. 
Thank you for being here.
    Sarah Emerson from Energy Security Analysis. Thank you for 
being here.
    Kevin Book is here with Friedman Billings Ramsey and 
Company in Arlington, Virginia.
    Jim Burkhard is here from Cambridge Energy Research 
Associates. Thank you for being here.
    Sean Cota is here representing the Petroleum Marketers 
Association of America.
    John Eichberger is here representing the National 
Association of Convenience Stores.
    So thank you all for being here. If each of you could take 
about 6 minutes or something like that and make the main points 
that you think we need to understand from your testimony. We 
will include your entire testimony in the hearing transcript.
    Mr. Harris.

STATEMENT OF JEFFREY HARRIS, CHIEF ECONOMIST, COMMODITY FUTURES 
                       TRADING COMMISSION

    Mr. Harris. Thank you, Mr. Chairman and members of the 
committee. I am Jeffrey Harris, Chief Economist of the 
Commodity Futures Trading Commission or the CFTC. I appreciate 
the opportunity to discuss the CFTC's role with respect to 
crude oil futures markets and the Office of Chief Economist's 
view of current trends in the marketplace as part of the 
government regulator charged with overseeing them.
    Congress created the CFTC in 1974 as an independent agency 
with a mandate to regulate commodity futures markets in the 
United States. Broadly stated CFTC's mission is two-fold. To 
protect the public and market users from manipulation, fraud 
and abusive practices and to assure that open, competitive and 
financially sound markets for commodity futures and options.
    Commodity commission's oversight of future trading is 
focused on the New York Mercantile Exchange, West Texas 
intermediate crude oil contract. That's it. Designated contract 
market. Secondarily on the intercontinental exchanges in 
Europe, ICE futures of Europe contract because one of its 
contracts cash settles on the NYMEX settlement price.
    The CFTC receives millions of data points everyday about 
trading activity in our markets. The agency's large trader data 
base system is the cornerstone of our surveillance system and 
is used to analyze data. Large trader positions reported to 
CFTC consistently represent more than 90 percent of all trading 
interest in NYMEX's WTI contract with the remainder being 
allocated to small traders who don't meet reporting 
requirements.
    The CFTC closely tracks the developments in the crude oil 
markets. Crude oil prices have risen significantly in the last 
few years. Are currently above $100 a barrel. Concurrently open 
interest in WTI contracts has expanded dramatically from about 
one million contracts in 2004 to more than 2.8 million 
contracts in the most recent week.
    The Office of the Chief Economist has studied these markets 
to better understand the compliments of this rapid growth. Our 
studies find three major things.
    First, we find similar rates of growth for both commercial 
and non-commercial trading interest. Where non-commercial 
interest is commonly considered speculative.
    Second, most of the growth in trading interest is 
concentrated in futures contracts that expire after 12 months 
suggesting that an increase in ability for hedging at longer 
horizons now exists in our markets.
    Figures 1-A and 1-B* in my presentation here demonstrate 
these two points.
---------------------------------------------------------------------------
    * Figures have been retained in committee files.
---------------------------------------------------------------------------
    The Chairman. Are these also in the testimony?
    Mr. Harris. These are also in the written testimony, yes.
    The Chairman. Ok.
    Mr. Harris. We've highlighted here 2000 verses 2007. As you 
can see the 2007 bars are much larger for commercial traders in 
2007 than they were in 2000. Figure 1-B highlights the 
positions of non-commercial traders or speculators in these 
markets, which also exhibit significantly larger trading 
volume.
    The second component is that you can see the bars are much 
larger as we move to the right on these graphs indicating the 
greater propensity or the opportunity to hedge in the futures 
markets at longer horizons.
    Figures 1-A and 1-B also highlight the fact that commercial 
trading in short positions, hedging in the market, rely 
intimately on the ability of the speculators to take the 
opposite sides of trades.
    The Chairman. Let me just ask on this. The second, the 
columns there, do I understand it correctly that that indicates 
the----
    Mr. Harris. The bars above the zero mark are long 
positions.
    The Chairman. Right. So there's----
    Mr. Harris. Bars below are short.
    The Chairman. So there's been well over a tenfold increase 
in the number of non-commercial traders involved in these 3 to 
6 month futures contracts. Is that accurate?
    Mr. Harris. Yes.
    The Chairman. Ok. Go right ahead.
    Mr. Harris. The point being with commercial traders being 
short and non-commercials being long, the supply and demand for 
hedging services intimately ties hedgers and speculators 
together in futures markets.
    The third major trend during the past few years is that 
crude oil markets have witnessed a rapid growth in swap dealer 
trading. Swap dealers now hold significantly larger positions 
in crude oil. These dealers, who take the short sides of over 
the counter swap trades lay off their risk with long positions 
in the crude oil futures markets.
    This development has altered the traditional role of 
commercial traders. Previously commercial traders predominately 
hedged using long positions in the stock market and went short 
in the crude oil futures markets. Recent development has swap 
dealers, those also classified as commercial dealers, hedging 
their short, swap positions with long positions in our futures 
markets.
    Figures 2-A here and 2-B show the difference between the 
two different types of commercial traders. 2-A shows that 
traditional commercial traders are typically net short in the 
near term futures contract. Swap dealers also considered 
commercial traders are net long in these same contracts. So 
commercial traders, depending on the type, trade very 
differently in our markets.
    Figure 2-B also demonstrates the growth in swap dealer 
market in the near term futures contracts. Partially represents 
this flow from commodity index trading. Even the substantial 
increase in open interest in crude oil futures, the Office of 
the Chief Economist utilizes the Commission's extensive data to 
examine the role of all market participants. How their 
positions might affect prices.
    Although longer term studies show a slight increase in the 
number of non-commercial market share in crude oil market, OCE 
analysis shows that more recent increases in oil prices to 
levels above $100 has not been accompanied by significant 
changes to participants in the market. Figure 3 here shows that 
the number of commercial and non-commercial traders has 
remained nearly constant over the last 22 months with about 120 
commercial and 310 non-commercial traders in the market.
    OCE has also studied the impact of speculators as a group 
in the oil markets during the most recent price run up. 
Specifically we have closely examined the relationship between 
futures prices and the positions of speculators in the crude 
oil markets. Our studies have consistently found that when new 
information comes to the market it is commercial traders such 
as oil companies, utilities and airlines who react first by 
adjusting their futures positions. When these commercial 
traders adjust their futures positions it is speculators who 
are most often taking the other side of their trade.
    Price changes that prompt hedgers to alter their futures 
positions attract speculators who've changed their positions in 
response. Simply stated there is little evidence that position 
changes by speculators precede price changes in the crude oil 
futures contracts. Instead, changes in commercial traders 
significantly precede oil price changes.
    To highlight this effect a bit more clearly, Figure 4 plots 
the prices in the market share one group of highly active 
speculators, managed money traders, over the past 22 months. 
Notably, while the WTI contract prices have doubled in the last 
14 months managed money positions, as a fraction of their 
overall market have changed very little. Speculative positions 
do not generally amplify crude oil price changes.
    More specifically, the recent crude oil price increases 
have occurred with no significant change in the net speculative 
positions. The OCE has also studied position changes of 
commercial and non-commercial traders by category finding 
similar results. We find little evidence that net positions 
changes of any category of non- commercial traders is affecting 
or preceding price changes in crude oil futures prices.
    Figure 5 highlights the fact that commercial and non-
commercial open interest has grown during the most recent 22 
months. But generally this growth remains balanced between long 
and short positions for each trader group. Looking at the 
trends in the marketplace combined with studies on the impact 
of speculators in the market there is little evidence that 
changes the speculative positions are systematically driving up 
crude oil prices.
    Given the relatively stable make up of participants and 
their positions in the markets and the absence of evidence of 
speculation causing oil price changes, it appears that 
fundamentals provide the best explanation for crude oil price 
increases. These fundamentals can be either broad factors 
affecting many markets like the dollar or general inflation 
fears or factors particular to this market such as strong 
demand from China or India. In addition geopolitical events, 
tensions in Venezuela, Nigeria and other countries have 
affected crude oil markets.
    Concerns about the high price of oil are not unique to the 
United States. I recently presented some of these findings to 
the International Energy Agency in Paris, which representatives 
attended from 40 different countries, OPEC, industry economists 
and traders. Our findings were supported by many of the 
conference presenters and attendees who've conducted their own 
research on these topics.
    Given the widespread interest in crude oil in particular, 
is something I'm certain we will continue to monitor closely as 
will my counterparts around the world. This concludes my 
remarks. I'd be happy to answer any questions if you'd like.
    [The prepared statement of Mr. Harris follows:]

   Prepared Statement of Jeffrey Harris, Chief Economist, Commodity 
                       Futures Trading Commission
    Thank you, Mr. Chairman and members of the Committee. I am Jeffrey 
Harris, Chief Economist of the Commodity Futures Trading Commission 
(CFTC or Commission). I appreciate the opportunity to discuss the 
CFTC's role with respect to the crude oil futures markets and our view 
of current trends in the markets as the government regulator charged 
with overseeing them.
                              cftc mission
    Congress created the CFTC in 1974 as an independent agency with the 
mandate to regulate commodity futures and option markets in the United 
States. Broadly stated, the CFTC's mission is two-fold: to protect the 
public and market users from manipulation, fraud, and abusive 
practices; and to ensure open, competitive and financially sound 
markets for commodity futures and options. To do this, the Commission 
employs a highly-skilled staff who work to oversee the markets and 
address any suspicious or illegal market activity.
    The Commodity Exchange Act (CEA or Act) grants the Commission 
exclusive jurisdiction with respect to, among other things, accounts, 
agreements, and transactions involving commodity futures and options 
contracts that are required to be traded or executed on an exchange or 
a designated contract market, also known as a DCM. DCMs are regulated 
futures exchanges that are self-regulatory organizations (SROs) subject 
to comprehensive oversight by the CFTC. DCMs can list for trading any 
type of contract, they can permit intermediation, and all types of 
traders (including retail traders) are permitted to participate in 
their markets.
    The CFTC has been overseeing the U.S. futures industry under 
principles-based regulation since the passage of the Commodity Futures 
Modernization Act (CFMA) in 2000. A principles-based system requires 
markets to meet certain public outcomes in conducting their business 
operations. For example, DCMs must continuously meet 18 core 
principles--ranging from maintaining adequate financial safeguards to 
conducting market surveillance--in order to uphold their good standing 
as a regulated contract market.
                            market oversight
    The CFTC's Division of Market Oversight (DMO) is responsible for 
monitoring and evaluating a DCM's operations. DMO conducts market 
surveillance of all activity on DCMs. While operational, DCMs must 
establish and devote resources toward an effective oversight program, 
which includes surveillance of all activity on their markets to detect 
and deter manipulation and trading abuses. The CFTC routinely assesses 
the regulatory and oversight activities of DCMs through regularly 
scheduled examinations of DCMs' self-regulatory programs. The 
Commission currently regulates DCMs located in New York, Chicago, 
Kansas City, and Minneapolis.
    The CFTC's market surveillance mission regarding DCM activity is to 
ensure market integrity and customer protection in the futures markets. 
Traders establishing positions on DCMs are subject to reporting 
requirements so that CFTC staff and the DCM can evaluate position sizes 
to detect and prevent manipulation. In addition, trade practice 
surveillance involves compilation and monitoring of transactional-level 
data by the Commission and the DCM to protect market participants from 
abusive trading such as wash sales, money laundering and trading ahead 
of customers.
    A key market surveillance mission is to identify situations that 
could pose a threat of manipulation and to initiate appropriate 
preventive actions. Each day, for the estimated 1,400 active futures 
and option contracts in the U.S., the CFTC market surveillance staff 
monitors the activities of large traders, key price relationships, and 
relevant supply and demand factors to ensure market integrity.
    Surveillance economists routinely examine trading in futures and 
options contracts that are approaching their expiration periods for any 
unusual trading patterns or anomalies. Regional surveillance 
supervisors immediately review unusual trading or anomalies to 
determine whether further action is warranted. Surveillance staff 
advise the Commissioners and senior staff of significant market 
developments as they occur and also conduct weekly surveillance 
meetings (non-public, closed meetings) so that the Commission will be 
prepared to take action if necessary. In addition to the transparency 
provided to the CFTC by position reporting by large traders, the 
Commission provides a degree of transparency to the public by 
publishing aggregate information in the CFTC's weekly Commitment of 
Traders Report.
    As noted, surveillance of DCM trading is not conducted exclusively 
by the Commission. As SROs, DCMs have significant statutory 
surveillance responsibilities. Typically, however, surveillance issues 
are handled jointly by Commission staff and the relevant DCM. The 
Commission, while continuing to monitor market events, typically 
permits the DCM, as the front-line regulator, to utilize its self-
regulatory authorities to resolve issues arising in its markets. If a 
DCM fails to take actions that the Commission deems appropriate, 
however, the Commission has broad emergency powers under the CEA to 
order the DCM to take specific actions. The Commission has exercised 
its emergency authority four times in its history.
                          financial oversight
    The Commission's Division of Clearing and Intermediary Oversight 
(DCIO) is responsible for and plays an integral role in ensuring the 
financial integrity of all transactions on CFTC-regulated markets. 
DCIO's most important function is to prevent systemic risk and ensure 
the safety of customer funds. DCIO meets these responsibilities through 
an oversight program that includes the following elements: (1) 
conducting risk-based oversight and examinations of industry SROs 
responsible for overseeing Futures Commission Merchants (FCMs), 
commodity trading advisors, commodity pool operators, and introducing 
brokers, to evaluate their compliance programs with respect to 
requirements concerning fitness, net capital, segregation of customer 
funds, disclosure, sales practices, and related reporting and 
recordkeeping; (2) conducting risk-based oversight and examinations of 
all Commission-registered derivatives clearing organizations (DCOs) to 
evaluate their compliance with core principles, including their 
financial resources, risk management, default procedures, protections 
for customer funds, and system safeguards; (3) conducting financial and 
risk surveillance oversight of market intermediaries to monitor 
compliance with the provisions of the CEA and Commission regulations; 
(4) monitoring market events and conditions to evaluate their potential 
impact on DCOs and the clearing and settlement system and to follow-up 
on indications of financial instability; and (5) developing 
regulations, orders, guidelines, and other regulatory approaches 
applicable to DCOs, market intermediaries, and their SROs. 
Collectively, these functions serve to protect market users, the 
general public and producers; to govern the activities of market 
participants; and to enhance the efficiency and effectiveness of the 
futures markets as risk management mechanisms.
    The DCOs that the Commission currently regulates are located in New 
York, Chicago, Kansas City, Minneapolis and London, England. The 
intermediaries overseen by the Commission are located throughout the 
United States and in various other countries.
                              enforcement
    In Section 3 of the CEA, Congress provided that transactions 
subject to the Act ``are affected with a national public interest'' 
because they constitute ``a means for managing and assuming price 
risks, discovering prices, or disseminating pricing information through 
trading in liquid, fair and financially secure trading facilities.'' 
The Commission's Division of Enforcement (Enforcement) is responsible 
for prosecuting fraudulent, abusive and manipulative trading practices. 
Enforcement has a substantial role over maintenance and protection of 
principles of fairness and integrity in commodity markets. At any one 
time, Enforcement's investigations (which are non-public) and pending 
litigation involve, on average, approximately 750 individuals and 
corporations.
    In protecting the national public interest associated with 
transactions subject to the Act, the Commission has broad authority to 
investigate and prosecute misconduct occurring in both the futures and 
cash markets. Included in this broad authority is Section 9(a)(2) of 
the CEA which prohibits manipulating or attempting to manipulate the 
price of any commodity in interstate commerce or for future delivery, 
cornering or attempting to corner any such commodity, and knowingly 
delivering or causing to be delivered false or misleading or knowingly 
inaccurate reports of crop or market information that affects or tends 
to affect the price of any commodity in interstate commerce.
    During the last five years, Enforcement has maintained a record 
level of investigations and prosecutions in nearly all market areas, 
including attempted manipulation, manipulation, squeezes and corners, 
false reporting, hedge fund fraud, off-exchange foreign currency fraud, 
brokerage compliance and supervisory violations, wash trading, trade 
practice misconduct, and registration issues. Working closely with the 
President's Corporate Fraud Task Force, Enforcement is staffed with 
skilled professionals who prosecute cases involving on-exchange 
transactions and, to the extent of the Commission's jurisdiction, 
complex over-the-counter (OTC) transactions as well. Enforcement also 
routinely assists in related criminal prosecutions by domestic and 
international law enforcement bodies. Through those efforts, during the 
past five years (April 2003--March 2008), the CFTC has obtained more 
than 2 billion dollars in monetary sanctions, which include civil 
monetary penalties and orders to pay restitution and disgorgement.
    In the energy sector, from December 2001 through the present, 
Enforcement investigated or prosecuted Enron and BP, dozens of other 
energy companies, and more than one hundred energy traders (including a 
pending action against Amaranth). With respect to crude oil in 
particular, Enforcement staff in August 2007 announced a settlement for 
a charge of attempted manipulation in OTC crude oil markets against 
Marathon Petroleum Company, a subsidiary of Marathon Oil Corporation 
(Marathon Petroleum). In that action, which imposed a $1 million civil 
monetary penalty, the Commission entered an Order finding that Marathon 
Petroleum attempted to manipulate a price of spot cash West Texas 
Intermediate (WTI) crude oil by attempting to influence downward the 
Platts market assessment for spot cash WTI on November 26, 2003. The 
Platts market assessment for WTI is used as the price of crude oil in 
certain domestic and foreign transactions. At the time in question, 
Marathon Petroleum priced approximately 7.3 million barrels of physical 
crude per month off the Platts market assessment for WTI.
         crude oil trading on futures markets and other markets
    The Commission's oversight of oil futures trading focuses on the 
New York Mercantile Exchange or (NYMEX) and secondarily on the 
Intercontinental Exchange Europe (ICE Futures Europe)--the latter 
because one of its contracts cash settles on the price of the NYMEX WTI 
Light Sweet Crude futures contract. (Notably, crude oil futures 
products are also traded on some Exempt Commercial Markets, but those 
contracts are fairly low in trading volume.)
    NYMEX is a DCM with self-regulatory responsibilities and operates 
under the Commission's oversight as provided by the CEA. NYMEX lists 
several crude oil futures contracts. The exchange's highest volume 
crude oil contract is the WTI Light Sweet Crude Oil futures contract, 
which provides for physical delivery of oil in Cushing, OK. NYMEX's 
Light Sweet Crude contract traded a volume of 122 million futures 
contracts in 2007. NYMEX also lists several cash settled futures 
contracts based on the Light Sweet Crude Oil futures contract price. 
NYMEX also lists futures contracts based on Brent blend crude oil, 
which settle on the price of the ICE Futures Europe Brent contract, as 
well as a Dubai crude oil calendar swap contract. In addition, NYMEX 
offers several financially-settled, cleared contracts, including 
differential and spread contracts involving prices of the WTI, Brent 
and Dubai crude oil futures contracts.
    ICE Futures Europe lists a Brent Crude Oil futures contract, a WTI 
Crude Oil futures contract that settles on the price of the NYMEX light 
sweet crude oil contract, and a Middle Eastern Sour Crude futures 
contract. The Brent and WTI contracts are very actively traded, while 
the Middle Eastern Sour Crude contract trades much less frequently.
    ICE Futures Europe is a UK Registered Investment Exchange and is 
regulated by the UK's Financial Services Authority (FSA). The U.S.-
based members of ICE Futures Europe were granted permission by 
Commission staff to directly access the Exchange's trading system from 
the U.S. pursuant to a Commission no-action letter issued to ICE 
Futures Europe's predecessor, the International Petroleum Exchange 
Limited, on November 12, 1999, as amended.
    Pursuant to the no-action letter's terms and conditions and 
information--sharing arrangements, CFTC surveillance staff knows, among 
other things, when ICE Futures Europe proposes to list new contracts to 
be made available from the U.S., the volume of trading originating from 
the U.S., the identities of members who have direct access to the 
trading system in the U.S., and when there are material changes to any 
aspect of the information provided that resulted in the issuance of the 
no-action letter. Pursuant to CFTC-FSA information--sharing 
arrangements, CFTC surveillance staff also receives ICE Futures 
Europe's member position reports for its WTI Crude Oil futures contract 
on a weekly basis (daily during the week prior to contract expiration). 
Thus, CFTC surveillance staff knows the positions and identities of 
members/customers who meet or exceed position-reporting requirement 
levels in the ICE Futures Europe WTI contract, and can consider that 
data along with the large trader reporting information that it receives 
from NYMEX for its counterpart contract.
                        foreign boards of trade
    The CFTC employs a ``no-action'' process when foreign boards of 
trade (FBOTs) seek to provide electronic screen access to the U.S., but 
without registering as a DCM. With the advent of the ICE Futures Europe 
WTI contract in 2006, the CFTC undertook a thorough review of its FBOT 
policy. The Commission concluded that the best way to handle the issue 
was to continue its no-action approach, a response that reflects the 
internationally accepted ``mutual recognition'' approach used by 
regulators in many developed market jurisdictions to govern access to 
foreign electronic exchanges by persons located in their jurisdictions. 
This approach generally is based upon a review of, and ongoing reliance 
upon, the foreign market's ``home'' regulatory regime, and is designed 
to maintain a threshold level of regulatory protections while avoiding 
the imposition of duplicative regulation.
    The CFTC has followed the no-action approach since 1996 and it has 
never experienced any market integrity or customer protection problems. 
The no-action procedure provides the CFTC with flexibility in dealing 
with the particular foreign exchanges and different CFTC practices. The 
Commission held an FBOT hearing in June 2006, including a related open 
public comment opportunity, during which market users, foreign 
exchanges and even competitive domestic exchanges that compete with 
FBOTs overwhelmingly confirmed the success of the CFTC's approach in 
terms of market and customer protection and access to additional 
products. Subsequently, the CFTC issued a Statement of Policy re-
affirming the use of the FBOT no-action process, but also enhancing it 
through the imposition of information-sharing conditions where no-
action relief is sought for FBOT contracts that could adversely affect 
the pricing of contracts traded either on a DCM or on any cash market 
for commodities subject to the CEA.
    On November 17, 2006, the CFTC and the UK FSA signed a Memorandum 
of Understanding (MOU) concerning consultation, cooperation and the 
exchange of information related to market oversight. The MOU 
established a framework for the CFTC and FSA to share information that 
the respective authorities need to detect potential abusive or 
manipulative trading practices that involve trading in related 
contracts on U.S. and UK derivative exchanges. Since the adoption of 
the MOU, the CFTC and FSA have been holding monthly conference calls to 
discuss matters of mutual interest including trading on ICE Futures 
Europe. Commission staff has found that the 6 MOU has strengthened 
information-sharing on an ongoing basis between the two regulatory 
authorities.
                       exempt commercial markets
    In the Commodity Futures Modernization Act of 2000 (CFMA), Congress 
enacted special provisions in the CEA to govern Exempt Commercial 
Markets (ECMs), which are electronic marketplaces for commercial 
participants to trade contracts in energy and certain other 
commodities. ECMs have been evolving over time since then, such that 
today, certain ECM contract settlement prices link to DCM futures 
contract settlement prices. Linkage of contract settlement prices was 
not something that was contemplated at the time of the CFMA.
    Last September, the CFTC conducted an extensive public hearing on 
ECMs, and found that certain energy futures contracts traded on ECMs 
may be serving a significant price discovery function. This raised the 
question of whether the CFTC has the necessary authority to police the 
ECM markets for manipulation and abuse. The Commission concluded that 
changes to the CEA would be appropriate as a result and, to that end, 
in October 2007 the Commission recommended legislative changes in a 
Report delivered to Congress. Specifically, the Commission recommended 
that significant price discovery contracts on ECMs be subject to the 
same position limit and position accountability core principle that 
applies to contracts traded on DCMs. In addition, its recommendations 
would further require: 1) large trader position reporting on 
significant price discovery contracts on ECMs; 2) self-regulatory 
responsibilities for the ECM; and 3) CFTC emergency authority over 
these contracts.
    We are pleased that the Commission's recommendations were endorsed 
by the President's Working Group on Financial Markets, and have been 
well received in Congress. In December, these recommendations were 
included in legislation that moved forward in both the House of 
Representatives and the Senate. Both bills largely adopt the CFTC's 
recommendations on the need for enhanced oversight over significant 
price discovery contracts traded on ECMs, including position limits and 
position accountability. The modest differences between the bills are 
being worked out as part of the Conference on the Farm Bill, and we are 
hopeful that Congress will take final action on these proposals soon to 
give the CFTC these additional and necessary authorities.
                   bilateral over-the-counter trading
    Much crude oil trading also takes place by what is known as ``over-
the-counter'' (OTC) trading. This trading is typically non-standardized 
and between two sophisticated participants. The CFTC does not regulate 
privately-negotiated OTC contracts, nor does it regulate cash markets 
or forward markets. However, we have the tools to adequately police the 
markets falling under CFTC jurisdiction. The typical OTC market 
transaction involves a sophisticated market participant's request to a 
swap dealer to structure an OTC transaction. The dealer facilitates the 
customer by taking the opposite side of the customer's position. The 
dealer then turns to the futures markets to offset the risk that it has 
taken on. (We see the actions of OTC dealers in our Large Trader 
Reporting System as explained below.)
    The first thing to recognize about OTC contracts is that they are 
typically benchmarked to NYMEX futures prices or to cash market 
indexes. In terms of administering the anti-manipulation provisions of 
the CEA, our current authority and our current surveillance program are 
sufficient to detect an attempted manipulation of the NYMEX futures 
price to benefit an off-exchange OTC position.
    Our current authority also gives us the ability to ask what we call 
``reportable traders'' in the futures markets to reveal their OTC 
positions, as well as their cash market and forward market positions. 
If required, we also have subpoena authority. We have used this 
authority to help bring 50 enforcement actions in energy markets in 
recent years.
    The enactment of the CFMA brought about multilateral clearing of 
OTC positions at futures clearinghouses. As a result, OTC trades become 
transparent to the CFTC through the clearing process. For 2007, 
approximately 224 million OTC contracts cleared through NYMEX and the 
InterContinental Exchange (ICE). In fact, as traders in the OTC markets 
have become more aware of credit considerations and the benefits of 
transparency, they have been moving their positions onto exchanges 
where the exchange clearinghouse enhances credit worthiness and the 
market is transparent.
                   using data to oversee the markets
    The CFTC receives millions of data points every day about trading 
activity in the markets. The agency's Large Trader Reporting System is 
the cornerstone of our surveillance system and is used to look at data. 
Clearing members, FCMs, foreign brokers and other traders file 
confidential electronic reports with the CFTC each day, reporting 
positions of each large trader on each DCM. In the NYMEX WTI contract, 
for instance, a trader with a position exceeding 350 contracts in any 
single expiration is ``reportable.'' Large trader positions reported to 
the CFTC consistently represent more than 90% of total open interest in 
the NYMEX WTI contract, with the remainder being smaller traders who do 
not meet reporting thresholds.
    When a reportable trader is identified to the CFTC, the trader is 
classified either as a ``commercial'' or ``non-commercial'' trader. A 
trader's reported futures position is determined to be commercial if 
the trader uses futures contracts for the purposes of hedging as 
defined by CFTC regulations. Specifically, a reportable trader gets 
classified as commercial by filing a statement with the CFTC (using the 
CFTC Form 40) that it is commercially `` . . . engaged in business 
activities hedged by the use of the futures and option markets.'' 
However, to ensure that traders are classified consistently and with 
utmost accuracy, CFTC market surveillance staff checks the forms and 
re-classifies the trader if they have further information about the 
trader's involvement with the markets.
    In fact, a reportable participant may be classified at the CFTC as 
non-commercial in one market and commercial in another market, but is 
never classified as both in the same market. For instance, a financial 
institution trading Treasury Notes might have a money management unit 
whose trading positions are classified as non-commercial but a banking 
unit that is classified as commercial. Reporting firms must file Form 
102 to identify each account, and this information allows the CFTC to 
relate separate traders to a single higher level of ownership.
    In addition to the breakdown between commercial and non-commercial 
categories, the large trader data can be filtered by type of trading 
activity. For example, on the commercial side, the CFTC can sort the 
data by more than 20 types of institutions, ranging from agricultural 
merchants and livestock feeders to mortgage originators. Traders that 
are non-commercial include commodity trading advisors, commodity pool 
operators (managed money traders), and floor brokers and traders.
    Using data from the Large Trader Reporting System, the CFTC also 
publishes a weekly breakdown of reporting positions of each Tuesday's 
open interest known as the Commitments of Traders (COT) report. COT 
reports are published for markets in which 20 or more traders hold 
positions above CFTC-established reporting levels.
    COT reports are available on the CFTC's public website every Friday 
at 3:30 PM in both a short and long format. The short report shows open 
interest separately by reportable and non-reportable positions. The 
long report, in addition to the information in the short report, shows 
the concentration of positions held by the largest four and eight 
traders and groups the data by crop year, where appropriate. For 
reportable positions, additional data is provided for commercial and 
non-commercial holdings, spreading, changes from the previous report, 
percentage of open interest by category, and numbers of traders.
                 speculation in the commodities markets
    The current market environment has brought questions about the role 
that speculators play in affecting prices in the futures markets. The 
proper and efficient functioning of the futures markets requires both 
speculators and hedgers. While certain targeted controls on speculation 
are appropriate, speculators, as a class, provide the market liquidity 
to allow hedgers to manage various commercial risks. Unnecessary 
limitations on the amount of speculation that an individual or entity 
may engage in could limit the amount of liquidity in the marketplace, 
the ability of hedgers to manage risks, and the information flow into 
the marketplace, which could in turn negatively affect the price 
discovery process and the hedging function of the marketplace.
    While speculation is critical to well-functioning markets, 
excessive speculation can be detrimental to the markets. Under Section 
4a of the CEA, the concept of ``excessive speculation'' is based on 
trading that results in ``sudden or unreasonable fluctuations or 
unwarranted changes in the price'' of commodities underlying futures 
transactions. The CEA specifically makes it a violation of the Act to 
manipulate the price of a commodity in interstate commerce or for 
future delivery. The CEA does not make excessive speculation a per se 
violation of the Act, but rather, requires the Commission to enact 
regulations to address such trading (for example, through speculative 
position limits).
    The Commission has utilized its authority to set limits on the 
amount of speculative trading that may occur or speculative positions 
that may be held in contracts for future delivery. The speculative 
position limit is the maximum position, either net long or net short, 
in one commodity future (or option), or in all futures (or options) of 
one commodity combined, that may be held or controlled by one person 
(other than a person eligible for a hedge exemption) as prescribed by a 
DCM and/or by the Commission. Moreover, CEA Section 5(d)(5) requires 
that a DCM, ``[t]o reduce the potential threat of market manipulation 
or congestion, especially during trading in the delivery month . . . 
shall adopt position limitations or position accountability for 
speculators, where necessary and appropriate.''
    All agricultural and natural resource futures and options contracts 
are subject to either Commission or exchange spot month speculative 
position limits--and many financial futures and options are as well. 
With respect to such exchange spot month speculative position limits, 
the Commission's guidance specifies that DCMs should adopt a spot month 
limit of no more than one-fourth of the estimated spot month 
deliverable supply, calculated separately for each contract month. For 
cash settled contracts, the spot month limit should be no greater than 
necessary to minimize the potential for manipulation or distortion of 
the contract's or underlying commodity's price.
    With respect to trading outside the spot month, the Commission 
typically does not require speculative position limits. Under the 
Commission's guidance, an exchange may replace position limits with 
position accountability for contracts on financial instruments, 
intangible commodities, or certain tangible commodities. If a market 
has accountability rules, a trader--whether speculating or hedging--is 
not subject to a specific limit. Once a trader reaches a preset 
accountability level, however, the trader must provide information 
about his position upon request by the exchange. In addition, position 
accountability rules provide an exchange with authority to restrict a 
trader from increasing his or her position.
    Finally, in order to achieve the purposes of the speculative 
position limits, the Commission and the DCMs treat multiple positions 
held on a DCM's market that are subject to common ownership or control 
as if they were held by a single trader. Accounts are considered to be 
under common ownership if there is a 10 percent or greater financial 
interest. The rules are applied in a manner calculated to aggregate 
related accounts.
    Violations of exchange-set or Commission-set limits are subject to 
disciplinary action, and the Commission, or a DCM, may institute 
enforcement action against violations of exchange speculative limit 
rules that have been approved by the Commission. To this end, the 
Commission approves all position limit rules, including those for 
contracts that have been self-certified by a DCM.
 office of the chief economist study of trends in the crude oil market
    The CFTC's Office of the Chief Economist (OCE) closely tracks 
developments in the crude oil markets. Crude oil prices have risen 
significantly during the past few years and are currently above $100/
barrel. Concurrently, open interest in WTI crude oil futures has 
expanded dramatically, growing from about 1 million contracts in 2004 
to more than 2.8 million contracts during the most recent week.
    OCE has studied these markets to better understand the components 
of this rapid growth. Our studies find three major trends in crude oil 
markets. First, we see similar rates of growth for both commercial and 
non-commercial interests. Non-commercial participants are commonly 
considered speculators. Non-commercial share of total open interest has 
increased marginally from 31% to about 37% over the past three years. 
It is important to understand that the majority of non-commercial 
positions are in spreads; that is, taking a long position in one 
contract month and a short position in another.
    Second, much of the growth in open interest is concentrated in 
futures contracts that expire after 12 months. Whereas contracts beyond 
one year were rare in 2000, we are now seeing significant open interest 
in contracts with expires out to five years. In fact, contracts beyond 
six years are now available at NYMEX. Figures 1a and 1b below highlight 
these two trends.
    Figures 1a and 1b also highlight the fact that commercial traders 
taking short positions to hedge rely on non-commercial traders to take 
the opposite side of their trades. Were fewer non-commercial positions 
opened, hedging costs would likely increase. In this light, commercial 
traders demand hedging services that are supplied by non-commercial 
traders. The supply and demand for hedging services intimately ties 
hedgers and speculators together in futures markets.
    The third major trend during the past few years in crude oil 
markets is that swap dealers now hold significantly larger positions in 
crude oil. These dealers, who take the short sides of over-the-counter 
swaps against commodity index traders, hedge this exposure with long 
futures positions in crude oil. This development has altered the 
traditional role of commercial traders. Previously, commercial traders 
predominately hedged long cash positions using short futures contracts. 
The recent development has swap dealers (also classified as commercial 
traders) hedging their short swap positions with long futures. Figures 
2a and 2b below depict these differences.
    Figure 2b also demonstrates the growth in swap dealer trading in 
the near-term futures contract, which largely represents flows from 
commodity index trading.
    Given the substantial increase in open interest in crude oil 
futures markets, OCE utilizes the Commission's extensive data to 
examine the role of all market participants and how their positions 
might affect prices. Although longer-term studies show a slight 
increase in non-commercial market share in the crude oil market, OCE 
analysis shows that the more recent increase in oil prices to levels 
above $100/barrel has not been accompanied by significant changes to 
the participants in this market. Figure 3 below shows that the number 
of commercial and non-commercial traders has remained nearly constant 
over the past 22 months, with about 120 commercial and 310 non-
commercial participants in the market.
    OCE has also studied the impact of speculators as a group in oil 
markets during the most recent price run-up. Specifically, we have 
closely examined the relation between futures prices and positions of 
speculators in crude oil. Our studies have consistently found that when 
new information comes to the market and prices respond, it is the 
commercial traders (such as oil companies, utilities, airlines) who 
react first by adjusting futures positions. When these commercial 
traders adjust their futures positions, it is speculators who are most 
often on the other side of the trade. Price changes that prompt hedgers 
to alter their futures positions attract speculators who change their 
positions in response. Simply stated, there is no evidence that 
position changes by speculators precede price changes for crude oil 
futures contracts. Instead, changes in commercial positions 
significantly precede crude oil futures price changes.
    To highlight this fact more clearly, Figure 4 below plots the 
prices and the market share of one group of active speculators (managed 
money traders) over the past 22 months. Notably, while WTI contract 
prices have more than doubled during the past 14 months, managed money 
positions, as a fraction of the overall market, have changed very 
little. Speculative position changes do not amplify crude oil futures 
price changes. More specifically, the recent crude oil price increases 
have occurred with no significant change in net speculative positions.
    OCE has also studied position changes of commercial and non-
commercial traders by category, finding similar results. In no case do 
we find net position changes of any category of non-commercial traders 
significantly preceding changes in crude oil futures prices. Figure 5 
below highlights the fact that commercial and non-commercial open 
interest has grown during the most recent 22 months, but generally 
remains balanced between long and short positions for each trader 
group.
    OCE staff has also studied the propensity of various market 
participants to be trading on the same side of the market 
concurrently--a phenomenon commonly known as ``herding.'' Although many 
rules govern the behavior of individual traders, the Commission 
recognizes that concurrent trading by groups of traders--``herds''--can 
detrimentally affect markets. Herding behavior can represent an 
impediment to the efficient functioning of markets if market 
participants follow the herd blindly, causing prices to over-adjust to 
new information. The OCE study found little evidence of significant 
herding in crude oil futures markets. In fact, when herding was found, 
it appeared to be beneficial, and not destabilizing for prices--buy 
herding appeared only when prices were falling and price increases were 
unrelated to herding activity.
                               conclusion
    Looking at the trends in the marketplace, combined with studies on 
herding behavior and the impact of speculators in the markets, there is 
little evidence that changes in speculative positions are 
systematically driving up crude oil prices. Given the relative 
stability of the makeup of participants and their positions in the 
markets and the absence of evidence that speculation has caused oil 
price changes, it appears that fundamentals provide the best 
explanation for crude oil price increases. These fundamentals can be 
either broad factors that affect many markets--like the value of the 
dollar or general inflation fears--or factors particular to a market--
such as strong demand from China and India for crude oil and other 
commodities. In addition, geopolitical events, such as tensions 
involving Venezuela, Nigeria, Iran, Iraq, Turkey and the Kurds have 
affected commodity markets, especially the energy and precious metals 
markets.
    Concerns about the high price of oil are not unique to the United 
States. I recently presented these findings to the International Energy 
Agency conference in Paris which included representatives from 40 
different countries, OPEC, industry economists and traders. Our 
findings were supported by many of the conference presenters and 
attendees who have conducted their own research on the topic. Given the 
widespread interest in crude oil in particular, it is something I am 
certain we will continue to monitor closely, as will my counterparts 
around the world.
    This is a dynamic time in the futures markets, given the growth in 
trading volume, product innovation and complexity, and globalization--
in all commodities, including energy. The Commission will continue to 
work to promote competition and innovation, while at the same time, 
fulfilling our mandate under the CEA to protect the public interest and 
to enhance the integrity of U.S. futures markets.

    The Chairman. Alright. Thank you very much for your 
testimony. Ms. Emerson, why don't you go right ahead?

   STATEMENT OF SARAH A. EMERSON, MANAGING DIRECTOR, ENERGY 
             SECURITY ANALYSIS, INC., WAKEFIELD, MA

    Ms. Emerson. Good morning, Mr. Chairman, distinguished 
committee members. I'm the Managing Director of Energy Security 
Analysis, an Energy Research Firm. I oversee all petroleum 
market analysis for my firm. I have been asked today to provide 
a physical market context for the increased oil prices to over 
$100 and the role of the institutional investors in the oil 
markets.
    We are witnessing striking developments in global markets. 
The price of crude oil has doubled since the beginning of 2007 
and is at or above $100 today. The dollar has fallen and is now 
worth only about two-thirds of a Euro. Oil exporting countries 
are pumping petrodollars into the global economy. Some 
estimates put that amount at $4 trillion as of the end of 2007. 
This is the status quo.
    As shocking as it seems it appears to be relatively stable 
because these developments reinforce each other. The weak 
dollar cushions the impact of high oil prices on consumers 
outside of the United States. The petrodollars provide 
liquidity of investment which helps grow the global economy, 
especially outside of the United States.
    These two factors support oil demand growth, again outside 
the United States, in spite of the higher price. Excuse me. 
Meanwhile the weak dollar and the high oil price encourage 
institutional investors to buy commodities especially oil as a 
hedge against inflation. Now as we witness these developments 
in global markets it's important to keep in mind that we have 
reached this status quo in large part because of what is taking 
place in the underlying physical market for oil.
    During the 1980s and 1990s as you know, the global oil 
markets was characterized by over supply. The capacity to 
produce oil significantly exceeded demand. Nominal prices were 
flat. Real prices fell. These low oil prices supported oil 
demand not only in the transportation sectors of the 
industrialized countries, but also in the power generation, 
industrial and now chemical transportation sectors of the 
developing world.
    As a result global oil demand caught up with the capacity 
to produce oil. Spare crude production capacity has been 
reduced to a bare minimum. To illustrate, in the 1980s there 
was as much as 15 percent spare crude oil production capacity 
in the global market. By the 1990s that number had fallen to 7 
percent. Now we are down to 2 to 3 percent.
    In the meantime with low consumer prices for much of the 
last two decades, refining has been a fairly low margin 
business discouraging capacity investment. Except in countries 
where refiners are at least partially protected by government 
policies such as price subsidies or import controls. In sum, 
today both crude oil production and global oil refining have 
very limited spare capacity when compared to the previous two 
decades.
    In addition to these structural factors, there have also 
been more transient factors that have contributed to crude oil 
march from $30 to $100. Some have been geopolitical events 
already referenced this morning, such as interruptions to oil 
flows in Iraq and Nigeria or just the threat to an interruption 
of oil from Venezuela or Iran. There have also been supply 
chain mishaps, like pipeline explosions and of course, the 
hurricanes hitting our own refining facilities in the Gulf 
coast.
    In the past, these surprise events might have had a limited 
or short-lived price impact as alternative supplies flowed into 
the market. But today, regardless of the severity of the threat 
they pose to the supply of crude or products, the impact of 
these events on prices is tremendous because again of the 
absence of spare capacity, no alternative suppliers. We are 
still living in a world with little margin for error.
    These factors have helped lift crude oil prices from $30 to 
at least $50 or $60. So this brings us to 2007 and 2008 and the 
current run up in oil prices. At the end of 2006, oil prices 
were sliding and OPEC decided to cut production by about 1.7 
million barrels per day. This decision had a significant impact 
on the global balance for oil in 2007.
    Let me explain. In a typical year, on a global basis, oil 
demand exceeds oil supply in the first and fourth quarters of 
the year and inventories typically climb. In the second and 
third quarters, oil supply typically exceeds oil demand and 
inventories typically rise.
    In 2007 oil demand exceeded oil supply in the first, third 
and fourth quarters and was essentially balanced in the second 
quarter. In short the global market did not build supplies last 
summer to use this winter. On average in 2007, global oil 
demand exceeded global oil supply by somewhere between 500,000 
barrels per day and one million barrels per day. A rally in oil 
prices was a forgone conclusion at the end of 2007 or at least 
in the second half of 2007.
    There were of course, other factors that affected the oil 
price in 2007. But this basic story of demand outstripping 
supply has been the physical market backdrop for the recent run 
up in prices. Now we get to the critical question. Can it 
account for the entire move to $110?
    I personally do not think so. As I said at the beginning of 
these comments, institutional investors have identified oil as 
an attractive investment. This is in part, in large part, 
because the physical market had not discouraged the community 
investors who want to buy and hold oil as a portfolio 
investment.
    Let me conclude by saying some relief is on its way in the 
physical market. Hope OPEC has increased production 
significantly since late 2007, although perhaps not as much as 
some would like them to. Oil demand indeed is slowing because 
of the economic slow down here in the United States.
    But the fundamentals have not turned yet enough. They 
haven't flipped enough to discourage investors who want to 
invest in and hold oil as a portfolio investment. In the 
meantime, we on the physical side see nothing in the financial 
markets themselves that indicates a desire to sell crude oil. 
Thank you very much.
    [The prepared statement of Ms. Emerson follows:]

  Prepared Statement of Sarah A. Emerson\1\ Managing Director, Energy 
                 Security Analysis, Inc. Wakefield, MA
---------------------------------------------------------------------------
    \1\ Sarah A. Emerson is the Managing Director of Energy Security 
Analysis, Inc (ESAI), an independent energy research and forecasting 
firm located just outside of Boston, Massachusetts. Ms. Emerson joined 
ESAI when the petroleum consulting practice was launched in 1986.
---------------------------------------------------------------------------
    Good morning Mr. Chairman and distinguished committee members. I am 
honored to testify before you today. I have been asked to provide a 
physical market context for the increase in oil prices to over $100 and 
the role of institutional investors in the oil markets.
                              introduction
    We are witnessing striking developments in the global markets. The 
price of crude oil has doubled since the beginning of 2007 and is at or 
above $100 per barrel. The dollar has fallen precipitously and is now 
worth only about 2/3 of a Euro. Oil exporting countries are pumping 
``petrodollars'' into the global economy. Some estimates put that 
amount at $4 trillion dollars as of the end of 2007.\2\
---------------------------------------------------------------------------
    \2\ ``Oil Producers See the World and Buy it Up,'' NYT, Wednesday, 
November 28, 2007, page A1.
---------------------------------------------------------------------------
    This is the status quo, and as shocking as it seems, it appears to 
be relatively stable. The weak dollar cushions the impact of the high 
oil price on consumers outside of the U.S., the petrodollars provide 
liquidity in investment which helps grow the global economy, especially 
outside of the U.S. And one could argue the Fed's monetary policy, 
designed to stimulate our slowing economy by lowering interest rates, 
keeps the dollar weak, which in turn encourages investors to buy 
commodities, especially oil, as a hedge against inflation.
    But, as we witness these developments in the financial markets, it 
is important to keep in mind that oil prices could only display this 
kind of strength because of what has taken place in the physical market 
for oil.
    Over the 20 year period prior to 2003, the global oil market was 
characterized by over-supply. The capacity to produce oil significantly 
exceeded demand. Nominal prices were flat and real prices fell.
    Years of relatively low oil prices supported oil demand not only in 
the transportation sectors of the industrialized countries, but also in 
the power generation, industrial and now chemical and transportation 
sectors of the developing world. As a result, global oil demand caught 
up with the capacity to produce oil. The spare capacity held by OPEC 
has been reduced to a bare minimum. Specifically, in the 1980s, there 
was as much as 15 percent sparecrude oil production capacity in the 
global market. By the 1990s, that number had fallen to 7 percent. Now, 
we are down to 2-3 percent.
    In the meantime, with low consumer prices for much of the last two 
decades, refining has been a fairly low-margin business, discouraging 
investment except in countries where refiners are at least partially 
protected by government policies such as price subsidies or import 
controls. In sum, both global crude production and global refining have 
very limited spare capacity relative to the previous two decades.
    In addition to these structural factors, there have also been more 
transient factors that have contributed to crude oil's march from $30 
to $100. Some have been geopolitical events such as interruptions to 
oil flows in Iraq and Nigeria or threats to the flow of oil in 
Venezuela or Iran. There have also been supply chain mishaps like 
pipeline explosions or hurricanes hitting refining facilities. In the 
past, these surprise events might have a limited or short lived price 
impact.
    What is most striking about these events today is that, regardless 
of the severity or the duration of the threat they pose to the supply 
of crude or products, their impact on prices is tremendous because of 
the absence of spare capacity (or alternative supplies). We are still 
living in a world with little margin for error.
    This brings us to 2007/2008 and the current run up in oil prices. 
At the end of 2006, oil prices were sliding and OPEC decided to cut 
production by as much as 1.7 million b/d. This decision had a 
significant impact on the global balance for oil in 2007. In a typical 
year, on a global basis, oil demand exceeds oil supply in the first and 
fourth quarters and inventories decline. In the second and third 
quarters, oil supply exceeds oil demand and inventories typically rise. 
In 2007, oil demand exceeded oil supply in the first, third and fourth 
quarters and was essentially balanced in the second quarter. In short, 
the global market did not build supplies last summer to use this 
winter. The global market dug a big hole. On average, in 2007 global 
oil demand exceeded global oil supply by somewhere between 500,000 b/d 
and 1.0 million b/d. A rally in oil prices in late 2007 was a foregone 
conclusion.
    There were other factors that affected the oil price in 2007, but 
this basic story of a tight global market has been the physical market 
backdrop for the run-up in prices. Can it account for the entire move 
to $110? No I do not think so. But, the physical market has not 
discouraged or disciplined the community of investors who want to buy 
and hold oil as a portfolio investment.
    Relief is on its way in the physical market. OPEC increased 
production significantly in the latter half of 2007 and oil demand is 
slowing because of the economic slowdown here in the U.S. But the 
fundamentals have not turned enough . . . yet . . . to discourage 
investors who want to invest in and hold oil. In the meantime, we see 
nothing in the financial markets that indicates a desire to sell crude 
oil.
          Attachment.--The Factors Encouraging High Oil Prices
                            background paper
                          by sarah a. emerson
Sarah A. Emerson is the Managing Director of Energy Security Analysis, 
Inc (ESAI), an independent energy research and forecasting firm located 
just outside of Boston, Massachusetts. Ms. Emerson adapted this paper 
from one she wrote for the Electric Power Research Institute.

    During the 1950s, 1960s, and the early 1970s, oil prices were 
``posted'' or set by the major integrated oil companies. Indeed, the 
volume of trade in crude oil spot markets accounted for only about 15 
percent of international crude oil transactions. Moreover, spot 
transactions were possible only because the major oil companies needed 
to balance their own supply and demand, unloading small surpluses and 
covering minor deficits in the spot markets. The oil crises of 1973-74 
and 1979-80 led to a threefold increase in prices, the adoption of 
fixed prices by OPEC, and the abandonment of fixed volume contracts 
between OPEC member countries and their customers. Higher world prices 
for oil stimulated non-OPEC production and cut global oil demand. As a 
result, in the market for the marginal barrel of crude (the spot 
market) prices fell below OPEC's elevated and fixed price. Not 
surprisingly, independent refiners, traders and even the integrated 
majors bought more and more crude in the spot market. By the early 
1980s, crude oil transactions at spot prices or prices tied to the spot 
market accounted for more than 50 percent of total international crude 
oil transactions.
    Within OPEC, the role of swing producer in defense of higher prices 
became increasingly untenable for Saudi Arabia. Ultimately, Saudi 
Arabia abandoned this role, a market share war ensued and prices 
collapsed in 1986. Since 1986, almost all of the world's oil has been 
sold bilaterally with transactions linked to some kind of market-based 
pricing, such as netbacks or formulas tied to spot, and more recently, 
futures prices.
 . . . Gives Way to Market Forces
    The emergence of spot and futures markets in oil has led to two 
decades of market forces as the organizing principle of the global oil 
sector. The deregulation of domestic oil industries and the 
liberalization of petroleum product pricing have proceeded all over the 
world as countries have opted to integrate into the large, transparent 
and relatively low priced global oil market. The view that market 
forces, rather than government policies, were best suited to allocate 
resources equitably was mirrored by the rise of Reagan-Thatcher 
laissez-faire conservatism of the 1980s and the eventual collapse of 
the Soviet bloc by the early 1990s. The devaluation of the Russian 
ruble and the Asian financial crisis later in the 1990s showed the 
folly of policies that ran counter to market forces in global capital 
markets. More recently, the market-friendly approach adopted by the 
Bush White House and China's accession to the World Trade Organization 
(WTO) have again underscored the dominance of the ``market.''
    Meanwhile, financial institutions have become important 
participants in the futures markets, buying and selling paper barrels 
of oil. Futures markets and the liquidity provided by speculators have 
transformed the global oil market from one dominated by month-to-month 
pricing to one driven by minute-to-minute pricing. A striking example 
of the influence of speculation in the futures market on short-term 
price direction has been the impact of the net position (long or short) 
of the noncommercials (non-hedgers) on the price of WTI on the NY 
Mercantile Exchange (NYMEX).\3\
---------------------------------------------------------------------------
    \3\ A chart comparing the net long position of the non-commercials 
with the price of WTI is included in the Appendix.
---------------------------------------------------------------------------
    It is not just the existence of spot and futures markets and the 
political preference for unfettered markets, however, that has allowed 
the market to reign in oil. Over most of the last 20 years, the global 
oil market has been characterized by over supply. The capacity to 
produce oil has significantly exceeded demand. Nominal prices have been 
flat and real prices have fallen.
The Era of Market Forces May be Coming to an End
    Now as we face the next 20 years, the era of ``market'' as the 
primary organizing principle may be coming to an end. Market forces are 
under attack from many sides. This is, in part, due to the state of the 
physical market itself. Years of relatively low oil prices have 
supported oil demand not only in the transportation sectors of the 
industrialized countries, but also in the power generation, industrial 
and now chemical and transportation sectors of the developing world. 
Global oil demand has caught up with the capacity to produce oil. The 
spare capacity held by OPEC has been reduced to a bare minimum. That 
cushion will not be replaced overnight, unless something distinctly 
slows oil demand growth.\4\
---------------------------------------------------------------------------
    \4\ A global balance that compares global oil demand with global 
supply is presented in the Appendix. Spare production capacity is held 
by OPEC and is presented graphically later in the text in Chart C.
---------------------------------------------------------------------------
    In the meantime, with low consumer prices for much of the last two 
decades, refining has been a fairly low margin business, discouraging 
investment except in countries where refiners are at least partially 
protected by government policies such as price subsidies or import 
controls. In sum, both global crude production and global refining are 
capacity constrained relative to the previous two decades.
    But that is only part of the physical market story. The market 
impact of the capacity crunch has been intensified by government 
efforts to protect the environment. Policies to cut polluting emissions 
have led to fuel specification changes that have chipped away at the 
profitability of refining by forcing refiners to focus on investments 
to refine predominantly medium sour crude into clean low sulfur 
transportation fuels rather than investments to expand capacity. These 
refining investments have barely kept pace with demand for cleaner 
products, so the global market for clean products is supported not only 
by tight distillation capacity but also limits on the upgrading and 
desulphurization capacity available to make cleaner and lighter fuels.
High Oil Prices
    In thinking about the factors that have led crude oil prices from 
$30 to almost $100, some are structural factors that will take years to 
change. Others are more transient factors that change almost daily. As 
shown in the chart A* the structural factors include basic items such 
as weighted average production costs and transportation, but they also 
include supply chain factors such as the preference for just in time 
inventories, limited refining capacity and thin spare production 
capacity.\5\ These supply chain factors are not easily or quickly 
changed and they have made the current era of pricing a departure from 
the previous 20 years when companies carried a lot of inventory and 
there was significant spare refining and production capacity.
---------------------------------------------------------------------------
    * Charts A-F has been retained in committee files.
    \5\ The values in this chart are the judgment of the author.
---------------------------------------------------------------------------
    Charts B and C illustrate the elimination of spare capacity in both 
refining and crude oil production. In the case of global refining 
capacity, since 1990, the global utilization rate (here defined as 
global demand/global capacity) has exceeded 90 percent, but since 2004 
has exceeded 95 percent.\6\ 2004 was a remarkable year because oil 
demand grew very quickly around the world, but especially in the U.S. 
and China. Indeed, China's demand growth was extraordinary. Even though 
China's oil demand growth has slowed since then, that one-year spike 
drew a great deal of attention. China'sgrowth will continue on a steady 
pace, but is unlikely to return to 2004 levels. In any event, the 
enormous increase in oil demand in 2004 led to a commensurate increase 
in crude oil production, especially in OPEC countries.\7\ That jump in 
output eliminated a significant volume of spare capacity. Since then, 
some spare capacity has been rebuilt as some new fields are brought on 
line in OPEC countries and as global oil demand has slowed down 
distinctly in 2005-2007. Indeed, oil demand growth in 2005 through 2007 
has averaged about 1.2 million b/d whereas oil demand in 2004 was 
roughly 3.0 million b/d on the back of the Chinese surge.
---------------------------------------------------------------------------
    \6\ Data for chart B is based on the BP Statistical Review and 
ESAI's own database.
    \7\ Data for chart C comes from ESAI's own proprietary database. 
ESAI maintains a country-by-country database of supply, demand, 
inventories, refinery operations, crude production, production capacity 
for crude oil and each petroleum product for the entire world. All of 
ESAI's market analysis is based on a bottom-up approach to analyzing 
supply and demand at the national regional and global level.
---------------------------------------------------------------------------
    The other factors included in chart A are more transient factors, 
which may have a shorter life span than structural factors. They 
include short-term developments in supply and demand, geopolitical 
events involving oil-producing countries like Nigeria, Iraq, Iran and 
Venezuela, supply chain mishaps like pipeline explosions or hurricanes 
hitting refining facilities. There is also speculation when 
noncommercial traders buy crude oil either as a short-term speculative 
investment or a hedge against something else like inflation. Each of 
these categories of factors has different impacts. Under the supply and 
demand developments, some factors have more lasting impact. The 
previously mentioned oil demand surge in 2004 was driven, in part, by a 
sudden acceleration in China's oil use. That was really a one-year 
phenomenon, although China continues to post healthy demand growth. 
Another example is the start up of a new oil field or a warmer or 
colder than normal winter. The rest of the transient factors are 
largely surprise events that are generally difficult to predict, but 
also relatively short lived. Regardless of the severity or duration of 
the threat these transient factors pose to the supply of crude or 
products, their impact on prices can be tremendous because of the 
absence of spare capacity in the global supply chain. This is well 
known by speculators who are inclined to ``buy'' oil at the first news 
of an actual or potential supply interruption.
Will Market Forces Bring Oil Prices Down?
    In response to these oil market realities, a pure market economist 
might contend that high oil prices will spur conservation and temper 
demand growth while encouraging investment in crude oil production. The 
result will be more supply and less demand and oil prices will fall 
signaling the end of the current cycle. At current prices, even 
development of the least conventional sources of liquid hydrocarbon 
production (i.e., gas and coal to liquids and tar sand, shale and 
bituminous deposits) is affordable. In short, conventional oil gets a 
boost from the traditional investors and oil sands, bitumen, oil shale, 
biodiesel, and other alternatives get a boost from the entrepreneurs. 
The current boom cycle comes to an end, the market equilibrates and 
prices fall.
    The mean reversion, market equilibrates view of today's prices, 
however, does not yield an accurate characterization of where we go 
from here. Given that many of the factors that have led to $100 oil are 
structural ones, the amount of investment in new production of oil (or 
alternatives) and the demand restraint required to re equilibrate the 
market is substantial. Moreover, the players in the market, whether 
they are national governments or private companies, are either changing 
altogether or developing new attitudes towards oil.
Governments May Not Think So . . . and May Intervene in Markets
    In today's market, oil supply disruptions are perceived to be more 
likely and more difficult to counteract. The recent strength in oil 
prices is, in part, because they have internalized the energy security 
concerns highlighted by the War in Iraq and terrorist attacks in and 
outside of the Middle East. Civil unrest in Nigeria, the standoff 
between the U.S. and Iran over nuclear weapons, and tensions between 
the Bush Administration and President Chavez of Venezuela underscore 
historical concerns about the security of supplies. In a well-supplied 
market, the consequences of a supply disruption can be managed through 
alternative supplies. In a capacity constrained market, however, every 
disruption has more severe consequences. These energy security concerns 
have moved energy higher on the public policy agenda in many countries.
    Higher oil prices have also lent perhaps undeserved credence to the 
claim that the volume of conventional oil production is at or very 
close to its peak. Pinpointing the year in which conventional oil 
production peaks or plateaus is unnecessary and far too contentious an 
exercise. What matters is that alternative liquid hydrocarbons like 
syncrudes from oil sands or bitumen and alternative fuels from biomass 
and agricultural crops will increasingly become part of the liquid fuel 
mix over the next few decades. The expansion of ethanol in the U.S. 
gasoline pool is an early and instructive example of the trend towards 
greater volumes of non-traditional hydrocarbons or non-hydrocarbons in 
the petroleum product pool. This trend will become more widespread.
    Regardless of the veracity of the ``Peak Oil'' argument, it has 
raised a red flag about the longterm supply of conventional oil and its 
adequacy for meeting oil demand. This has led the major stakeholders, 
including producers, consumers and government regulators to rethink the 
alternatives. In some countries, especially those without oil 
production, the government response to these concerns is likely to be 
more conservation. Regulations that improve efficiency and reduce 
consumption seem almost inevitable in some countries. Likewise, 
countries with dwindling oil production, which are becoming bigger and 
bigger net importers are pursuing policies to secure foreign supplies. 
Meanwhile, all net oil-importing countries are considering changes to 
their energy mix if their resource endowments allow.
    Finally there is the environment. Efforts to reduce emissions and 
clean up fuels, especially transportation fuels, will continue around 
the world. But behind those efforts is a far bigger environmental issue 
for the global oil sector: reducing greenhouse gas (GHG) emissions.
    In sum, the continued dominance of the ``market'' as the organizing 
principle of global oil is under attack by two overriding concerns: 
energy security and the environment. One could argue that these 
challenges have always existed, but it seems clear that the absence of 
``spare'' capacity in production and refining has dramatically 
underscored the energy security issue while growing consensus on 
climate change has transformed the environment issue. With this in 
mind, market regulation in the petroleum sector is far more likely in 
the next two decades than in the last two.\8\
---------------------------------------------------------------------------
    \8\ The recent signing of the 2007 Energy bill into law already 
signals more government intervention in the U.S. oil sector as it 
raises CAFE (fuel economy) standards to 35 mpg by 2020 and calls for 36 
billion gallons of alternative fuels used in transportation fuels by 
2022.
---------------------------------------------------------------------------
Where Do We Go from Here
    It is difficult to look very far out when examining the structural 
factors shaping oil prices today, but one can say something about the 
next 5 years or so with some confidence. As described earlier, the two 
most important structural factors contributing to high oil prices are 
tight refining capacity and limited spare crude production capacity. 
But investment is underway and in the medium term those problems will 
ease. *Charts E and F are projections of Charts B and C presented 
earlier. Based on ESAI's analysis of global expansion of refining 
capacity and production capacity, both improve. The refining capacity 
projection indicates that the global utilization rate should fall below 
95 percent. This is still a high number, but more consistent with the 
1990s when oil prices were lower. The production capacity projection is 
more speculative because it encompasses many countries with declining 
oil fields and a handful of countries with expanding production. All of 
the spare capacity is held in OPEC and the view in Chart F is probably 
optimistic in magnitude but accurate in direction.
    Beyond 2013, the picture is much more difficult to draw because the 
structural tightness in the global supply chain never disappears. It 
just improves and deteriorates depending on the ebb and flow of 
investment and demand. With that in mind it is difficult to imagine a 
return to $30 crude oil. At the same time, $90-100 crude oil will be 
hard to sustain. In short, market equilibrium is much more loosely 
defined and probably refers to a price range of $50-$80 with more 
potential to break above that range than below that range.
Conclusions
    The last two decades of deregulation and reliance on market forces 
as the defining principle of the oil markets has run its course and, on 
the margin, regulation is moving back into the oil patch. The 
confluence of high prices, limited upstream and downstream spare 
capacity, instability in producing countries and concerns over climate 
change are encouraging coalitions that endorse change in energy 
policies. Whether it is in the name of environmentalism, national 
security, resource stewardship or mercantilism, many different 
political and economic interests are looking for a change to the 
regulatory status quo. Slowly their efforts will gain ground in 
countries all over the world.
    In the meantime, the global oil market remains perched on a three-
legged stool of high oil prices, a weak dollar and huge flows of 
petrodollars into investments around the world. This stool has been 
fairly steady over the last several months, but it does not represent a 
status quo that will satisfy most governments. The high oil prices, in 
particular, are a direct concern for consuming governments and an 
indirect concern for producing governments if they see consumers 
turning to conservation and alternatives. The weak dollar is a concern 
for U.S. consumers and must make oil producers worry about inflation in 
their economies. Consuming governments will be compelled to take action 
to protect their economies. Producing governments will invest to 
broaden their oil price windfall and, in the process, perhaps take the 
edge off high prices. But it will take time to effectively slow demand 
growth and increase supply growth. Moreover, slower demand and faster 
supply will not be smooth and not commensurate, especially as 
governments take a bigger role in markets. So the stool may rock, but 
remain upright for some time. Oil prices will eventually moderate (and 
the stool will topple), but prices will remain volatile and 
unpredictable as the steps taken by governments unfold.

    The Chairman. Thank you very much.
    Mr. Book.

    STATEMENT OF KEVIN BOOK, SENIOR ANALYST AND SENIOR VICE 
   PRESIDENT, FBR CAPITAL MARKETS CORPORATION, ARLINGTON, VA

    Mr. Book. Thank you, Chairman Bingaman, Ranking Member 
Domenici and distinguished members of this committee. Thank you 
especially given what I do for a living is I analyze energy 
policy in the geopolitics of energy for institutional 
investors. So spending this time with you is a little bit like 
spending the morning with Elvis.
    I'm very, very grateful to be here. Part of this discussion 
as well because I think you've done wonderful things on a 
bipartisan way to engage corporations and citizens in what has 
to be discussed which is how energy works and why it's 
important for energy and environmental security to know these 
things. So I'm very grateful for all of those things.
    At the core of this discussion the global economies of 
emerging nations have entered their energy hungry adolescence. 
The policy decisions that will have 30 to 50 year implications 
amid rapid change will require public and private sector 
leaders to keep their heads. If history is any guide, it won't 
be easy.
    Since there's a lot of the same things probably that are 
going to be said in our testimonies, I'm going to go a little 
off script. But I want to make a point that every one of the 
issues that has been cited by financial economists, Wall Street 
types, academics, have been true as a result of what Ms. 
Emerson said just now and what I'll suspect you'll hear again 
and from others. They include insufficient working inventories, 
refinery capacity constraints, the growth of China, 
geopolitical risk, cost inflation and depreciation of the 
dollar and the notion that non-commercial buyers are driving 
prices up is also partially true today, I believe. Particularly 
if you believe that investors are seeking value retentive 
refuge from the falling U.S. dollar.
    But what I would encourage is the thought that this 
phenomenon certainly won't be true forever. It may not even be 
true for long. Since you've kindly offered to put my written 
testimony in the record, I want to just hit on a few points 
that are incremental to what has already been said.
    First, an institutional investor, these are the people that 
are my firm's clients. They manage other people's money 
professionally. Simply put those people will fire their money 
managers when they lose them money. This pressure applies 
equally to sovereign funds and hedge funds.
    So CalPERS announced their plans to invest billions in 
commodities and commentators said well, if they're doing it and 
they're very conservative of the pension fund they must be by 
charter, and every investor must be doing it. I think that's 
partially true. Investors of all strides are indeed 
diversifying into commodities. Some are buying. Some are 
selling. Some who are buying today may be selling tomorrow. If 
the funds flow into commodities is in fact elevating oil 
futures and accumulating evidence of a slow down in oil 
consumer nations could provoke a sell off as conservative 
investors close their positions and aggressive investors sell 
short.
    Second, I want to draw a distinction between markets and 
mobs. Markets price value and emotions move mobs. Markets tend 
to reflect disagreement over price where as mobs reflect 
uniformity of opinion. In market bubbles mobs of otherwise 
rational actors may ignore readily available data that might 
have discouraged their behaviors had they not been blinded by 
fear, greed, or what 19th century author Charles MacKay, 
Extraordinarily Popular Delusion and the Madness of Crowds.
    It is not obvious to me that oil markets are over 
saturated. The aggregate value of daily oil consumption is 
about $7.5 billion. If every barrel for the next 8 years of 
future delivery were contracted at today's prices which is a 
hypothetical extreme and not a rational case, just to make the 
point. The volumes could absorb about $20 to $25 trillion.
    As our first witness noted open interest in oil recently 
reached about 2.8 million contracts. That's about $280 billion 
at $100 dollars per barrel. That is a significant amount of 
money in its own right, but only about 1 percent of the 
theoretical market size.
    This is also not the only place for speculative money to 
go. Investors buy stocks for tomorrow's cash-flows. They buy 
commodities for tomorrow's scarcity.
    Too many dollars chasing too few barrels can be 
inflationary in the short term. In the medium term, however, 
non-commercial dollars provide working capital, as you know, to 
lower the cost of insuring future supply. In the long run 
premium signal even higher cost projects may be rewarded.
    This year WTI futures prices have risen about 10 percent. 
With share prices of the three largest U.S. oil companies have 
fallen about 9 percent. As companies respond to these price 
signals those investments flows may shift.
    Futures prices cannot trade ahead of distraction costs 
forever. The price of oil is driven by speculation. The 
economies are slowing as we're seeing. Eventually one of two 
things will dispel the mob. Either oil will fill up storage 
facilities and buyers will be physically unable to take 
delivery. Or new capacity will show up to take advantage of 
price premiums.
    Just a couple comments on oil and I'll try to stick as 
close as possible to the time as well. Dramatic policy shifts 
and tax hikes can have self-defeating implications in a world 
where you're effectively transitioning. I think that is the 
vision of this committee. I think it's a good vision.
    But let's look at what's happening right now. The market is 
telling investors there's a high price because of scarcity. 
Some of the marketers suggesting, and I don't think they're 
right, that countries like this one, industrialized economies, 
can't conserve, won't balance energy through environmental 
stewardship and don't have the technology to produce 
alternative fuels cheaply.
    Others are suggesting that the production oil has peaked. I 
think that twice during the last 6 months, you know, you found 
big finds off the Brazilian coast. Currently high prices 
encourage new technologies. Part of oil companies will have to 
make those investments and operate those technologies for long 
periods of time.
    When you start to get into the production process, you 
start to find things with new technologies. Oil production can 
become very sticky because if you're going to invest your own 
company, you don't necessarily have the option to stop 
producing. Your board is expecting you to pay off the debt and 
fund future operations. So volumes may show up even if the 
price starts to soften.
    The circumstance of peak access is not a fundamental 
either. It's political. The majors are coming out. Last month 
$3.7 billion were bid for drilling rights in the Gulf of 
Mexico.
    In this context you have to think that restricting where 
the U.S. has oil will only transfer wealth and market power to 
OPEC and this to my last point. OPEC can be, right now you can 
say it's a little bit more of an effective cartel. Because at 
$100 a barrel there's no reason for the weakest economies to 
blow through their quotas and defect to fund their cash-flows.
    That doesn't mean, however, that protection isn't the right 
answer. These countries do control 80 percent of the world's 
reserves. They may not be enthusiastic about inviting western 
companies into their production bases, but they are 
enthusiastic about potentially investing their money in the 
downstream here in this country. Because they have very cheap 
oil and they can make more money if they can turn that oil into 
gasoline and sell it into our hungry market.
    So I would caution against the protectionist response. I'd 
also just close with the notion that we are probably reaching a 
peak appetite for oil. As we get there we will diffuse new cars 
into the vehicle fleet will be more efficient. We will 
eventually get to flex fuel or more flexible fuel vehicles.
    It's a lot of investment. It's a lot of time. But while we 
get there, flexibility implies a choice in policies that 
encourage petroleum investment will help keep that choice open 
hence the cautious response to the idea of raising taxes on the 
companies that produce oil here at home.
    I've gone fairly off script, but I'm here for any 
questions. I look forward to them at the appropriate time. 
Thank you.
    [The prepared statement of Mr. Book follows:]

  Prepared Statement of Kevin Book, FBR Capital Markets Corporation, 
                             Arlington, VA
    Chairman Bingaman, Ranking Member Domenici and distinguished 
Members of this Committee, thank you for the privilege of appearing 
before you today. The views I will present this morning are my own and 
do not necessarily represent those of my employer.
    I would like to begin by offering my admiration for the comity and 
caution this Committee has demonstrated in addressing the energy and 
environmental security challenges facing the nation. Your efforts have 
already engaged corporations and private citizens alike in a necessary 
national discussion regarding the sources and uses of our natural 
resources. All around the globe, emerging nations are entering into 
their energy-hungry adolescence and the dislocations wrought by this 
paradigm shift will require public and private sector leaders to keep 
their heads. If history is any guide, it won't be easy.
    During the last five years, the world's top energy economists have 
offered a disarmingly variable sequence of explanations for the run in 
crude oil prices. At the beginning of the decade, market watchers 
counted days of demand cover, a measure of whether working inventories 
contained sufficient oil to meet expected demand. Subsequently, many of 
the same experts linked escalating prices to refining capacity 
constraints, the growth of wealth in China, geopolitical risks in the 
Middle East and Nigeria, cost inflation and, most recently, the 
depreciation of the dollar relative to other currencies. Each of these 
phenomena has correlated to, and sometimes predicted, oil prices. But 
none of these explanations has proven consistently useful throughout 
the decade or when back-tested against earlier data.
    The same might be said for the notion that non-commercial buyers of 
forward and futures contracts are driving up oil prices. This may be 
partially true today, and it may even be somewhat price-predictive to 
assess the flow of investor wealth into commodities, particularly if 
one believes that institutional investors may be seeking a value-
retentive refuge from the falling U.S. dollar. But this phenomenon 
certainly won't be true forever. It may not even be true for long. My 
comments regarding investor motivations, market dynamics and oil 
production are intended to suggest that an optimal policy response 
should not ignore the historical tendency of the law of supply and 
demand to govern long-term oil market outcomes.
           an overview of institutional investors' incentives
    Generally speaking, an ``institutional'' investor manages other 
people's money professionally. One or several layers of management 
expertise can lie between primary investors and markets. Institutional 
investors themselves compete in the market for asset management 
services. Widely variable charters constrain the asset classes that 
different investment funds may hold and the strategies that 
institutional investors may employ, but all asset managers share a 
common trait: they are paid to retain, and ideally to augment, their 
clients' wealth. Simply put, investors fire managers who lose their 
money.
    On February 28, 2008, CalPERS, the California pension fund, 
announced plans to invest as much as $7.2 billion through calendar year 
2010 in commodities. At the upper bound, this could represent a little 
less than 3% of the portfolio, a meaningful commitment to commodities 
as an asset class. This was neither unexpected nor unheralded. The 
first exchange-traded fund (ETF) created to track crude oil contract 
prices began trading on the London Stock Exchange in July 2005. The 
first U.S. oil ETF began trading on the American Mercantile Exchange in 
April 2006. Oil ETFs typically buy and sell oil futures to enable 
investors who might not buy commodities to replicate the performance of 
oil markets. Oil ETFs largely resemble an earlier vintage of ETF, S&P 
500 ``index funds'' that buy and sell S&P component equities.
    At the time of the CalPERS announcement, several market 
commentators extrapolated its implications, reasoning that, if 
institutions as conservative as pension funds were buying oil, then 
everyone else must be, too. I would respectfully submit an alternative 
thesis. Investors of all stripes may be diversifying into commodities 
markets, but they are not all buying. Some are likely to be selling, 
and many of the investors who are buying today might well be selling 
tomorrow, depending on their risk tolerances.
    Hedge fund managers typically earn fixed management fees but the 
bulk of their compensation usually derives from percentages of earned 
profits. Because hedge funds may hold heavily concentrated positions or 
illiquid investments, it can take fund managers days, weeks or months 
to gracefully unravel their positions without destroying fund value. As 
a result, most hedge fund charters limit the opportunities for 
investors to ``redeem'' invested capital to narrow, periodic windows. 
This can encourage hedge fund managers to pursue higher-risk 
strategies, including investments that may result in short-term losses. 
But the wealthy individuals and institutions who buy into hedge funds 
pay premiums in return for high performance. These clients can grow 
impatient and vote with their wallets if managers deliver sustained 
losses. Managers of funds with smaller cash holdings could conceivably 
exert downward pressure on oil prices by closing long positions in a 
hurry to service a spate of redemptions.
    Sovereign funds exist to diversify national wealth away from its 
source. This is a matter of particular concern for oil-producing 
nations and Asian export economies. Sovereign fund managers usually 
have a single client, eliminating the competitive pressures for 
performance that can force quick sales of securities or, for that 
matter, discourage risky bets. Historic wealth transfers from largely 
Western, consumer nations to the largely Eastern producer nations that 
supply them have provoked timely calls for best practices and 
transparency by the IMF and OECD. Transparency is warranted, but 
protectionism is not. If fund managers are ``diversifying'' producer 
nations' sovereign wealth into oil futures, this might suggest similar 
economic circumstances to those that often motivate corporate stock 
repurchases: managers may not see any better way to safely invest the 
money. If this is true, new barriers--including bills like the ``No Oil 
Producing and Exporting Cartels'' (NOPEC) Act--to U.S. investment might 
further encourage dollar flight to commodity futures.
    At the same time, there may be two offsetting forces influencing 
sovereign investment in oil futures. Sovereign fund managers must 
answer to their clients, after all, and leaders of Gulf Cooperation 
Council nations have made known their concerns that the declining 
dollar has eroded their largely dollar-linked national wealth. Since 
oil trades in U.S. dollars, fund managers have an obvious motivation to 
hedge. On the other hand, these same clients are also best positioned 
to know when oil demand may be slowing, and they might well advise 
their fund managers to lighten up on commodities ahead of a slowdown, 
even if it means downward pressure on oil prices. This could 
conceivably occur if EU-27 economic growth began to slow as a United 
States slowdown continues, as oil could sell off at the same time that 
the U.S. dollar appreciated relative to the Euro.
    If funds flowing into commodities are indeed elevating oil futures, 
then accumulating evidence of a slowdown within the world's biggest 
oil-consuming economies could provoke an equal and opposite reaction as 
conservative investors close their positions and aggressive investors 
sell short.
                        markets, prices and mobs
    The question remains unclear, in my mind, whether the oil markets 
are vulnerable to manipulation by speculators, or whether speculators 
are vulnerable to manipulation by the oil markets.
    There is a lot of difference between a market and a mob. Markets 
are driven by the value of a good or service; mobs are driven by human 
emotions. Markets reflect disagreement over price; mobs typically 
reflect uniformity of opinion. Retrospective analyses of market bubbles 
often reveal how many otherwise rational actors caught up in the mob 
ignored readily available data that might have discouraged their 
behaviors, had they not been blinded by fear, greed or what 19th 
Century author Charles Mackay termed ``extraordinary popular delusions 
and the madness of crowds''.
    Markets set prices for buyers and sellers, but market prices also 
inform those buyers and sellers by summarizing the collective decisions 
of market participants into a number and a direction. Numbers and 
directions are objective truths, but their interpretation can be very 
subjective. For example, the market could be suggesting that this--and 
other--nations lack the willpower to adhere to conservation plans, the 
flexibility to rebalance energy needs with environmental stewardship or 
the technological wherewithal to produce economically-viable 
alternative fuels.
    Many market participants appear to believe with great certainty 
that high prices signify peak oil production. This seems particularly 
surprising now that, twice during the last six months, oil companies 
have identified possible ``super-giant'' oil fields off the Brazilian 
coast, underneath the salt layer and well within the reach of modern 
technology. It might seem safer to assume that the moment when mankind 
will have exhausted 50% of the oil molecules in the Earth's crust is 
still a long way off, but that's not what the futures market may have 
been thinking in March. A March 16, 2008 Financial Times story 
entitled, ``Investors bet on $100 a barrel until 2016'' was the first 
of many media reports I read that attributed the close of long-dated 
crude futures as a shift in sentiment towards enduring scarcity. Indeed 
there were bets out to 2016 on $100 oil, but not a lot of them. In 
fact, only 108 December 2016 WTI contracts traded on March 14, 2008 
(the date referenced by the article) as compared to 293,217 front-month 
contracts.
    The oil market isn't the only place for speculative money to go, 
nor are oil markets obviously oversaturated. Crude oil is the most 
widely traded commodity in the world. Daily oil consumption of about 86 
million barrels has an aggregate value of approximately $7.5 billion, 
discounting for quality. Commodities exchanges trade contracts for 
physical deliveries eight years in the future. In theory, if every 
barrel for the next eight years of future delivery were contracted at 
today's price and volume assumptions, those contracts could absorb 
about $20-25 trillion. Open interest in light sweet crude oil contracts 
is approximately 2.5 million contracts. Each contract represents 1,000 
barrels, making open interest worth $250 billion at $100 per barrel. 
$250 billion is a staggering sum in its own right, but only about 1% of 
the theoretical maximum market size, and a rounding error in contrast 
to the global notional value of derivative instruments of all kinds, 
which the Bank of International Settlements estimated in June 2007 to 
be worth more than $500 trillion.
    Capital markets and commodities markets play different roles in 
wealth creation. The value of equity securities derives from investor 
expectations that today's investments will deliver tomorrow's cash 
flows. When equity values appreciate, corporations can sell treasury 
stock or issue a follow-on stock offering to capitalize investment or 
retire expensive debts. The value of commodities usually derives from 
scarcity, at least in the short-term. The short-term effects of a 
growing volume of dollars chasing a currently fixed number of barrels 
can be inflationary in cases where new investment grows meaningfully 
relative to the market size. For the intermediate term, however, 
dollars spent by non-commercial bidders provide working capital that 
doesn't have to come from either producers or commercial users, 
lowering the transactional and financial costs of ensuring adequate 
future supply. In the long run, dollars that rush into the oil markets 
will play a very important role. The premiums above production cost 
visible in today's oil market will ultimately have the effect of 
encouraging future production by signaling producers that even higher-
priced projects like tar sands, tertiary oil recovery and alternative 
fuels may be rewarded.
    As companies begin to position themselves to respond to price 
signals, investment flows may shift. This year, WTI futures prices have 
risen about 10%, while the share prices of the three largest U.S. 
integrated oil companies, ChevronTexaco, ConocoPhillips and ExxonMobil 
have fallen about 9% on a market-cap-weighted average basis during the 
comparable period. This suggests at a very cursory level that investors 
would rather hold oil itself than the companies that produce it (it is 
cursory to say this because the same investors don't always play 
equities and commodities markets). A shift in investment flows into oil 
companies and away from commodities may have predictive value as well 
as a technical effect. Historical oil prices have normalized in 
response to demand abatement, but also as a result of technology 
improvements and the economic decisions made by nations that control 
access to resources.
    Investors have limited visibility into the true state of global oil 
production. Divining the state of affairs requires constant attention 
to the reserves and production data reported publicly by governments, 
investor-owned companies and some state-owned firms as well as the 
refiners who ultimately purchase oil for commercial use. Investors may 
also consider proxies for consumption, like economic growth, and value 
chain constraints, like freight and shipping indices, as well as a 
range of third-party, proprietary sources that investigate everything 
from the comings and goings of tankers to orders for specialized 
capital equipment used for oil production. Some investors may be 
overwhelmed by the sheer volume of data to the point where the marginal 
benefit of incremental analysis exceeds the marginal benefit (or cost) 
of making a bad investment. Ironically, other investors may rely in the 
absence of empirical evidence on the signals generated by financial 
markets for futures contracts, in which case the endless trumpeting of 
rising WTI contract prices may create a ``feedback loop'' that seems to 
suggest enduring scarcity.
    Futures contracts cannot trade ahead of extraction cost forever. If 
the price of oil is, as OPEC suggests, being driven by speculation, 
then at least one of two things might happen to dispel the mob: either 
oil will fill up storage facilities and buyers will be physically 
unable to take delivery, or new capacity (or alternatives) will show up 
on the market to take advantage of price premiums.
                peak oil, peak access or peak appetite?
    The price of oil goes up--and down--but it doesn't always move 
smoothly. Commodities markets can be ``sticky''--that is, supply may 
not immediately respond to price. The following, very brief description 
of the exploration, production and refining sectors may help illustrate 
some of the reasons.
    First, let's be clear about what we mean by ``oil''. Geological 
petroleum deposits take many forms. The word ``oil'' can apply to a 
wide range of compounds of differing densities, viscosities and 
purities. The petroleum industry classifies oils that contain more 
natural gasoline and lower-density molecules as ``light'' and oils that 
contain lower levels of sulfur and other impurities as ``sweet''. 
Ultimately, the value of oil depends on the processing capabilities of 
the refiners--the commercial customers--who buy it. Refiners consider 
oils that are light and sweet to be ``high quality'' because they can 
be distilled into transportation fuels, chemicals and industrial 
products at lower fixed and variable costs than oils that are ``heavy'' 
and ``sour''. As global demand grows, oil companies are drilling deeper 
for oil and producing, on average, barrels that are heavier and sourer. 
Refiners' corresponding investment in new and higher complexity 
refineries generates new market opportunities for exploration and 
production companies (or divisions) to look again at resources they 
once ignored.
    Oils of similar composition tend to be interchangeable in the 
short-term. In the intermediate term, refiners of higher-quality oils 
who want to use lower-quality oils must invest in new refining 
equipment capable of processing impurities. Operating these higher-
complexity refineries requires more energy, resulting in increased per-
unit costs. However, the finished products that refiners make from 
oil--gasoline, diesel and jet fuel--are also commodities. Refiners must 
accept the market price offered for the products they produce, because 
any attempts to recapture additional costs by charging a higher price 
are likely to be undercut by competitors who produce fuel at lower 
marginal cost. As a result, the global refining industry as a whole 
typically prefers to pay less for lower-quality grades. Price 
relationships between oil grades tend to normalize over time because 
refiners will eventually invest in highercomplexity equipment to take 
advantage of sustained discounts for heavier or sourer oils. Similarly, 
greater demand for low-quality oils can bid them up relative to high-
quality oils and diminish or stabilize demand for high-quality oils.
    Thanks to high prices, oil companies are willing to consider new 
technologies. Incremental technology improvements are expensive to 
deploy. Oil companies will be most willing to put capital at risk when 
they believe robust demand will reward their investments. Incremental 
deployments of new technologies often bring rewards in the form of 
process improvements as employees climb their ``learning curves''. In 
subsequent deployments, oil companies can also take advantage of scale 
economies by standardizing operations around new technologies. On the 
other hand, oil production doesn't easily switch on and off, for a 
variety of practical and economic reasons. Petroleum production takes 
time; seven to ten years typically lie between the corporate decision 
to proceed and delivery of oil to the market. Because executives at 
investor-owned companies are accountable to shareholders, even if the 
price of oil falls between the time company management puts money into 
a project and the time production begins, oil companies may need to 
operate at loss in order to generate enough cash to pay back their up-
front investments and fund future efforts.
    Thanks to technology, it's easier to find oil. The days when a lone 
wildcatter with a dowsing rod and big dreams could uncover a gusher of 
Texas Tea with a hand drill ended decades ago. That's because most of 
the readily accessible large oilfields discoverable through yesterday's 
technologies are already in production. But this doesn't mean that the 
world's oil supply has peaked. The Earth is a big place, and oil 
deposits reside at varying depths throughout the Earth's crust all the 
world over. New seismic and electromagnetic technologies and advanced 
computer modeling make it possible for oil companies to identify 
significant new petroleum deposits in places where it had never been 
possible to look in the past, like underneath thousands of feet of rock 
or seawater. Drilling technologies are becoming superficially similar 
to endoscopic surgical techniques. In the not-too-distant future, 
producers may be able to access underground reservoirs by creating 
minimally intrusive surface holes and threading their drill-bits 
between rock formations. Oil companies are getting more out of every 
well, too. Enhanced oil recovery technologies using water and carbon 
dioxide are enabling North American production volumes that exceed 
original estimates by as much as 30% to 45%.
    Are we on the other side of ``peak access'' to oil reserves? 
Investor-owned companies face increasing barriers to drilling overseas 
as oil-rich sovereigns renegotiate, expropriate and nationalize their 
petroleum sectors to capture greater value from high prices. High 
prices may also have made OPEC a more effective cartel. At $100 per 
barrel, OPEC nations collectively generate about $3 billion each day. 
When prices were $10 to $15 per barrel, the poorest oil exporters 
sometimes exceeded their assigned quotas to keep national treasuries 
solvent. Today, even weaker producer economies can afford to hold the 
line on supply. Greater wealth means that the state-owned oil companies 
that control more than 80% of global reserves can afford their own 
advanced oilfield technologies and have fewer incentives to grant 
favorable concessions to investor-owned oil companies. A telling sign 
that the game is changing arrived last month, when oil companies bid a 
record $3.7 billion for offshore drilling rights in the Gulf of Mexico. 
In this context, restricting drilling where the U.S. has oil--including 
the Arctic National Wildlife Refuge and the Eastern Gulf of Mexico--
will only transfer wealth and market power to OPEC.
    Once again, protectionism is the wrong answer. Petroleum refining 
is a tough business for the U.S. oil companies that must pay top dollar 
for raw materials on the global market but end up selling a commodity. 
The prospect of punitive taxation and escalating environmental 
expenditures may make investor-owned companies understandably leery of 
committing multiple billions of dollars towards the building and 
expansion of their refineries. Not every oil company may regard 
investment in U.S. energy infrastructure as a bad deal. For state-owned 
oil companies, a new or bigger U.S. refinery could improve the profits 
associated with production of lower-quality crudes by turning them into 
gasoline to capture what has typically (but not always) been at a 
premium to their unrefined value.
    It may be that we are merely reaching our ``peak appetite'' for 
oil. Energy crises provoke transformational efficiency gains, even 
though they are expensive and take a long time to play out. Assessing 
oil production limits requires an examination of the vehicles that use 
petroleum-derived fuels, too. Today's cars, trucks and things that go 
are already quite flexible and will become more so. Forecasts made by 
the EIA, IEA and industry groups leave little doubt that many of the 
vehicles on the road today are taking growing advantage of fuels from 
non-oil sources that are similar in composition and performance to 
petroleum distillates. Likewise, tomorrow's transportation fleet is 
likely to employ liquid fuels of any origin much more efficiently than 
today's fleet. Technologies like hybrid petroleum-electric propulsion 
systems are now maturing. High prices are already provoking commercial 
aviation companies to look for low-cost, high-yield design changes that 
minimize energy lost to friction, like the wing ``tips'' frequently 
installed on commercial airlines. It seems likely that a conservation 
response is already underway and I believe the U.S. government is right 
to encourage it.
    New taxes could have self-defeating implications in the meantime. 
Replacing the 230 million passenger vehicles on U.S. roads will take 15 
to 20 years if we start today. Electric cars may require, among other 
things, investment towards a more reliable power grid. Likewise, 
diffusion of flexible fuel vehicles and E85 dispensers could require 
more than $50 billion in incremental spending and will rely on 
economic, large-scale production of cellulosic biofuels. A ``flexible'' 
vehicle implies a choice, and policies that encourage petroleum 
investment will keep that choice open, even as policies this Committee 
has enacted pave the road to future fuels. Corporate leaders of for-
profit companies must balance expected returns from 30-year projects 
against the risks that federal budgets can change annually, 
congressional polarities can reverse biennially and new regulators 
might reinterpret existing law every four or eight years. Dramatic 
policy shifts and tax hikes could make it harder, not easier, for oil 
companies to transition to future fuels.
     an afterthought regarding the u.s. relationship with petroleum
    Addiction is the wrong metaphor. We didn't start refining oil by 
accident. Oil continues to fuel 97% of the world's vehicles because 
generations of engineers, corporate leaders and policy planners 
selected it on the basis of its suitability. Oil is energy-dense, 
readily transportable and plentiful relative to alternatives, even 
despite the high prices of the moment. Allow me to suggest a different 
metaphor. For the foreseeable future, petroleum will continue to fuel 
industrialized societies the same way oxygen nourishes the body. Two 
obvious conclusions emerge.

    First, increasingly prosperous, growing populations will 
        require more oil, not less.
    Second, a man who is short of breath is not addicted to 
        oxygen; he may just need to get in shape. We will need to use 
        oil more efficiently.

    This concludes my prepared testimony. I will look forward to 
responding to any questions the Committee might have at the appropriate 
time.

    The Chairman. Thank you very much.
    Mr. Burkhard.

   STATEMENT OF JAMES BURKHARD, MANAGING DIRECTOR, CAMBRIDGE 
           ENERGY RESEARCH ASSOCIATES, CAMBRIDGE, MA

    Mr. Burkhard. Thank you, Mr. Chairman. It is an honor to 
address the committee on the issue of the influence of non-
commercials on the price of oil.
    First of all, who are these non-commercial investors? They 
are more than just short-term, speculative, traders. They 
represent a broad spectrum of investors ranging from managers 
of pension funds and university endowments and other 
institutional investors. They allocate investment capital based 
upon a view of the world's need for oil and other commodities.
    So why have oil prices been rising? The growing role of 
non-commercial investors can accentuate a given price trend. 
But the primary reasons why oil prices in recent years have 
been rising are rooted in several factors.
    One is the fundamentals of demand and supply, which we've 
heard about. Geopolitical risks which do have a real impact. 
Skyrocketing oil industry costs. More recently we've seen the 
decline in the value of the dollar play a more significant 
role, particularly since the credit crisis first erupted last 
summer and energy and other commodities got caught up in the 
upheaval of the global economy.
    That to be sure the balance between demand and supply is 
integral to oil price formation and will remain so. But there 
are, what we call, new fundamentals that are behind the 
momentum that push oil prices to their recent record high 
levels. These new fundamentals are one, new cost structures and 
two, global financial dynamics.
    First, new cost structures. As oil prices have risen, so 
has demand for the people and equipment that are needed to 
find, develop and produce oil. Major shortages of equipment and 
personnel have dramatically raised the cost of finding and 
developing oil all around the world. The latest IHS CERA 
upstream capital cost index, which is a sort of consumer price 
index for the oil industry, shows that the cost of developing 
oil fields has doubled in the last 3 years. In addition, 
increasingly heavy fiscal terms on oil investments and in the 
form of higher taxes and greater state participation mean that 
much higher oil prices are needed to support development of new 
supplies.
    The second new fundamental is what we refer to as global 
financial dynamics. The oil price has long reflected major 
trends in the economy and geopolitics. For example in 1998 when 
the oil price went down to $10 that was largely a reflection of 
the fallout from the East Asian financial crisis.
    Today two major trends are the decline of the dollar and 
the rising economic clout of regions outside of the United 
States. In the past half year in particular, lower interest 
rates in this country in anticipation of further cuts in 
interest rates has pushed the dollar lower. Amid great 
turbulence and credit and other financial markets the influence 
of the weak dollar on the oil market has grown.
    Oil has become what we refer to as the new gold. A 
financial asset in which investors seek refuge as inflation 
rises and the dollar weakens. That key element of the oil as 
the new gold story is the expectation that demand for oil will 
continue to grow and thus be able to hold its value despite the 
weak dollar and rising inflation. To degree an expectation of a 
strong oil price environment is a bet on the future of China, 
India and other high growth markets around the world.
    Since the beginning of last year, eight of the ten largest 
oil markets in the world have seen their currencies appreciate 
significantly against the dollar. When the currency appreciates 
against the dollar it diminishes the impact of an increase in 
the dollar price of oil for that market. This helps to sustain 
oil demand growth outside the United States.
    If economic and oil demand growth remain vibrant outside 
the United States and the dollar continues to weaken then 
financial dynamics are likely to drive oil prices higher. In 
addition the political and man power difficulties that are 
currently constraining oil supply growth will not disappear 
overnight. The desire for higher living standards in China, 
India and other emerging markets will remain as strong as it 
was in Europe, Japan and the United States in post World War II 
period. Higher living standards mean longer life expectancy, 
lower infant mortality and higher energy consumption.
    This year just as economic worries began to mount oil 
prices touched a new high of around $110 per barrel. Although 
oil prices are just one factor that affects the global economy, 
they are a significant one. Because the world economy was able 
to take $70 oil in stride does not mean that it can easily 
absorb $100 or higher.
    Oil prices are fluctuating in line with the latest economic 
signals. This will continue until a clearer view of economic 
growth materializes. But one factor is clear. The price of oil 
will reflect major swings in the value of the dollar both up 
and down. Thank you.
    [The prepared statement of Mr. Burkhard follows:]

  Prepared Statement of James Burkhard, Managing Director, Cambridge 
               Energy Research Associates, Cambridge, MA
    It is an honor to address this Committee on the relationship 
between oil prices and the influence of noncommercial institutional 
investors, sometimes referred to as market speculators. Trading in 
futures markets establishes the reference price for nearly all crude 
oil sold in the world. Crude oil futures trading activity on the New 
York Mercantile Exchange--the largest in the world--is currently about 
350 percent higher than in 2002.\1\ Noncommercial investors have 
contributed to this increase. Growth in trading activity is coincident 
with a rise in oil prices from $26 per barrel in 2002 to more than $100 
in early 2008. The concurrence of these two trends has raised the 
question about the level of influence that noncommercial investors have 
in oil price determination.
---------------------------------------------------------------------------
    \1\ The figure of 350 percent represents the increase in open 
interest in NYMEX crude oil contracts, which is a proxy for levels of 
trading activity. Open interest is defined by the US Commodity Futures 
Trading Commission as ``the total number of futures contracts long or 
short in a delivery month or market that has been entered into and not 
yet liquidated by an offsetting transaction or fulfilled by delivery.''
---------------------------------------------------------------------------
    What has been driving oil prices upward? It is primarily the 
fundamentals of demand and supply, geopolitical risks and rising 
industry costs. The decline in the value of the dollar has also played 
a role, particularly in the past six months. But with noncommercial 
investors playing a bigger role, the direction of a given price trend 
can be accentuated. And since the credit crisis first erupted last 
summer, energy and other commodities have become caught up in the 
turbulence of the global economy.
                        noncommercial investors
    The US Commodity Futures Trading Commission defines noncommercial 
or speculative investors as those who are not physically exposed to the 
commodity but trade ``with the objective of achieving profits through 
the successful anticipation of price movements.'' This group of market 
participants includes more than just short-term speculative traders. It 
represents a broad spectrum of investors with different time frames and 
motivations such as mangers of pension funds, university endowments and 
other institutional investors. These investors increasingly view 
commodities and oil in particular as an asset class. They allocate 
investment capital based upon a view of the world's need for oil and 
other commodities. For example, the California Public Employees 
Retirement System (CalPERS), the largest public pension fund in the 
United States, recently increased the amount it could invest in an 
asset class that includes commodities. This move is part of a ``new 
strategy to provide a hedge against inflation while diversifying 
investments, thus mitigating losses during equity market 
downturns.''\2\
---------------------------------------------------------------------------
    \2\ CalPERS February 19, 2008 press release.
---------------------------------------------------------------------------
    Noncommercial investors are an essential part of a futures market. 
In the 1860s Chicago grain traders developed the first futures 
contract: an agreement to buy or sell a commodity at a future date. 
Farmers were able to offload price risk to speculative traders. In 
exchange for providing price certainty to the farmer, the trader had 
the opportunity to turn a profit--or a loss--from future price changes. 
This allocation of risk remains the foundation of today's futures 
markets.
    Noncommercial investors can also provide another attribute of a 
well functioning futures market: liquidity. Liquidity refers to how 
quickly a counterparty can be found for a transaction. The current 
turbulence in credit markets illustrates the dangers that materialize 
when trading in a market becomes illiquid. Uncertainty and fear come to 
the fore, which exacerbates market turmoil. Oil futures markets are 
among the most liquid in the world--and have remained so despite the 
upheaval in credit markets.
    In a sufficiently liquid market, the number and value of trades is 
too large for speculators to unilaterally create and sustain a price 
trend, either up or down. The growing role of non-commercial investors 
can accentuate a given price trend, but the primary reasons for rising 
oil prices in recent years are rooted in the fundamentals of demand and 
supply, geopolitical risks, and rising industry costs. The decline in 
the value of the dollar has also played a role, particularly since the 
credit crisis first erupted last summer, when energy and other 
commodities became caught up in the upheaval in the global economy. To 
be sure, the balance between oil demand and supply is integral to oil 
price formation and will remain so. But ``new fundamentals''--new cost 
structures and global financial dynamics--are behind the momentum that 
pushed oil prices to record highs around $110 a barrel, ahead of the 
previous inflation-adjusted high of $103.59 set in April 1980.
                          new cost structures
    In 2004 the price of oil (in nominal terms) averaged above $40 for 
the first time ever. This was sparked by extraordinary demand growth 
that reflected strong global economic expansion and a temporary surge 
in the use of oil to generate power in China. Further demand growth in 
2005 reduced spare oil production capacity to just 1 million barrels 
per day (mbd)--compared with 4 to 6 mbd in the 1990s. Amid the 
whittling away of spare capacity, political change and security worries 
in several major oil exporting countries fueled anxiety about the 
adequacy of oil supplies. With so little spare capacity, such fears 
drove oil prices higher.
    As oil prices rose, so did demand for the people and equipment 
needed to find, develop and produce oil. But nearly 20 years of low oil 
prices and industry consolidation meant ``a missing generation''--a 
generation that skipped entering the petroleum industry. As a result, 
major shortages of equipment and personnel dramatically raised the cost 
of developing an oil field whether in the Gulf of Mexico, West Africa 
or the Middle East. CERA and IHS have developed a series of indices to 
measure changes in cost--sort of a Consumer Price Index for the energy 
industry. Costs to build power plants and oil refineries have surged 
higher. But the one most relevant to our discussion today is the latest 
IHS/CERA Upstream Capital Cost Index. This index shows a doubling of 
oil field costs over the last three years. In other words, companies 
have to budget twice as much today as they did three years ago. Adding 
to the cost pressure are increasingly heavy fiscal terms on oil 
investments in the form of higher taxes and greater state participation 
in oil projects. The net result is that much higher oil prices are 
needed to support development of new supplies. Some projects that in 
the past needed oil prices of $20 or $30 in order to move forward now 
need price levels that are double that amount--or even higher.
    It can take ten years or more to find, develop and begin production 
from a new oil field, particularly if it is large and complex. Long 
lead times and the severe upturn in costs have led to one of the most 
significant changes in the oil market: a steep increase in long term 
oil price expectations. For nearly two decades, until 2004, 
expectations for long-term oil prices hovered around $18 to $25 per 
barrel. Since 2004 the price of a futures contract to buy or sell crude 
oil five years out has risen steadily. It topped $100 per barrel this 
year. Five years is considered long-term from an oil market perspective 
as opposed to the longer times that can be required to develop a new 
oil field. The sustained breakout of oil prices from a relatively 
narrow historical range along with global financial dynamics has 
fostered greater interest in oil among financial markets.
                       global financial dynamics
    The oil price has long reflected major trends in the economy and 
geopolitics. Rising inflation, a rush to invest in commodities and 
worrisome tension between the United States and Iran drove oil above 
$100 per barrel in real terms in 1980. In 1998 the price of oil 
collapsed largely because of the fallout from the Asian financial 
crisis. Today, two major trends that are reflected in the price of oil 
are the decline of the dollar and the rising economic clout of many 
regions outside the United States.
Oil and the Dollar: The New Gold
    The effect of a declining dollar on the price of oil first became 
prominent in early 2005. The dollar had fallen about 35 percent 
relative to the euro since 2002. OPEC generally imports more from 
Europe than the United States, so a weak dollar damages terms of trade 
from OPEC's perspective. The falling dollar contributed to the lifting 
of OPEC's implicit oil price objective, which altered market 
expectations about price and the balance between demand and supply. The 
price of oil was nearing $50 per barrel--a very high price at the time.
    In the past half year lower interest rates and anticipation of 
further cuts in interest rates pushed the dollar lower. Amid great 
turbulence in credit and other financial markets, the nature of the 
weak dollar's influence on the oil market changed. Oil has become the 
``new gold''--a financial asset in which investors seek refuge as 
inflation rises and the dollar weakens. This may seem counterintuitive 
at a time of weak oil demand in the United States, but today's dynamics 
in the marketplace reveal oil's increasingly cosmopolitan nature. The 
price of oil reflects not only demand and supply, but broader 
macroeconomic and geopolitical changes such as the growing influence of 
Asia, the Middle East, Russia and the Caspian countries.
    Strong economic growth outside the United States has not only 
supported growing oil demand but also propelled rising demand and 
prices for many commodities. In addition to energy, food prices are 
surging around the world. According to the International Monetary Fund. 
global prices for cereals--wheat, rice, corn (maize), and barley--
increased 82 percent from 2000 to 2007. More than half of this increase 
has been in the past two years. Recent data from China show food prices 
pushing overall inflation to 8.7 percent--the highest level in more 
than a decade.
    A key element of the ``oil as the new gold'' story is the 
expectation that demand for oil will continue to grow, and thus be able 
to hold its value despite a weak dollar and rising inflation. To a 
degree, an expectation of a strong oil price is a bet on the future of 
China and India. The United States is the world's largest oil consumer, 
but 75 percent of global demand is outside the United States. For 
example, since the beginning of 2007 eight of the ten largest oil 
markets in the world (excluding the United States and Saudi Arabia, 
whose currency is pegged to the dollar) have seen significant currency 
appreciation ranging from 9 percent (India) to 19 percent (Brazil). 
When a currency appreciates against the dollar, it diminishes the 
impact of an increase in the dollar price of oil in that market. Also, 
regulated prices of gasoline and diesel in some key markets means that 
consumers are not exposed to the full increase in the global market 
price of those products. This places pressure on government and company 
budgets, but if a given country enjoys strong economic growth it can 
withstand, at least for a time, rising oil prices.
                                outlook
    If economic and oil demand growth remain vibrant in large markets 
around the world and the dollar continues to weaken, then financial 
dynamics could continue to drive oil prices higher. But oil's role as a 
financial hedge does not mean that its price will rise continuously. 
Prior to the ascent in recent years, both gold and oil prices had been 
mired in long-term price slump. In the late 1990s, $100 oil--or even 
$80 oil--seemed preposterous. Today, $20 oil seems quaint.
    The political and manpower difficulties currently constraining oil 
supply growth will not disappear overnight. The desire for higher 
living standards in China, India, the Middle East, Russia and elsewhere 
will remain as strong as it was in Europe, Japan and the United States 
in the post World War II years. Higher living standards mean longer 
life expectancy, lower infant mortality--and higher energy consumption.
    But just when the future seems preordained in the oil market, the 
unexpected can unfold. It did in the decade following 1998, just as it 
had several times since 1970. This year will be a stiff test for the 
new oil price era that dawned on the world several years ago. Economic 
growth is the single most important determinant of oil demand growth--
and the course of the global economy in 2008 is fraught with worries.
    Financial innovation and the globalization of securities helped to 
lubricate the wheels of the global economy during an extraordinary 
expansion, but it also created risks that were not--and still are not--
fully understood. The US subprime mortgage meltdown is the most current 
example of misunderstood risk, but is it the last?
    Oil prices can remain high during an economic downturn. In the 
early 1980s, one of the weakest periods of economic growth since the 
depression of the 1930s, oil prices were at very high levels for 
several years. But eventually, the economy and demand catch up: the 
1986 oil price collapse was due to a multiyear decline in oil demand.
    This year, just as economic worries began to mount, oil prices 
touched a new high of about $110 per barrel. Although oil prices are 
only one factor affecting the global economy, they are a significant 
one. Because the world economy took $70 per barrel in stride does not 
mean that it would easily absorb $100. If prices hover in the $90-$100 
plus range for six months or more, then it would be increasingly 
difficult to argue that high oil prices do not have a significant 
impact on economic growth. Moreover, given the growing use of corn-
based ethanol, oil prices are now connected to food prices, which are 
rising. And the increase in food prices is a major source of inflation 
in many emerging markets around the world. Oil prices are fluctuating 
in line with the latest economic signals--up and down. This will 
continue until a clearer view of economic growth materializes. But one 
factor is clear. The price of oil will reflect major swings in the 
value of the dollar--both up and down.

    The Chairman. Thank you very much.
    Mr. Cota.

 STATEMENT OF SEAN COTA, CO-OWNER AND PRESIDENT, COTA & COTA, 
 INC., PRESIDENT, NEW ENGLAND FUEL INSTITUTE, BELLOWS FALLS, VT

    Mr. Cota. Honorable Chairman Bingaman and Ranking Member 
Domenici, distinguished members of the committee, thank you for 
this invitation to testify before you today. As both a 
petroleum marketer and as a representative of two respective 
trade groups that together represent our nation's independent 
motor fuel consumption and heating fuel dealers, I appreciate 
the opportunity brought to provide you with insight on extreme 
volatility and record setting prices seen in the recent months 
on the energy commodity markets.
    I serve as the Petroleum Marketers Association of America's 
executive, on their executive committee. PMAA is a national 
federation of 46 States in regional associations representing 
8,000 independent marketers that collectively account for 
approximately half the gasoline and nearly all of the 
distillate fuel consumed by motor vehicles and heating 
equipment in the United States.
    I'm also President of the New England Fuel Institute, a 60-
year-old trade association representing over 1,000 heating fuel 
dealers in related companies in Northeastern United States. The 
five member companies deliver about 40 percent of the nation's 
home heating oil and many market diesel fuel, bio, heat, 
propane, jet fuel and so on.
    Finally I provide insight as co-owner and President of Cota 
and Cota, Inc. of Bellow Falls, Vermont, a third generation, 
family owned business operating as a heating fuel supplier in 
Southeastern Vermont, Southwestern New Hampshire. My business 
provides home heating fuel to approximately 9,000 homes and 
businesses. Unlike larger energy companies most retail heating 
fuel dealers are small family run businesses.
    Also unlike larger companies, heating oil and propane 
dealers deliver products directly to the doorstep of American 
homes and businesses. Because of this close association with 
our customers we have deep concerns for their well-being and 
the general welfare of our communities. Few recognize the small 
business nature of our industry. We recently have proposed an 
array of measures to policymakers in Washington that can assist 
our industry in assuring adequate supply of home heating fuel 
and insulate the consumer from current volatility in excesses 
that dominate commodities markets.
    First we urge members of this committee and this Congress 
to support our recent and standing request to the Bush 
Administration to release all 1.97 million barrels of the 
Northeast home heating oil reserve. Contrary to statements from 
the Administration the release of this product from this 
reserve may not be tied solely to crude--to heating oil 
differentials for a trigger mechanism. This speculation driven 
vault of futures market with a record price surge as seen in 
recent months perhaps this measure could break the back of some 
of this excess speculation.
    Second we urge Congress and the Administration to implement 
real and substantial reforms to existing law and Federal 
regulation designed to fully insure transparent and accountable 
and stable energy futures markets. For 2 years now the New 
England Fuel Institute and the Petroleum Marketers of America 
and their various allies in the energy market oversight 
commission have asked for such changes and little has been 
done. Consequences of inaction are now apparent and will only 
continue to worsen. For the sake of all Americans and the 
economy at large, you must act now.
    It has become apparent that excess speculation on energy 
trading facilities is driving this crude runaway train with 
prices. One example, on January 3, 2008, one floor trader 
bought 1,000 barrels of crude oil and immediately sold it at a 
loss for about $600. The trader deliberately pushed the price 
of the barrel of crude over $100 just because he wanted to tell 
his grandchildren that he was the first person to ever buy 
crude over $100.
    Commitments in trading like this concerns PMAA and NEFI 
members who argue that recent volatility in crude prices will 
force small business and consumers to pay excessively high 
energy prices that do not reflect supply and demand factors. 
The rise in crude prices in the recent weeks, which has reached 
$110.21 a barrel on March 13, 2008, this is dragged with every 
single refined petroleum product, which is especially heating 
oil. Just over 1 month also heating oil prices from February 
11, 2008, to March 18, 2008, have risen from $2.65 a gallon to 
$3.31 a gallon.
    The price by it comes despite reports by the Energy 
Information Administration, EIA, that heating oil inventories 
remain around 5 year averages. Gasoline inventories have also 
risen dramatically reaching a high of $3.33 per gallon on March 
17, 2008, at nearly two-decade high inventory levels.
    Many heating fuel companies like myself hedge in order to 
protect the consumers against roller coaster volatility. 
However, our ability to manage in these commodity markets in 
order to set price on economic fundamentals has become less and 
less reliable. As a result so do our hedging programs. As the 
influence of price setting functions on unrelated and under 
regulated markets in trading on over the counter and foreign 
based exchanges continues to be the norm, American consumers 
are forced to ride the speculative roller coaster on energy 
prices.
    For far too long insufficient oversight and transparency 
has encouraged excessive speculation. Created a trading 
environment that rewards trading misdeeds like that of the 
Amaranth hedge funds and British petroleum. Loopholes in 
Federal law that have created what I call these dark markets or 
energy markets engaging in futures and futures like contracts, 
swaps, derivative and trades have nearly no oversight and very 
little Federal oversight and regulation. Today I believe the 
vast majority of trading occurs on these unregulated dark 
markets.
    More specifically we urge Congress to take swift action to 
bring light to these dark markets by one, closing the notorious 
Enron loophole ripped open by the Commodities Futures 
Modernization Act, which through its trillions of dollars have 
poured since it was created in 2001. Virtually overnight the 
Enron loophole freed all electronic markets from oversight. 
Congress needs to close this loophole and close it for all 
energy commodities thereby returning the CFTC statutory 
authority that it lost in 2001.
    As an important step in closing this Enron loophole 
Congress must pass the Senate version of the CEA 
Reauthorization Act included as an amendment on the 2007 Farm 
bill, HR 2419, which is currently in conference. This 
legislation will reauthorize the CFTC and bring greater 
transparency and accountability to energy trading facilities 
through an array of important policy reforms. It is stronger 
than the CEA Reauthorization language drafted by the 
Presidential Working Group currently under consideration in the 
House Agriculture Committee. Further the Senate legislation 
also gained bipartisan support from the United States Senators 
Levin, Feinstein, Chambliss, Snowe, Cantwell, Coleman, Conrad, 
Dorgan, Lieberman, Collins, Crapo, Durbin and Schumer.
    Two, investigate CFTC's use of no action letters, which we 
believe equate to a loophole for foreign markets to gamble with 
American energy commodities and American economic interests. 
Under no action letters the CFTC may provide regulatory 
exemptions under certain conditions, which are--to which an 
applicable form board of trade, FBOT, offers contracts for 
delivery within the United States. The current process fails to 
provide sufficient public notice and consultation and may not 
take into full account the impact that these letters have on 
markets.
    Moreover, in order to obtain such exemptions CFTC requires 
that a comparable regulatory authority be present in the 
country, which the exchange operates. Congress should examine 
whether or not Congress determines such regulatory authority be 
comparable. Finally, we are concerned that no action letters 
may be or have been requested by exchanges to establish 
electronic platforms with the intent to circumvent United 
States law.
    Three, reduce the dominance of non-fiscal players in the 
commodity markets. The commodity markets----
    The Chairman. Could you sort of summarize the remaining 
points you have to make, please?
    Mr. Cota. The markets have been taken over by the financial 
community. To reference George Soros from his interview 
yesterday on CNBC, we are in the worst financial crisis that 
this country has experienced since 1930. The crisis is 
exacerbated by the lack of regulation in a variety of 
investments, not the least of which is energy commodities.
    Soros stated further without regulations, markets tend to 
extremes, not equilibrium. Because of this weakness in the 
United States dollar most of the speculative moneys going into 
commodities through dark markets to park cash, which will 
further exacerbate our economic crisis. This is now an economic 
and national security crisis. Thank you, Mr. Chairman.
    [The prepared statement of Mr. Cota follows:]

 Prepared Statement of Sean Cota, Co-Owner and President, Cota & Cota, 
     Inc., President, New England Fuel Institute, Bellows Falls, VT
    Honorable Chairman Bingaman, Ranking Member Domenici and 
distinguished members of the committee, thank you for the invitation to 
testify before you today. As both a petroleum marketer and as a 
representative of two respected trade groups that together represent 
our nation's independent motor vehicle and heating fuel dealers, I 
appreciate the opportunity to provide you with our insight on the 
extreme volatility and record setting prices seen in recent months on 
the energy commodity markets.
    I serve on the Petroleum Marketers Association of America's 
(PMAA)\1\ Executive Committee and serve as PMAA's Brands Director. PMAA 
is a national federation of 46 states and regional associations 
representing over 8,000 independent fuel marketers that collectively 
account for approximately half of the gasoline and nearly all of the 
distillate fuel consumed by motor vehicles and heating equipment in the 
United States.
---------------------------------------------------------------------------
    \1\ Official website www.pmaa.org.
---------------------------------------------------------------------------
    I am also President of the New England Fuel Institute (NEFI)\2\, a 
60-year-old trade association representing well over 1,000 heating fuel 
dealers and related services companies in the Northeastern United 
States. NEFI member companies deliver over 40 percent of the nation's 
home heating oil, and many market biodiesel, bioheat, propane, 
kerosene, jet fuel, off-road diesel and motor vehicle fuels.
---------------------------------------------------------------------------
    \2\ Official website www.nefi.com.
---------------------------------------------------------------------------
    And finally, I provide you insight today as co-owner and President 
of Cota&Cota, Inc. of Bellows Falls, Vermont, a third generation 
family-owned and operated heating fuel provider in southeastern Vermont 
and western New Hampshire. My business provides quality home heating 
fuel to approximately 9,000 homes and businesses. Unlike larger energy 
companies, most retail fuel dealers are small, family-run businesses. 
Also unlike larger energy companies, heating oil and propane dealers 
deliver product directly to the doorstep of American homes and 
businesses.
    Because of this close association with our customers, we have a 
deep concern for their well being and the general welfare of our 
communities. Not only do few recognize the small business nature of our 
retail industry, but few also grasp also our deep commitment to 
providing the highest quality products at the most affordable and 
competitive prices. To this end, we have recently proposed an array of 
measures to policy makers in Washington that can assist our industry in 
ensuring adequate supply of home heating fuel and insulate the consumer 
from the currently volatility and excess that dominate the commodities 
markets.
    First, we urge members of this committee and this Congress to 
support our recent and standing request to the Bush Administration 
release all 1.97 million barrels of the Northeast Home Heating Oil 
Reserves. Contrary to statements from the administration, release of 
product from the reserve need not be tied solely to a crude oil to 
heating oil differential trigger mechanism.\3\ Federal law also permits 
a release from the reserve under discretionary authority provided there 
is a ``regional supply shortage of significant scope and duration.''\4\ 
We are indeed in the midst of such a shortage due to: skyrocketing 
distillate demand overseas; the steepest decline in refinery runs in 
over two years; infrastructure limitations and pipeline partitioning 
due to the current transition to lower sulfur off-road diesel fuel; and 
declining interest by small bulk plants and terminals to take on high 
sulfur distillates such as jet fuel and heating oil due to the 
backwardated market and, as mentioned, the transition to low/ultra-low 
sulfur diesel. All of these factors will only further exacerbate the 
already speculation-driven, volatile futures market and record price 
surges seen in recent months.
---------------------------------------------------------------------------
    \3\ 42 U.S.C. 6250b(a)(1).
    \4\ 42 U.S.C. 6250b(a)(2).
---------------------------------------------------------------------------
    Second, we urge on Congress and the administration to implement 
real and substantial reforms to existing law and federal regulation 
designed to ensure fully transparent, accountable and stable energy 
futures markets. For two years now, the New England Fuel Institute, the 
Petroleum Marketers Association of America, and their various allies in 
the Energy Market Oversight Coalition have asked for such changes and 
little has been done. The consequences of inaction are now apparent and 
will only continue to worsen. For the sake of all Americans and the 
economy at large, you must act.
    It has become apparent that excessive speculation on energy trading 
facilities is the fuel that is driving this runaway train in crude oil 
prices. For example, on January 3, 2008, one floor trader bought 1,000 
barrels; the smallest amount permitted, and sold it immediately for 
$99.40 at a $600 loss. The trader deliberately pushed the price of a 
barrel of crude oil over the $100 just because he wanted to tell his 
grandchildren that he was the first person ever to buy crude oil over 
$100.\5\
---------------------------------------------------------------------------
    \5\ (BBC News, 2008).
---------------------------------------------------------------------------
    In addition, in times of a national crisis, excessive speculation 
can also exacerbate an emergency. An example of this comes from a Wall 
Street Journal article from September 2005, wherein an oil trader 
bragged about his profits following Hurricane Katrina. This futures 
trader bragged that some traders made enough money in one week 
following Katrina that they would not have to work for the rest of the 
year. Comments like these concern PMAA and NEFI members who argue that 
the recent volatility in crude oil prices will force small businesses 
and consumers to pay excessively high energy prices that do not reflect 
supply and demand factors.
    And the rise in crude oil prices in recent weeks which reached 
$110.21 on March 13, 2008 has dragged with it every single refined 
petroleum product, especially heating oil. In just over one month, 
wholesale heating oil prices from February 11, 2008--March 18, 2008 
have risen from $2.65 to $3.31.\6\ The spike comes despite reports by 
the Energy Information Administration (EIA) that heating oil 
inventories remain around the five-year average.\7\ Gasoline prices 
have also risen dramatically reaching as high as $3.33 on March 17, 
2008.
---------------------------------------------------------------------------
    \6\ Energy Information Administration, ``U.S. No. 2 Heating Oil 
Wholesale/Resale Prices,'' February 11-March 17, 2008.
    \7\ The EIA reported that U.S. heating oil inventories were to 
remain within the 5-year average. See Ibid, ``Short Term Energy 
Outlook,'' March 11, 2008.
---------------------------------------------------------------------------
    Many heating fuel companies like mine hedge in an effort to protect 
their customers against roller-coaster-like price volatility on the 
energy commodity markets. Because of our industry's hedging activities, 
we strongly support open, transparent and well-managed exchanges 
subject to the rule of law. In fact, it is essential to businesses like 
mine. My company began offering fixed price programs to our customers 
twenty years ago. We enter into New York Mercantile Exchange (NYMEX) 
based futures contracts with our suppliers, who purchase contracts for 
future delivery and resell these contracts to me for a profit. In this 
way, companies like mine are able to financially hedge heating fuels 
for the benefit of the consumer, and help protect them against 
uncertainty and volatility.
    However, the ability of the commodities markets to set a price 
based on economic fundamentals has become less and less reliable, and 
as a result, so do our hedging programs. As the influence of price-
setting functions on unregulated or under-regulated markets continues 
to grow, and as trading on over-the-counter and foreign-based exchanges 
continues to become the norm, American consumers are forced to ride the 
same speculative roller coaster as the energy trader. For far too long, 
insufficient oversight and transparency has encouraged excessive 
speculation and created a trading environment that rewards trading 
misdeeds, like that of Amaranth Hedge Funds and British Petroleum. 
``Loopholes'' in federal law have created what I call ``dark markets,'' 
or energy commodity markets engaging in futures or futures like 
contracts, swaps and derivatives trades without adequate federal 
oversight and regulation. Today, a vast majority of trading occurs on 
these markets.\8\
---------------------------------------------------------------------------
    \8\ Nearly all experts agree that a majority of trading now occurs 
off of traditional exchanges like the NYMEX, and some estimate that 
number to be 75 percent or more.
---------------------------------------------------------------------------
    More specifically, we strongly urge Congress to take swift action 
to bring light to the ``dark markets'' by:

          1. Closing the notorious ``Enron Loophole,'' ripped open by 
        the Commodity Futures Modernization Act (CFMA)\9\ and through 
        which billions of dollars have poured since it was created in 
        2001. Virtually overnight, the ``Enron Loophole'' freed all 
        electronic markets from oversight. Congress needs to close the 
        loophole, and close it for all energy commodities, thereby 
        returning to the Commodity Futures Trading Commission (CFTC) 
        the statutory authority that it lost in 2001. As an important 
        first step in closing the Enron Loophole, Congress must: Pass 
        the Senate version of the CEA Reauthorization Act, included as 
        an amendment to the 2007 Farm Bill, H.R. 2419 is currently in 
        conference. This legislation will reauthorize the CFTC and 
        bring greater transparency and accountability to energy trading 
        facilities through an array of important policy reforms. It is 
        stronger than the CEA Reauthorization language drafted by the 
        Presidential Working Group and currently under consideration in 
        the House Agriculture Committee. Further, the Senate 
        legislation gained bipartisan support from U.S. Senators Levin 
        (D-MI), Feinstein (D-CA), Chambliss (R-GA), Snowe (R-ME), 
        Cantwell (D-WA), Coleman (R-MN), Conrad (D-ND), Dorgan (D-ND), 
        Lieberman (I-CT), Collins (R-ME), Crapo (R-ID), Durbin (D-IL), 
        and Schumer (D-NY).
---------------------------------------------------------------------------
    \9\ See 7 U.S.C. Sec. 2(h)(3), (g) (2006)
---------------------------------------------------------------------------
          2. Investigating the CFTC's use of ``no-action letters'' 
        which we believe equates to a loophole for foreign markets 
        seeing to gamble with American energy commodities and economic 
        interests. Under the no-action letter process, the CFTC may 
        provide regulatory exemptions under certain conditions to an 
        applicable foreign board of trade (FBOT) offering contracts for 
        delivery within the United States.\10\ The current process may 
        fail to provide sufficient public notice and consultation, and 
        may not take into account the full impact that these letters 
        may have on the market. Moreover, in order to obtain such an 
        exemption, the CFTC requires that a ``comparable'' regulatory 
        authority be present in the country where the exchange 
        operates. Congress should examine whether or not it determines 
        such regulatory authorities to be ``comparable.'' And finally, 
        we are concerned that no-action letters may be or have been 
        requested and approved for exchanges seeking to establish 
        electronic platforms overseas with the intent to circumventing 
        U.S. regulatory authority.
---------------------------------------------------------------------------
    \10\ See 17 CFR 140.99.
---------------------------------------------------------------------------
          3. Reduce the dominance of non-physical players in the 
        commodities markets: The commodity-related futures markets were 
        primarily created to provide industry participants with a tool 
        to manage inventory and future price related risks. However, 
        our industry's management tool has been dominated by investment 
        banks and hedge funds that profit from price volatility. This 
        market domination is an extremely significant contributor to 
        high gasoline, natural gas, diesel and heating oil prices. 
        Virtually every commodity has experienced price volatility, 
        reaching record levels from gold to wheat and it seems that 
        there is no end in sight.
            Hedge funds and investment banks are not driven to provide 
        U.S. citizens the most affordable energy supplies; they are 
        driven to profit from volatility. PMAA and NEFI believe that 
        margin requirements for speculators who do not have the ability 
        to take physical delivery of their product should be 
        dramatically increased. Futures market officials could impose a 
        physical delivery component for traders to qualify for reduced 
        margins. Earlier this week, Congressman John Larson of 
        Connecticut announced legislation that would eliminate the 
        commodities markets as an investment tool and return the market 
        to the physical players and consumers that have lost faith in 
        its ability to reflect hard fundamentals.

    We realize that there are several different policy recommendations 
floating around Capitol Hill from an array of sources, including 
legislators, commission and administration officials, futures trade 
groups and the commodity exchanges themselves. We ask that your 
deliberations take in to account all trading environments and all 
energy commodities, not just the regulation of one commodity at the 
exclusion of all others.
    I thank you again, Mr. Chairman, and to your colleagues for this 
opportunity to share my insight on this issue. I am open to any 
questions that you might have.

    The Chairman. Thank you very much.
    Mr. Eichberger, go right ahead.

   STATEMENT OF JOHN EICHBERGER, VICE PRESIDENT, GOVERNMENT 
    RELATIONS, NATIONAL ASSOCIATION OF CONVENIENCE STORES, 
                         ALEXANDRIA, VA

    Mr. Eichberger. Thank you very much and good morning. I 
think it's fitting that I'm the last witness today because my 
testimony is going to be quite different from what we've heard 
already today. I represent the convenience and petroleum 
retailing industry, which sells about 80 percent of the 
gasoline in the United States. I thank you for the opportunity 
to share that perspective today.
    We've been hearing a lot about crude oil today because 
that's the topic of the hearing. But I think Senator Barrasso 
commented earlier that that's not really what your constituents 
are talking about around the water cooler. They're not talking 
about the $4 increase yesterday in the crude oil price.
    But they probably are talking about the price of retail 
gasoline in their neighborhood. That's what I'm here to talk 
about. Hopefully give a little bit of understanding of what 
happened to the market.
    The retail petroleum marketplace is the most transparent, 
competitive market in the nation. For no other product can your 
constituents drive down the road, shopping for the best price 
at 45 miles per hour. Our members have put their price on big 
billboards on the side of the road to empower consumers to find 
the best deal as easy as possible. Competition is thriving.
    To me, this is a predominantly small business, 
entrepreneurial industry. There are more than 115,000 
convenience stores selling gasoline. Nearly 60 percent of those 
are owned by companies that operate just one store. Despite 
common misconceptions integrated oil companies and refining 
companies only own and operate less than 5 percent of retail 
outlets. This number is actually declining.
    Convenience stores rely upon their daily operations to 
generate revenue. This is getting increasingly difficult. In 
2006, the average convenience store made only about $33,000 in 
profit. Motor fuel sales represented two-thirds of gross 
revenues, but only contributed to less than one-third to the 
bottom line.
    Retailers make their money by selling in store products 
like coffee and sandwiches. Gasoline is predominately used to 
draw customers to the store. This makes it critical that fuel 
prices are as competitive as possible.
    The competition for the consumer is extremely fierce. 73 
percent of consumers say that price is the most important 
factor when choosing a gasoline retailer. They are so focused 
on price that 29 percent of them say that they would drive 10 
minutes out of the way to save as little as three cents per 
gallon. If you would run the numbers you'd see that they'd 
actually lose money on this transaction. Yet it is exactly this 
type of behavior that has created a situation in which 
profitability at the pump has reached its lowest level in 
history.
    According to oil price information service in 2006 the 
annual average national retail price for gasoline has increased 
53 cents from 2006, has increased 53 cents to about $3.09 so 
far this year. Meanwhile gross retail margins have dropped 
nearly half a cent to 13.4 cents per gallon. This 13 and a half 
cents must cover operating costs, like labor, rent and most 
importantly credit card fees.
    You may not realize it at $3.09 every time you swipe your 
card at the dispenser the bank takes 7.7 cents from the 
retailer leaving him with 5.7 cents to cover all of his other 
expenses. Today the banks are making more on gas than the 
retailers selling the product. This is putting tremendous 
pressure on the market.
    Crude oil, as we know, is the most significant component of 
the retail price of gasoline. According to EIA in February 
crude oil was responsible for 69.7 percent of the retail price 
of gasoline. This is a sharp departure from historic norms. 
Between 2000 and 2005, crude oil averaged only 45.3 percent of 
the retail price. The increase in crude oil price has driven 
the wholesale price of gasoline and put retailers in a very 
precarious economic situation.
    The price for an 8,000 gallon delivery has gone up more 
than $4,000 in the last 2 years. Yet the average margin for 
that delivery has actually gone down. Many retailers have been 
forced to extend their credit lines while their creditors have 
tightened lending terms to protect the liquidity of their 
business. This situation is increasing costs incurred by the 
retailer, forcing them to suspend investments necessary to 
improve its operations and could ultimately jeopardize its 
ability to obtain future delivery of motor fuel.
    Clearly the impact of crude oil is being felt throughout 
the economy, nationally and internationally. In January, 45 
percent of consumers reported that gasoline prices already 
affected their spending behavior. Retailers are increasingly 
concerned of the growing liquidity problems they're facing as 
they attempt to pass through higher cost of fuel. Even some 
refiners are struggling to accommodate the higher cost of crude 
oil.
    Congress has a responsibility to monitor the markets to 
protect against inappropriate behavior and this hearing is one 
of those opportunities. However, I would like to advise caution 
as you move forward. The motor fuels market is critical to the 
economic welfare of the United States. Any legislative or 
regulatory actions that could disrupt the market, reduce 
supplies or cause unnecessary cost to the system should be 
avoided whenever possible.
    I urge Congress to work with the affected stakeholders to 
identify challenges and develop solutions that benefit the 
long-term interest of the motor fuel market. Thank you for the 
opportunity. I look forward to your questions.
    [The prepared statement of Mr. Eichberger follows:]

   Prepared Statement of John Eichberger, Vice President, Government 
 Relations, National Association of Convenience Stores, Alexandria, VA
    Chairman Bingaman, Senator Domenici, Members of the Committee. My 
name is John Eichberger and I am vice president of government relations 
for the National Association ofConvenience Stores (NACS). Thank you for 
the opportunity to share with you today the effects of high crude oil 
and motor fuel prices on the retail marketplace.
    NACS is an international trade association comprised of more than 
2,200 retail member companies. The convenience and petroleum retailing 
industry in 2006\1\ generated $569.4 billion in sales and sold more 
than 80 percent of the gasoline in the United States.
---------------------------------------------------------------------------
    \1\ Data for 2007 is not yet available.
---------------------------------------------------------------------------
    This hearing focuses primarily on the factors influencing the price 
of oil. While this is a very important topic and one with serious 
implications for the economy in general and investors in particular, it 
does not necessarily resonate with your typical constituent. However, 
the downstream effects of crude oil prices, in particular the retail 
price of gasoline, do have a profound impact on these individuals. It 
is this level of trade that I will address today.
    First, let me point out for the Committee that the retail petroleum 
marketplace is the most transparent and competitive market in the 
nation. For no other product can consumerscomparison shop for the best 
value while driving down the road at 45 miles per hour. Retailers 
advertise their motor fuels prices on billboards along the side of the 
road, empoweringconsumers to wield an amazing influence over prices in 
a competitive market. Yet, it is at the same time a market about which 
there is much confusion.
                         the retail marketplace
    Before we can begin to assess the impact of crude oil prices on the 
retail marketplace, it is essential to have a basic understanding about 
the composition of that market. Withoutspending too much time on the 
topic, below is a snapshot of who controls the retail marketplace:
      
    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
    
      
    The convenience and petroleum retailing industry is dominated by 
small, independent companies. These companies rely on their daily 
retail sales to generate sufficient revenues tocover their operations 
and provide a modest profit, a point reinforced by an April 1, 2008, 
Associated Press story that appeared in dozens of newspapers and media 
outlets this week. Just as they do not benefit from the corporate 
revenues generated by the corporations which provide drink and snack 
items sold inside the store, retailers do not benefit from the revenues 
generated by their petroleum suppliers. In fact, the typical 
convenience retailer in 2006 reported a pre-taxprofit of only $33,360.
                        competition drives price
    Although motor fuels are a major source of revenues, representing 
about three-quarters of a store's overall sales, they contributed only 
about one-third to gross profits in 2006. By contrast, in-store items 
were about two-thirds of overall gross profits but represented only 
about one-fourthof overall sales. Consequently, it has become essential 
for retailers to price motor fuels at a level that is sufficiently 
competitive in the market to generate enough customer traffic 
togenerate sales inside the store. Meanwhile, competition for the 
consumer has become even more intense as retail prices have escalated.
    In February 2008, NACS released its 2008 Consumer Fuels Report 
which reported information obtained through interviews with more than 
1,200 nationwide consumers conductedbetween December 2007 and January 
2008. We sought a better understanding of consumers' behavior with 
regards to the retail marketplace. What we learned helps explain why 
retailers areunable to generate significant profits at the dispenser:

   73% of consumers report that price is the most important 
        factor when choosing a retailer from whom to purchase gasoline
   45% say that high gas prices have had a ``very significant'' 
        effect on their spending behavior
   29% say they will drive 10 minutes out of their way to save 
        3 cents per gallon

    The bottom line is consumers feel the pressure of higher gasoline 
prices; they are shopping for the best-priced gasoline; and they will 
go out of their way to save as little as a fewcents per gallon. In 
addition, the competitive market has become even more so with the 
popularity of gasoline pricing websites which enable consumers to plan 
their routes to take advantage of lower prices. Retailers understand 
these dynamics and are aggressive about pricing motor fuel to maximize 
their customer volume and their in-store sales potential.
         higher retail costs do not mean higher retail profits
    While retailers set their prices to remain competitive in the 
marketplace, their profitability at the pump is determined by their 
costs, which have been increasing substantially inrecent years. 
According to the Oil Price Information Service (OPIS) weekly report, 
Retail Fuel Watch, the average national retail price for regular 
unleaded gasoline has increased 53 cents per gallon from the average of 
2006 to the most recent week reported. Meanwhile, retail gross margins 
(the difference between retail price and wholesale cost) have declined 
0.4 cents.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    It is important to remember when considering profitability in the 
petroleum industry, one must not take a snapshot approach. At any given 
time throughout the year, a retailer may be losing money per gallon 
sold or may be making more than the averages demonstrated above. 
However, only by analyzing a complete market cycle can one obtain a 
clear understanding of aretailer's potential profitability.
    There was a time when retailers would receive notification of price 
changes once a day. The price set in the morning was often sufficient 
to cover operations for the entire day. Morerecently, however, due to 
the dynamic nature of the market and the advent of technology, 
wholesale prices fluctuate several times throughout the day. Given the 
slim operating margins onwhich retailers operate, they must ensure that 
the gallons they sell will generate sufficient revenues to purchase the 
replacement gallons at the new wholesale price. In a perfect world, if 
they learn their next load will cost an additional 10 cents per gallon, 
they would increase their retail prices 10 cents to cover the next 
shipment. Unfortunately, their competitors may not be incurring the 
same increase in costs and may not enable the retailer to increase 
prices to that extent, at least not immediately. According to the U.S. 
Energy Information Administration, the statistical arm of the U.S. 
Department of Energy, it may take several weeks before a change in the 
wholesale price of gasoline may be fully reflected in the retail price. 
(Source: U.S. Energy Information Administration, ``Gasoline Price Pass-
through,'' January 2003).
    Because of the market delay in passing through wholesale price 
changes, during periods of escalating wholesale prices, retailers 
typically experience a decline in gross margins.However, the opposite 
is true when wholesale prices decline-retailers seek to completely pass 
through costs previously incurred and to recover their lost margins by 
holding retail prices steady for as long as competition may allow. But 
at some point, one retailer in a market will begin to drop prices in 
search of additional customer volume, and others will follow suit to 
avoid losing in-store sales. This is why it is necessary to look at a 
retailer's operation from the perspective ofa complete market cycle, 
the duration of which can vary greatly.
    A significant cost not represented in the OPIS report of average 
gross margins is credit card fees. Whenever a consumer uses a credit 
card to purchase any product or service, the banksthat issue the card 
and that process the transaction collect a set of fees. For petroleum 
retailers, this typically equates to about 2.5 percent. As gasoline 
prices have gone up, so have the fees associated with these 
transactions. Over the time period represented above when gasoline 
prices increased from $2.56 to $3.09, credit card fees increased from 
an average of 6.4 cents to 7.7 cents per gallon. While this increase 
may not seem significant, to the retailer this automatically reduces 
potential profitability. Subtracting credit card fees from the OPIS 
reported margins during that time period, retail profitability declined 
from 7.4 cents per gallon to 5.7 cents. Credit card companies and their 
banks now make more per gallon sold than does the retailer. In fact, 
the convenience and petroleum retailing industry paid $6.6 billion in 
fees in 2006 while generating only $4.8 billion in pre-tax profit.
    Compounding the impact of credit card fees is the fact that 
consumers are increasingly turning to this form of payment as prices 
increase, for a variety of potential reasons. The typicalconsumer does 
not often carry sufficient cash to pay for a $50 gasoline fill-up, 
consequently plastic payment has become the default currency for many. 
For others, their household budgetsmay not have sufficient cash flow to 
cover increasing fuel expenses, leaving credit as their best option to 
finance purchases.
                    crude oil drives wholesale costs
    The price of crude oil is a significant factor in the retail price 
of gasoline. Each month, the U.S. Energy Information Administration 
reports the breakdown of retail gasoline prices into four sectors: 
crude oil, taxes, refining, and distribution/marketing. This last 
category includes all the factors that are incurred after the product 
leaves the refinery, including pipelines, terminals, distribution and 
retail. The latest data available is for February 2008 and indicates 
that crude oil at the time contributed 69.7% to the retail price of 
gasoline. This is a sharp departure from historic norms. Crude oil's 
average contribution from 2000 through 2005 was only 45.3%. Meanwhile, 
the relative contribution of the other components has declined:

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                   retailers struggle with liquidity
    The overall impact on retailers of higher crude oil prices, and the 
resulting increase in wholesale and retail gasoline prices, is 
profound. Not only have consumers become more pricesensitive resulting 
in lower margins, but the overall economics of retail operations have 
become more challenging. As margins have remained static on a cents-
per-gallon basis over the past few years, inventory costs have not.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    The combination of increased inventory costs with declining 
profitability has created a potential liquidity crisis for retailers. 
Retailers now must pay more for the inventory they sell, reducing cash 
flow and increasing liabilities. Compounding this increase in costs, 
many retailers incur additional fuel surcharges for each delivery as 
their distributors seek to cover the increased expense of the fuel 
required to power their trucks. (Similar surcharges also apply to the 
delivery of in-store items.) This has greatly reduced the ability of 
cash flow from fuel sales to purchase replacement gallons.
    Consequently, many retailers are forced to extend their lines of 
credit to keep fuel in their tanks. This has brought with it additional 
costs. In addition, terms extended to retailers may have historically 
required payment within 10 days. Now that creditors are seeking to 
ensure their own liquidity, these terms may have been reduced to 7 days 
or even fewer. Many of these creditors are actually wholesale 
distributors servicing multiple retailers and they are running into 
their own credit limits in their efforts to keep their customers 
supplied with fuel. As more inventory is purchased on credit, the 
additional payments of interest have further reduced cash flow.
    After months of operating on credit, while wholesale costs have 
continued to increase and gross margins have remained stagnant or 
declined, many retailers are approaching the limit of their available 
credit. This forces companies to delay or suspend investments in their 
operations and, in the most dire circumstances, threatens their ability 
to keep fuel in their tanks.
                               conclusion
    It is clear that the price of crude oil has a profound impact on 
the domestic motor fuels market, and in particular its retailers and 
their customers. With higher prices, motor fuelsretailers regularly see 
that increased price volatility reduces already slim margins. In the 
last few years retailers have continued to see both gross and net 
margins decrease to the level where they are at historic lows on a 
percentage basis and the lowest since the the early 1980s on a cents-
per-gallonbasis. Quite simply, motor fuels retailers cannot survive on 
fuels sales alone and have to either reinvent themselves to expand 
their in-store offers or sell what is often a multi-generation, long-
term community-based business.
    While motor fuels retailers are as frustrated by the current state 
of the industry as consumer and policy-makers, I would caution the 
Senate to proceed carefully when consideringpolicy options. The motor 
fuels market is critical to the economic welfare of the United States 
and any legislative or regulatory actions that could disrupt this 
market, reduce supplies, or cause unnecessary costs to the system, and 
ultimately consumer, should be avoided whenever possible. I urge 
Congress to work with motor fuels retailers and other affected groups 
to come to a solution that addresses the dynamics of the marketplace 
and affects long-term change.
    Thank you for the opportunity to share the perspective of the 
nation's convenience and petroleum retailing industry on the impact of 
crude oil prices on the retail motor fuels market. Iwelcome your 
comments and input at this hearing and in the future on how we can help 
create a system that addresses our nation's motor fuels challenges and 
can affect permanent change to a system that frustrates both consumers 
and retailers alike.

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
    

    The Chairman. Thank you all very much. I think it's 
excellent testimony. Let me start questioning.
    Mr. Burkhard, let me ask you about your comment, oil is the 
new gold. That raises some concerns on my part. I think for a 
long time people have seen gold as something to invest in order 
to essentially hedge against what is happening in other 
financial markets. It's a way to hedge against the decline of 
the value of the dollar.
    I think we've seen what's happened to the price of oil, of 
gold. As more and more people have gone into that market and 
bought gold or bought gold futures, or whatever it is they're 
buying. That's something which doesn't affect the daily lives 
of most people.
    It doesn't affect the folks Mr. Eichberger was talking 
about, primarily in the sense that I don't need to go buy gold 
everyday to get to work. But in the case of oil, I do have to 
go buy gasoline refined from that oil to get to work. If we 
have the same thing happening with oil where it is become a 
refuge.
    I think you referred to it as people investing in oil 
seeking a refuge from the decline of the value of the dollar. 
If that is having the effect of driving up the price of oil and 
thereby impacted what I have to pay in order to get gas to come 
to work, isn't that something we ought to try to confront and 
deal with in the financial market some way or other, to try to 
discourage the investment in oil strictly as a refuge against 
volatility elsewhere?
    Mr. Burkhard. I don't know if it should be discouraged or 
encouraged. But what's happening is the impact of the dollar is 
simply a reflection of broader macroeconomic trends that are 
underway. The large forces that have been putting downward 
pressure on the price of oil are really at the roots of oil 
being viewed as a hedge against inflation.
    Oil has a different supply and demand dynamics relative to 
gold, but because of those dynamics it has placed it in a 
position where it can act as a hedge against inflation.
    The Chairman. My understanding is the value of the dollar 
is declining because of our budget deficit, because of our 
trade deficit, because of a whole bunch of factors. But I 
understood your testimony to be that the decline of the value 
of the dollar is driving up the price of oil.
    Mr. Burkhard. That has been one of the factors that has 
contributed to it. Yes.
    The Chairman. Therefore we got more and more people just 
investing in oil in order to find that refuge against declining 
value in other assets, in this case, the dollar.
    Ms. Emerson, you referred, I think, in your testimony to 
the fact that the physical market does not in any way 
discourage investment in oil. Should we be doing something? 
Senator Dorgan in his early comments talked about the margin 
requirements if you want to go in and buy oil.
    Is there anything that should be done in a regulatory way 
or legislative way to discourage oil from being invested in by 
folks who have no earthly need to be buying oil?
    Ms. Emerson. There's no quick fix. There's no easy tool for 
doing that. I would actually agree that the margin requirements 
should be raised.
    The Chairman. But should they just be raised for oil. I 
mean, I don't feel a burning desire to raise the margin 
requirements if someone wants to go out and speculate on gold.
    Ms. Emerson. Yes, I don't think I can speak to the entire 
range of commodities. But in the case of oil, I do think it 
seems to be that the ratio between how much money you have at 
stake and how much you can make is striking. So I think that 
would be one step to take.
    The Chairman. So you think having a different margin 
requirement for oil would make sense, a difference than the 
margin requirement for something like gold.
    Ms. Emerson. Again, I only feel I can speak thoughtfully to 
the oil situation. I do think that the margin requirements are 
a little--I do think that's one tool that the Congress has. But 
I--or legislation would result in.
    There really aren't any other easy fixes. I mean, say, 
drawing down the SPR, which I wouldn't necessarily recommend.
    The Chairman. Mr. Book, did you have any comment on any of 
this?
    Mr. Book. I think that that's a--I don't entirely disagree 
or agree. I think that the margin requirement, it's an 
experiment that deserves a lot of thought. Senator Dorgan 
mentioned that there was 20 days of money chasing each day of 
oil or something like that. I think it may have hit 280 
billion, be closer to 30.
    The question is whether or not the market requires 30 days 
of money chases each day of oil in order for it to keep that 
market well supplied. I'm not sure that we know that. There may 
be an optimal size. Margin requirements are the way to start 
that experiment and that's reasonable.
    The Chairman. Senator Domenici.
    Senator Domenici. Thank you very much, Senator Bingaman. 
Let me just say to all of you, in particular to you, Mr. 
Harris, as you represent a larger group within your umbrella 
organization. I hope the American people understand what you 
said and what has been said here today about how much is being 
invested for oil by people that are not going to use the 
product.
    Investors are not buying a tanker full of oil--they're 
buying instruments of credit and instruments of purchase and 
sale and the like. If the people understood that, I guarantee 
you that they would insist that we find out, absolutely, 
whether that's impacting on the price of oil. I don't believe 
they would sit for a minute as a group, the American people, 
and let the price of oil rise as high as it is if a large 
percentage of that increase is being driven by speculators who 
are not going to use the product. That's the people you 
regulate. Speculators, right?
    They're good for America. But for me, after today's 
testimony, I'm seriously wondering how much we have made by way 
of mistakes in not further regulating--at least for the 
American investment--how people could invest in oil that they 
were not going to use themselves. The more I hear, the more I 
get concerned.
    Please understand all of you at the table, I have heard 
five or six major and minor reasons that represent traditional 
factors for high prices. I believe every single one of them. 
But I somehow believe that maybe there is something else when 
it comes to the American investor who might be driving this 
market up because of pure speculation. This is a very rich and 
ripe market.
    I want to also tell you that some of you know I work 
diligently around here. Some of you think I know an awful lot 
about what I'm doing. I knew how to proceed when we put the 
Energy bill together, but I'm telling you I'm learning this 
one. So don't think I know as much as I knew about the bill we 
put together for the United States on energy three years ago. 
This is a very confusing subject that seems to confuse 
everybody.
    I don't think, Mr. Chairman, that just because this is 
difficult and confusing that we ought to let it go. Some of you 
testified that speculators are not playing that much of a role. 
Things may be going alright at some of your firms, but I'm not 
sure of that, and I'm not sure they're alright for everyone 
else.
    Let me just ask, just to have a little bit of dialog with 
you. Mr. Cota, I believe you recommended the legislation that 
Congressman Larson of Connecticut introduced, which would 
eliminate non- commercial investors in the commodities market. 
You said that you recommended that approach. I don't assume 
anything has happened to that bill, has it?
    Mr. Cota. It's currently just being introduced right now. 
Nothing has happened at this point.
    Senator Domenici. Ok. May I ask, Mr. Harris, do you support 
that kind of legislation?
    Mr. Harris. I would focus on the fact that speculators are 
intimately related to hedging in these markets. I think futures 
markets in particular. You speak to the fact that nobody buys 
or sells oil, but futures markets in particular is set up to 
discover prices and to transfer risk. To the extent that we 
eliminate an entire group of traders from the market, I think 
that would be detrimental to both of those functions of the 
market.
    Senator Domenici. This would eliminate non-commercial 
investors in the commodities market, the whole commodities 
market. Your response is that you don't know what would happen. 
But what do you think may happen? Can you tell me why you 
oppose it? What do you think is going to happen?
    Mr. Harris. We're not in the business of prognosticating, 
but I believe, I guess, my statement was that we if we remove 
an entire group of traders from the market that take on risks 
that other people don't want that that diminishes or eliminates 
the entire need for a market. In particular it's futures 
markets are there to hedge risks and transfer risk from one 
party to another. I think part of my testimony is showing that 
the longer term futures contracts in crude oil in particular, 
signify that people are worried about future prices of oil and 
speculators and hedgers alike are transacting at longer and 
longer horizons to try and hedge against those price changes.
    Senator Domenici. See, I don't know what that means. You're 
giving me an answer that I don't understand. Explain that to me 
in ordinary language.
    Mr. Harris. Somebody who wants to buy oil for instance, 
they have to contract it. It's not like stopping at the gas 
station. You can't just get 4,000, four million gallons of oil 
delivered today. So the futures markets operate in projecting 
out future needs of purchases of oil.
    One of the risks of future needs is that if you need oil 
next September, you could wait until next September or next 
August and purchase that oil. The risk that you take in that 
chance is that oil between now and August goes up in price. So 
in this regard you might come to the futures market to lock in 
the price to buy the oil in September.
    So you can transfer the risk from your balance sheet or 
your books right now to some other counter party who's willing 
to take the risk that oil prices might go up between now and 
August in our markets. If you eliminate the counter party that 
is willing to take that risk it puts me, again, at more risk as 
a producer, as a manufacturer or as a convenience store 
operator that I don't know on any one day what I'm going to get 
for the price. I can't lock in a price in the futures market.
    Senator Domenici. Ok. So that overall set of transactions 
has some benefit, in your opinion, in terms of investors and 
the financing of crude oil from the supplier to the ultimate 
user. Is that right?
    Mr. Harris. Yes.
    Senator Domenici. Alright. Ms. Emerson, I appreciated your 
testimony very much. I understand how hard you have worked on 
trying to answer some of these questions that seem to you to be 
intractable.
    But you have a chart in your testimony which I think at 
least puts you on record as giving your best estimates. You've 
got one chart that shows the factors lifting oil prices. I wish 
you would have had it blown up so everybody could see. But 
maybe we'll just talk about it. Based on that chart and the 
rest of your testimony, can you tell me how much speculation 
contributes to an $83 barrel of oil?
    Ms. Emerson. This, as you can see, because this chart is 
only $90 or $85. It was made well before the recent run up in 
prices.
    Senator Domenici. Yes. I guessed $83, but how much would 
speculation contribute to $85 oil?
    Ms. Emerson. You know I'm reluctant to put a specific 
dollar sign on that because I think what----
    Senator Domenici. What percent is it?
    Ms. Emerson. I don't think you can even put a percent. I 
don't think that moves the dialog forward, trying to identify a 
specific dollar amount for speculation. I think it's, you know, 
it's--can we say today's price is $85 fundamental and $20 
speculation. I think that kind of layer cake analysis it's not 
really useful to us because----
    Senator Domenici. Ok, now let me tell you, ma'am, and 
excuse me. I'm not interested in a view of the layer cake 
impact. I'm interested in how we can understand the problem. 
Now if you don't have that box in there at all in your analysis 
then I would say let's button up the hearing. It's one thing if 
an expert says there is nothing, no speculation involved. But 
you say there is some.
    Ms. Emerson. Ok.
    Senator Domenici. You understand?
    Ms. Emerson. Yes.
    Senator Domenici. I'd just like to know what percent you 
think it is because it's rather significant if you look at your 
chart A. I'm not able to put on exact percent on the 
``speculation'' box--is it about ten percent?
    Ms. Emerson. Let me define speculation and then I'll give 
you that number.
    Senator Domenici. Ok.
    Ms. Emerson. Speculation, and I think I want to make a 
distinction between investment and the casino example used 
earlier. Speculation, and I think part of the reason of the 
hearing is in part the purchasing of oil by institutional 
investors. I think Mr. Book here mentioned the California 
pension fund purchasing oil.
    To me this is buying an asset to hold like you would buy an 
equity to hold. They're buying that for their members of their 
pension plan to hold value. That's one kind of speculation. 
Then on top of that, of course, there is some day-to-day 
trading that is perhaps a little bit more short term. Not 
necessarily where you're buying the oil to hold it as an 
investment in your portfolio.
    If I were to add the two of those together to get back to 
your question, you know, and I had to give you, and this is a 
gut call. If I had to say, I'd say the fundamental price is 
probably somewhere in the 1980s or 1990 or 1995 at the most. 
Probably there is some additional strength in the price as a 
result of not just sort of the gamblers in the casino, but in 
terms of actual institutional investors who see this as a way 
to hold value when they can't hold value necessarily in the 
equity markets or they want to diversify their portfolio.
    Senator Domenici. I understand your statement. Your 
explanation to us now makes sense to me. I just think 
eventually in my own analysis I have to go back beyond this and 
see if I could organize in my thoughts what would be the case 
if we did not permit oil to be speculated upon in any way, even 
the decent way that you mentioned.
    If we, from the beginning, had said that isn't going to be 
around, I believe there still would have been plenty of capital 
for oil. I believe people would have invested in it. But they 
would have been closer to the ultimate user than to the faraway 
investor.
    I can't do that yet, but I can have somebody look at it for 
me. I thank you very much. Thank you, Mr. Chairman.
    The Chairman. Thank you.
    Senator Dorgan.
    Senator Dorgan. Mr. Chairman, thank you. Let me make a 
couple of comments and then ask a couple of questions.
    I want to hold up the quote from Mr. Gage who has testified 
before this committee. This is November 6. I think the price of 
oil was around $85 then.
    But here's what he said. He's one of the top analysts with 
Oppenheimer. He said there's no shortage of oil. I'm convinced 
that oil prices shouldn't be a dime above $55 a barrel. Oil 
speculators including the largest financial institutions in the 
world, I call it the world's largest gambling hall that's open 
24/7. Totally unregulated, like a highway with no cops and no 
speed limit.
    You know, I don't know. Thank you. I don't know what all 
the facts are. I don't disagree with what's been said. I think 
the value of the dollar has an impact.
    I mean you'd have to be drunk not to understand when you 
run $800 billion yearly trade deficits you're not going to have 
some effect on the value of the dollar. I mean, you know, 
everybody understands that's coming at some point. So, I 
understand all of this has an impact.
    I also think there's a fairly substantial amount of 
evidence that there's too much speculation. We had EIA, Mr. 
Caruso say it was about 10 percent of the price. I don't know 
what it is. He thinks, Mr. Gage thinks it's about $30 a barrel. 
Mr. Harris, you don't think it's very much.
    Now Mr. Harris, I want to tell you. I mean I've read about 
the speculative bubbles. This is not quite that. I mean I know 
that they used to sell tulip bulbs during tulip mania for 
$25,000 a tulip bulb. Sounds a little nuts four centuries 
later, doesn't it? But it happens. You have speculative binges.
    I think there's some speculation going on here. We do have 
as was referenced by a question a moment ago, we have people 
involved and interests involved now. They are buying oil they 
will never get from interest that have never had it all to 
provide liquidity.
    I'm all for liquidity. Every market needs liquidity. I 
think we're way beyond liquidity here. I understand that, you 
know, we put on blue suits and then we come and describe what's 
happening. But we really don't know what's happening except 
drivers know. Truckers know. Airlines that close their doors 
know.
    We need to think about, as best we can, what kind of a 
normal market mechanism should exist and how would it work? I'm 
involved with Carl Levin to try to close the Enron loophole 
with some of my colleagues. It's an unbelievable loophole.
    Mr. Harris, my understanding is that your staffing at the 
CFTC at a time when we need referees is somewhere near a 33-
year low and that third of a century, you're at the low point. 
At a third of a century when we've got these run up and these 
dramatic markets and you're supposed to be the referee. My 
understanding also is that you come and testify to us based on 
what you know not on what you can't know because a substantial 
amount of that, I call it dark money, a substantial amount of 
that dark money is elsewhere. You can't see it and you don't 
know it.
    It's why, for example, a 32-year-old trader with a hedge 
fund named Amaranth, as you know, held huge sway over the price 
this country paid for natural gas not so long ago. It 
controlled, I think, 70 percent of the natural gas commodities 
of this country. You all, the CFTC, finally said, that you 
can't do that, you've got to stop. Finally you said that. They 
he just went to the intercontinental exchanges. Then you 
couldn't see him. He continued to do it anyway.
    So, you tell us what you know today. I appreciate your 
being here. But you can't tell us what you don't know. There's 
a lot that's dark for you.
    So, and Mr. Book, you either have bad judgment or bad 
vision suggesting your performing in front of Elvis here. I 
mean does anybody here look like Elvis to you?
    [Laughter.]
    Senator Dorgan. But I appreciated the comment of coming to 
the Congress, but this is not an Elvis committee. Let me ask--
--
    The Chairman. I think all of us take exception to that 
comment.
    [Laughter.]
    Senator Dorgan. When you said it I immediately leaned over 
to the chairman. I said, it's unbelievable he would refer to 
the chairman and the vice chairman as Elvis, but at any rate, 
we're pleased that you're here.
    Mr. Book. I think highly of Elvis, sir.
    [Laughter.]
    Mr. Book. You.
    [Laughter.]
    Senator Dorgan. Let me ask about this issue of margin 
requirements. It is so interesting to me that if you want to go 
in the stock market and buy a margin you pay about a 50 percent 
margin, I think. If you want to go control some oil or natural 
gas at the moment, you pay 5 to 7 percent. So you can control a 
substantial amount of the commodity with a very small 
investment.
    Does anybody here think that that ought to be changed? Mr. 
Cota?
    Mr. Cota. Yes, Senator. The amount of leverage that you get 
in these markets is just tremendous. You're doing ten times the 
amount of leverage trading by having a low margin requirement 
in commodities. It should be the same as all other equities 
because we become an investment tool. It's no longer about the 
base commodity.
    To answer Senator Domenici's question from earlier about 
how much we're paying to excess speculation. I think it's a 
minimum of a dollar a gallon. You know that's very significant.
    As to your point, Senator Dorgan, which is completely 
accurate, nobody can prove that because there's no data. The 
Amaranth's study was done by the Senate Investigations 
Committee was as close as we got. They had a figure of about 20 
percent minimum. That was back when crude oil was trading about 
$50 a barrel. So we're way beyond that.
    Senator Dorgan. It took them well over a year to do that 
study. It took them subpoena power. It was something that 
couldn't have come from our regulators, which I think, 
describes this deep hole that exists where dark money moves 
around. Without transparency. I think the market is not working 
properly.
    Now I don't want oil to go back to $10 because I think what 
happens is you dry up all investment for development here at 
home. But neither do I want it to go to $110 because investment 
banks and hedge funds, who never want, in most cases, don't 
want to take possession of oil ever, just want to effectively 
gamble in the marketplace. So the victim here is the consumer 
and the country.
    I mean it's not insignificant that two airlines have closed 
their doors in the last couple days. It's not significant that 
was on the news last night, the truckers said, you know, we 
can't continue doing this. So I want the price to be 
reasonable.
    I do think, however, this hearing that the chairman has 
called, and I appreciate it, is about the issue of speculation. 
Is there something happening in the marketplace that we don't 
quite understand that you can trace to speculation? The EIA 
says yes, but it's only about 10 percent. Others say it's much 
more. But it has a profound impact and will continue to have a 
profound impact on this country.
    There are certainly other things we have to do. We're going 
to borrow $800 billion in fiscal policy this year. I know they 
say that the Federal budget deficit is going to be 400. It's 
not.
    We're going to borrow $800 billion in fiscal policy. We're 
going to borrow $800 billion in trade policy. That's $1.6 
trillion against this economy in 1 year. That's unsustainable.
    So I know there are all kinds of other issues. But the 
price of oil has a profound impact on virtually everything else 
as well. I think there's a substantial portion of that that has 
no relationship to supply and demand.
    Mr. Harris, do you agree with my analysis that at a 
critical time when we need a referee, you can't see a lot of 
what you should be able to see and your staffing is at a 33-
year low?
    Mr. Harris. I think it's a fairly well known fact that 
we're at historically low staffing. It's a fairly well known 
fact that we're at historically high volumes in every commodity 
asset to monitor. So I would be supportive of, I guess, the 
reauthorization of our, that's pending now in front of 
Congress. That would be a positive development from our 
standpoint.
    Senator Dorgan. The issue that you can't see a lot of what 
you need to see in order to really understand all of the 
markets?
    Mr. Harris. I think one of the things I wanted to bring 
forth on my testimony today is that we--in these markets we 
actually do know quite a bit. The natural gas case with 
Amaranth in particular, went to highest futures. We also have 
pending legislation in front of Congress on that to try to 
close some of those loopholes.
    In the crude oil markets though we do have an information 
sharing agreement with the FSA for instance where's there's a 
large amount of trading in crude oil in the Brent contract and 
in ICE Futures UK. We get daily reports from the ICE Futures UK 
on trading activity in their markets in addition to the West 
Texas intermediate on NYMEX. So one of the--and part of our 
data and the large trader data as well is that we can identify 
large groups of traders classified by speculators or managed 
money in the case that I presented today where we can look at 
what groups of traders are doing. So we do have some tools to 
dig fairly deeply into these markets where you probably don't 
have the same capacity, for instance in the stock market, to 
understand who's buying and selling on a daily basis.
    Senator Dorgan. Mr. Chairman, I've exceeded my time. But 
let me just say what's going on these days with the Fed and our 
country's decision makers is that there's not a lot of risk for 
being a big speculator because if you're big enough in this 
country, we'll just take care of your losses at some point 
along the way which should raise another discussion, another 
committee perhaps.
    The Chairman. Thank you.
    Senator Barrasso.
    Senator Barrasso. Thank you very much, Mr. Chairman. 
Following up with Mr. Harris. Alan Greenspan actually 4 years 
ago, argued that in a tight market where supplies are not 
easily expanded that the futures investing does impact price. 
That was a time when oil was at $40 a barrel.
    Now watching all your charts, I got the impression that you 
weren't necessarily agreeing with the former chairman of the 
Fed on that. Would you like to expand because I see Ms. Emerson 
moving her head yes, up and down?
    Mr. Harris. The impression is futures markets do serve a 
price discovery function. So in the sense that, as I mentioned 
earlier, people forward contracting looking to purchase oil in 
the future will use the futures markets to do that. I can't 
speak to whether I agree or disagree.
    We've heard that there's a large speculative premium for a 
number of years now. One of the issues there is we heard that 
it was $50 a barrel. Then it's $60 and now we're at $100.
    I find it hard to believe that the speculative premium 
could be that variable over that short a period of time. We do 
see prices still reacting to fundamental changes in political 
risk around the world. It seems to make a little bit more sense 
to me.
    Senator Barrasso. Do you draw a distinction between the 
markets where you have good oversight? When I think of 
excessive speculators, there's hedge funds, general asset 
managers, pension funds or sovereign wealth funds. To me a 
difference is that sovereign wealth funds do have actually a 
control over the supply from some nations. Some nations have a 
wealth funds that have that.
    Is that something you feel you have enough information to 
comment on and if that impact is different than a hedge fund or 
a general asset manager?
    Mr. Harris. We do have fairly rich information, I would 
say. We're aware of the sovereign wealth fund issue. I'm not 
aware that we identified how sovereign wealth funds trades in 
our data.
    Senator Barrasso. Mr. Book, then, if I could ask you. You 
wrote the Associated Press article of March earlier this year 
where they talked about sovereign wealth funds adding 
speculative heat to the already red hot market. I think your 
comment was: while Persian Gulf sovereign funds would be taking 
a risk since oil prices could decline, it isn't the worst 
investment idea you could have, Book added, if you control the 
oil supply. Would you like to comment on that?
    Mr. Book. I would love to. I think that if you believe in 
markets you believe in transparency. If you believe in 
transparency, you believe in shame. Price discovery and actors 
in markets who exploit markets routinely should be excluded 
from markets.
    I do believe that fund managers, as a profession, are not 
the same thing as oil producers as a profession, nor sovereigns 
as a profession. In fact, the sovereign wealth funds will have 
an incumbent on them, not just for oil, but for all commodities 
and all investments to make clear the distinctions in who 
controls the money and who controls the decisions. I think with 
clarity there is no problem.
    I also, as I suggested in the article, I think that there 
are reasons why you might not want to do that. You might, if 
you paid this guy to diversify you out of the oil revenues that 
make your country go and then he puts you back in oil, that may 
not be the best performing fund manager you could hire. So it's 
not clearly the best decision. It may simply reflect, as I said 
in my testimony, that there aren't a lot of other good 
investments available right now for professional investment 
managers of any stripe, whether they be sovereign, hedge, 
mutual or other.
    Senator Barrasso. Our abilities, in the United States, to 
regulate sovereign wealth funds in terms of what they're able 
to do in international markets would be quite limited would you 
say?
    Mr. Book. Yes. The way they can invest can be through 
regulated vehicles. Again I think that the appreciation and 
their assets under management has occasioned already among the 
OECD and the IMF vigilance. I think it's appropriate. I also 
think it's important to not judge before we know.
    Senator Barrasso. Ms. Emerson, in your written testimony 
you concluded it with consuming governments will be compelled 
to take action to protect their economies. What specific 
government policies would you propose or endorse right now in 
terms of what we as a consuming nation should be, will be, 
compelled to take to protect our economy?
    Ms. Emerson. The way I see this problem is it's a 
structural one. There's no quick fix. I think that the kinds of 
policies that I see as being critical are going to be polices 
to conserve, to promote fuel efficiency.
    I mean, if you look at it from the U.S. prospective, it's 
all about transportation fuels. It's not about anything else. 
And we've made some steps last year with raising the CAFE 
standards and of course the EPA is considering CO2 
emissions regulations, which would indirectly improve fuel 
economy as well.
    We just need to be as vigilant and as aggressive on 
conservation and fuel efficiency as we can be because I don't 
see us rebuilding a whole lot of spare capacity. We're not 
going to return to $30 oil, certainly not in my lifetime.
    Senator Barrasso. You had made the issue of transportation 
fuels. That, Mr. Cota, if I could visit with you for a second. 
I think people are able to be good windshield shoppers at 45 
miles an hour like Mr. Eichberger talked about driving around.
    I drive around the State of Wyoming. All of us drive around 
our States, long distances between one community and other. You 
can't shop on that one main street when you're 75 or 100 miles 
away. You may see a jump in prices, as I did this last week, 
driving around Wyoming. Maybe 25 cents per gallon and all the 
prices in one community may be 25 percent higher or lower than 
another community even though they're all pretty close in 
price. But that differential of $3 to $3.25 per gallon is a 7-
percent difference.
    Would you like to comment on that and why that differential 
can be so great?
    Mr. Cota. I think that deferential could exist in the 
current market simply because of the volatility that's 
occurred. There has been a 70-cent change in the wholesale 
price within a 30-day period. So just depending on just a 
matter of days what could occur within that market could 
justify that.
    There have been a number of days where just the high and 
the low in some of these contracts has had us spread as high as 
20 cents a gallon within the day. That's just one day. So, you 
know, I get price changes as often as three times a day. Often 
I don't know what I actually paid until I've actually gotten 
the invoice the next day and it's draft out of my account. So 
that would explain that. It goes to underscore the volatility 
that we have in the markets.
    To bring up your point on the sovereign funds, which I 
think is really critical. That's a national security issue. If 
you have a sovereign fund that doesn't particularly like the 
United States and you want to go in a dark market through a 
derivative type of bilateral deal. You're selling the commodity 
that you want to also hurt the other guy with, you could make a 
huge impact for very short money both to jeopardize that 
economy and maximize your own commodity.
    We would have no way of knowing. There is no oversight. You 
don't even have the data.
    Senator Barrasso. Mr. Eichberger, anything else you'd like 
to add?
    Mr. Eichberger. I think Mr. Cota kind of nailed it on the 
head is that the volatility in the wholesale market is 
tremendous. I was with a retailer earlier this week who told me 
over a &ree day period he had something like a 20 cent increase 
in his wholesale cost in one day, a twelve cent drop the next 
day and an eight cent increase the following day. The 
volatility is incredible. Retailers are constantly chasing that 
cost where their competition will allow them to do.
    In different markets, competitive pressures are very 
different. The cost basis of their operations are very 
different. The distribution challenges of getting product to 
those retail locations could be very different. So the 
variables that influence retail price are huge.
    Senator Barrasso. Thank you, Mr. Chairman. I think I've 
exceeded my time.
    The Chairman. Senator Lincoln.
    Senator Lincoln. Thank you, Mr. Chairman. As usual thanks 
for bringing us together on an important issue, but a very 
complicated one as well.
    Just a couple of questions. Mr. Harris, you said repeatedly 
I think that future markets existed to discover prices and 
limit risk. You just I think answered Senator Barrasso's 
question with a version of that.
    I guess, although I do agree to some degree that that 
exists in a properly functioning futures market. I guess, would 
you also agree the flip side of that, that an improperly 
functioning futures market could distort prices and certainly 
inadequately limit risk resulting in the kind of excessive 
speculation that perhaps could exist?
    Mr. Harris. I totally agree. In fact that's the mandate of 
our organization is to monitor and investigate any activity 
that might be deemed suspicious, manipulative or otherwise in 
the market. So we do have----
    Senator Lincoln. Do you feel like you're agency or your 
department's got the adequate means to be able to do that?
    Mr. Harris. I don't work for the enforcement division in 
particular. I think it's pretty well known again that we're at 
low staffing levels. We're at record volumes in these markets.
    We're doing the best that we can. We have record numbers of 
enforcement cases as I understand. We have hundreds of 
investigations going on any given day in these markets to try 
and make sure that there is no nefarious behavior going on in 
any market.
    Senator Lincoln. Ms. Emerson, following up on Dr. 
Barrasso's question about what countries can do. You also, and 
I'm apologizing because I had to excuse myself and these 
questions may have been asked, but you did touch on the impact 
of biofuels and other new fuels and the effect that they could 
have on the price of oil is certainly of particular interest to 
me. Many of us come from agricultural-based States and 
innovative States.
    My State has a diversity of feedstocks that could be used. 
We've got a lot of interest among our Ag community. But also in 
terms of the innovation and technology that people are looking 
for in renewable fuels.
    I'd like to hear, I guess, more about what you believe and 
how you believe that maybe, perhaps, that could affect oil 
markets and what needs to be done to grow those industries 
properly in a way that could make a positive impact.
    Ms. Emerson. I think biofuels, both in the United States 
market and also in the global market are, must be seen as a 
portfolio approach. They're not a magic bullet.
    Senator Lincoln. Right.
    Ms. Emerson. But they certainly can be part of the 
solution. Obviously they have to be developed in a way that 
deals with the food or fuel issue and with the inflation issue. 
So you have to look very closely at the kinds of import, excuse 
me, input materials and the way in which they're grown.
    Then now we have the issue of are they grown in such a way 
or are the biofuels manufactured in such a way that they use 
more energy and/or emit more CO2. So I tend to be a 
little bit of a biofuels skeptic only because I find there's 
more emotion and excitement than careful planning with 
biofuels. Maybe that's what you have to do. Maybe you have to 
start with the excitement and then sort of throttle back and 
come up with the appropriate plan.
    Senator Lincoln. Second to Hollywood, we're all about 
glamour here in Washington.
    [Laughter.]
    Senator Lincoln. So you may be correct that creating the 
enthusiasm and excitement for things is what gets us started 
and then, obviously, practicality. I have a research physician 
in my house and certainly looking for the practicality. But I 
know in our State everything from algae to chicken litter, 
poultry litter to, you know, switch grass and a whole host of 
other things, looking at those as alternative for fuel and 
energy are great ideas in a sense that they're feed stocks that 
make sense and don't necessarily distract from other places in 
the marketplace. So your point is well taken in terms of making 
sure that we create that balance in terms of where those feed 
stocks come from.
    Mr. Eichberger, your testimony you mention that the affects 
of the increased use of credit cards to purchase fuel at 
convenience stores and the fees that are a part of that 
transaction. I have just met with my Arkansas marketers, 
petroleum marketers. I heard an awful lot about that issue.
    They, our petroleum marketers, are seeing, as you say, not 
only the volatility and the fluctuation in terms of price at 
the pumps. What they have to deal with, but also the lack of 
transparency. As well as what, you know, when that volatility 
happens what happens to them in terms of their cost of doing 
business.
    Could you expand any on your testimony as to how extensive 
you believe that problem is and what your association would see 
as a solution to that?
    Mr. Eichberger. It is the number one issue facing the 
retail market today. In 2006 overall convenience stores paid 
$6.6 billion in credit card fees. They only generated $4.8 
billion in profit.
    This is an escalating situation. The card will assess a fee 
of about two and a half percent on average on every gallon 
sold. As the price of gasoline goes up, their revenues go up. 
Yet they have absolutely have no risk in terms of buying 
product, putting in the ground, making sure you don't release 
in the environment, making sure that everybody is filling up 
properly and you're doing all your business operations. They 
just skim it right off the top.
    So as retailers who are constantly chasing the volatile 
wholesale markets and trying to figure out how they're going to 
be able to break even on gasoline to see seven and a half cents 
from every gallon come right out of their pocket, it's a major 
issue. A lot of retailers are in the situation where it is make 
or break. If something is not done to level the playing field 
and give them some relief at the pump, they may not be able to 
make a profit on gasoline in the long term. It could really 
destroy their economic well being.
    Senator Lincoln. I appreciate that. You certainly confirmed 
what I've been hearing at home. So thank you. Thank you, Mr. 
Chairman.
    The Chairman. Senator Murkowski.
    Senator Murkowski. Thank you, Mr. Chairman. Thank you 
ladies and gentlemen for your testimony this morning.
    Mr. Eichberger, listening to you this morning, we recognize 
that--we're always looking for some scapegoat, somebody to 
blame. The guy that you're getting the gas from at the pump 
seems to be the quickest and easiest but it reminds me of, you 
know, the scene in the airport where you've got the customer 
who is chewing out the ticket rep there for the cancellation of 
their flight. To a certain extent the retailers are in that 
situation. So I think your testimony here this morning was 
important for people to hear and to understand.
    Ms. Emerson, I think you said at least a half dozen times 
here this morning there is no single answer. There is no silver 
bullet. This is complicated. This is complex.
    But it seems that we are very, very quick to try to attach 
blame. But if we were to just take some of the profits from the 
oil companies, all would be fine in the world. I think it is 
important to understand how many different factors really go 
into what affects the price of oil. Why we're seeing what we're 
seeing today.
    As I listened to all of you, well, it's not clear to me 
that any one of you is wiling to attach a percentage or a price 
on what the speculation is in terms of all those factors that 
go into the price of oil. We recognize that speculation does 
play a role, maybe some of you think it's a much more limited 
role than others. But the other factors, the supply and demand, 
the geo-political factors, the oncoming role of China and 
India, it's clear to me that we're looking at this and 
recognizing all that comes into it.
    Mr. Burkhard, in your testimony you mentioned these new 
fundamentals and the first was the aspect of the cost structure 
and the reality that the labor and the materials that go into 
it are just continuing to increase. Then the second of those 
fundamentals was the global financial dynamics. You speak again 
of the role of China and India.
    I look at those two fundamentals that you've identified and 
I just see them continuing. Does this mean in your opinion that 
the price of oil will continue to rise because we're not able 
to contain these two areas or do we plateau it at some point 
here?
    Mr. Burkhard. The--first of all can't continue to rise 
forever. On the cost side, over a long period of time there 
will be more people and equipment entering the industry. But 
one important thing to keep in mind is in for most of the 1980s 
and 1990s for a generation, there is a whole generation of 
people that skipped entering the petroleum industry because of 
low prices and industry consolidation. So it's going to take 
time to reinvigorate the ranks of particularly on the technical 
side of the oil industry. But 10, 15 years, we hope to see more 
relief on that front.
    On the China, India issue, their aspirations for higher 
living standards are like anywhere else in the world. But there 
are limits in terms of price that those countries can take. 
They are, on average, the per capita income is lower than it is 
here in the United States.
    So when we get to--if we were to have a sustained oil price 
of let's say 110 to 120. By sustained, I mean 6 months or more, 
not a day or two. We would expect to see demand, even in those 
countries start to be negatively affected and push that could 
over time begin to take some of the pressure off price.
    Senator Murkowski. I don't think any of you have 
specifically mentioned the growing role, the domination really, 
of the nationally owned oil companies and what role this may 
play in driving up the prices worldwide. Could someone speak to 
that? Ms. Emerson?
    Ms. Emerson. It is absolutely the case where we're seeing a 
shift in the balance of power among oil companies from the 
integrated majors that we all know to national oil companies 
around the world. That's in part because they, in their host--
in their home countries they hold a lot of reserves. Actually 
they've become much larger companies and often times they're 
backed by their government in some of their investments.
    I think some commentators have said that this is just all 
together a bad development. I think that's a too simplistic. I 
think some of the national companies that I personally deal 
with are making very big steps to invest in oil production and 
in oil refining. They will probably significantly impact some 
of these capacity restraints that we have.
    So I think we have to adjust our thinking a little bit to 
understand that, you know, they're big players too now. It's 
not just about the Exxons and BP and Shell.
    Senator Murkowski. So you're viewing it as a positive in 
the sense that it will add to capacity.
    Ms. Emerson. Yes. What we're seeing is significant 
investment in capacity and from many national oil companies or 
companies that are technically private, but behave a little bit 
like national oil companies.
    Senator Murkowski. But what about their aspect then as a 
nationally owned oil company to really attempt to control, to 
what extent they can, the available prices. Are you not as 
concerned about that aspect of it?
    Ms. Emerson. I think it's a complicated issue. You have to 
look at national oil companies in terms of whether they are 
part of a net importing country or part of a net exporting 
country. So the decisions that a CNPC to a Chinese company 
would make would be different than a Saudi Aramco would make.
    I think in the case of the national oil companies in net 
exporting countries they're making so much money. They are 
definitely pumping that, to some degree back into capacity. Not 
necessarily maybe as much as we would like, but certainly 
they're building that capacity. That's a good thing.
    But it does mean that it's going to be those companies 
controlling the flow more so than in the olden days when Exxon 
and Mobil were sort of controlling the flow for the global 
market. You know, it depends a little bit on how you perceive 
the objectives of their governments.
    Senator Murkowski. Mr. Cota.
    Mr. Cota. The national oil companies, the exporting 
national oil countries and their companies have more subtle yet 
very large impact. It's in how they are taking the United 
States dollars, which they will continue to take into 
diversifying their portfolio. Then they in that way, part of 
that diversification to get out of United States dollars is to 
do the arbitrage deals to buy Euros, other foreign currencies 
and in the last form of cash which is commodities.
    So in their efforts in these predetermined arbitrage 
programs of diversifying their portfolios they are driving up 
the same thing that they're trying to diversify out of. So 
they're making a large impact by increasing the price, 
inadvertently, I don't think directly and inadvertently because 
they're trying to get out of United States dollars. As the 
United States dollar goes down everyone's buying commodities 
worldwide in United States dollars, not just energy. As you 
diversify out of the United States dollar because that's 
declining, you're going to go into commodities, which is going 
to drive the price up and which is going to return more to 
them.
    Senator Murkowski. My time is up, but Mr. Book had a 
comment. Let me ask him.
    Mr. Book. Senator, I just--I did speak to that briefly in 
my written remarks. I just wanted to point out that if you're 
going to satisfy global petroleum demand, you're going to need 
an and within demand, not an or. So the good thing about the 
national oil companies is that as they become richer and gain 
access to greater technology, they add to global supply on the 
market, typically when they make the investments that have been 
discussed.
    The other part of and was mentioned earlier, it's bio- 
fuels, it's alternatives, unconventional sources of petroleum. 
It is also access where you can have it. We are--I go to Norway 
sometimes to see clients. They have national sovereign wealth 
and oil producing, I think they might be importing, but I don't 
know.
    They say they take the--they like to tease me because we 
don't produce all of our offshore oil. Yet they're one of the 
greenest, sort of, national economies in terms of their ethos 
and their culture. They have paired responsible production with 
conservation. If you're going to get to and, I think 
responsible production and conservation are both parts of the 
story.
    Senator Murkowski. Alaska wants to help there. Thank you, 
Mr. Chairman.
    The Chairman. Thank you.
    Senator Cantwell.
    Senator Cantwell. Thank you, Mr. Chairman. Panelists, thank 
you for being here. There was an earlier testimony this week in 
the House by oil company executives and an executive from Exxon 
Mobil was quoted as saying, ``based on supply and demand 
fundamentals that they have observed that they estimate the 
price of oil should be about $50 to $55 per barrel.'' That's 
what the oil company executives believe.
    I think this hearing is very important. So I'm asking 
starting with you, Mr. Burkhard and Mr. Book. Did you predict 
that oil prices a year ago would be at $100 a barrel without a 
major oil supply shock or disruption? Did either of you predict 
that?
    Mr. Book. I'm wrong currently. I have this year's price at 
$85.
    Senator Cantwell. Mr. Burkhard.
    Mr. Burkhard. We were lower than the current price too 
because of the impact of the dollar and the rising cost as 
well.
    Senator Cantwell. If I asked you to predict what oil prices 
are going to be in 6 months, do you think you could give me a 
good basis for that?
    Mr. Burkhard. I could describe to you in detail the 
assumptions that would go into the outlook, but whether that 
actually happens or not is a different story. But it's if the 
dollar does weaken more than it's difficult to see oil prices 
declining.
    Senator Cantwell. Mr. Book, do you want to comment on that?
    Mr. Book. I believe in fact that $85 reflects a couple of 
things that do make sense to me. I'll enumerate them even if 
I'm wrong about the magnitude. The marginal nonevect barrel is 
probably $70.
    Senator Cantwell. Ok. Actually you've already made my 
point, which is just this that we didn't, no one predicted this 
without a major oil shock. Here's where we are today.
    When you are asked to predict again, which is trying to 
have some predictability in the markets with some certainty so 
people can hedge with some expectation, so that they can 
protect themselves. Yet we're basically saying this is all over 
the map. We don't have the fundamentals here. We don't have the 
fundamentals that are giving everybody the certainty and 
predictability we would like to see.
    It wasn't that long ago. I became a Senator in 2001 and at 
that time OPEC was doing all they could to keep oil prices 
between $22 and $28 a barrel. So my point is this thing is way 
out of control and it's causing great impact to the economy. I 
just don't understand why we aren't being way more aggressive.
    I plan next week when the FTC is before the Congress 
committee to ask them to hurry up and expedite the rules that 
were given to them in the new Energy bill on anti-manipulation 
provisions to make sure that petroleum markets, just like 
electricity markets, have the proper oversight. But Mr. Harris, 
my question is for you, just yes or no. Do you believe in 
closing the Enron loophole? Yes or no?
    Mr. Harris. Yes, absolutely.
    Senator Cantwell. So the CFTC will support that. Under your 
current authority while you may be able to look at the ICE 
markets, you don't have any ability to do any enforcement of 
wrongdoing. Is that correct?
    Mr. Harris. That's right.
    Senator Cantwell. So, a big problem exists today in the 
fact that we have online trading that doesn't have the 
enforcement and oversight. So we--to me, I don't care how many 
people we have. I mean, we ought to be able to, Mr. Chairman, 
get the oversight.
    That reminds me, you know, it took the Snohomish County PUD 
$100,000 to prove that Enron manipulated markets. It didn't 
take a lot. It didn't take the FERC to do that. Although they 
later found that, it took a little industry to bait a little 
entity to hammer home the point.
    My second point is in this chart, Ms. Emerson. If you 
could--your chart on factors lifting oil prices you have just 
in time. My question is how much does the industry moving from 
a 30-day actual physical supply of oil to a just in time 
trading on paper of supply impacted the market in not having--
in basically making a lot tighter supply and thereby more 
speculation.
    Ms. Emerson. I think, absolutely, the movement to just in 
time inventories has exacerbated the tendency of the supply 
chain to respond or prices to respond very quickly to supply 
chain hiccups. You know back in the 1980s and early 1990s we 
had as much as 30 days and we're probably around 22 days now of 
supply that the physical market is holding. To the degree that 
you reduce your capacity, you reduce your inventories. That, 
yes, absolutely, you cede control to others in terms of short-
term price dynamics because you can't discipline the speculator 
by dumping some oil into the market.
    You know in the olden days we used to talk about Brent 
squeezes. You know, someone would buy a bunch of Brent cargoes, 
but Shell or BP would just add another cargo and that would 
discipline that behavior out of the markets. So yes, you're 
right without the spare capacity and without the additional 
inventory it does make short-term speculation or short term 
trading have a bigger impact.
    May I also respond to your other question just to be sure?
    Senator Cantwell. It's up to the chairman. I'm out of time 
but it's up to the chairman. But I will just say these things 
are a lot clearer.
    Mr. Cota, thank you for your testimony. I think you were 
very crisp. I think when the oil industry is coming to us 
saying that they, in fact, see problems in this. It's time for 
us to clearly list out the things that need to happen and 
closing the Enron loophole. Basically looking at how to make 
sure that there's more physical supply for less speculation, 
making sure that the FTC gets about their job.
    It's just clear there is not--we can't go from 2001 at 28 
to where we are today at over 100 and then having people play 
these guessing games and thinking that we're going to have any 
kind of functioning markets. There's just too much going on 
here. If we were going to protect our economy we have to be a 
lot sharper at closing what are the lack of functioning market 
trends that are absent here. I think they're pretty clear. So, 
go ahead Ms. Emerson.
    The Chairman. Ms. Emerson, go ahead. Give whatever response 
you want and then Senator Sessions has some questions.
    Ms. Emerson. I'll just do 2 seconds and that's just to say 
about this issue of is the fundamental price at $50 or $80 or 
$90. One of the things that I wanted to make clear in my 
testimony this morning is that 2007 we had a very strong 
fundamental development which did move prices well above $50 
for supply/demand reasons. So I don't want to leave the 
impression that the potential speculative premium is something 
between $50 and $100. It's probably closer to $80 and $100.
    The Chairman. Alright. Senator.
    Senator Cantwell. For a lot of families even that is a big 
difference. Thank you.
    The Chairman. Senator Sessions.
    Senator Sessions. Ms. Emerson, it seems a little odd to me 
that you and Mr. Book seem to think that the national 
governments that are taking ownership of the oil in their 
country in contradiction to normal free market principles is 
not a problem. Mexico has tremendous reserves, yet their 
production is down. That's generally accepted because of 
corruption, inefficiency that is typical in these country's 
governments and in their production capacity.
    Isn't that a factor in the decline? Venezuela, showing a 
decline in their production, has large reserves. Isn't that a 
factor?
    Ms. Emerson. I absolutely agree that these countries are 
pursuing policies of resource nationalism. Their policies may 
or may not be beneficial to consuming governments.
    Senator Sessions. But I'm talking about their own country. 
In the short run or at least, it seems to me, they're not very 
effective in producing oil and putting it on the market. 
Because they're inefficient and less efficient and productive 
than private oil companies that have to compete on the 
marketplace.
    Second, isn't the biggest winner in all of this countries 
who own their oil reserves? When the prices go up dramatically, 
aren't Saudi Arabia, Hugo Chavez, and people like that just 
counting the money? Nothing has changed in their country. They 
have the same amount of production and they're getting more 
than two times what they were getting just a few years ago for 
their oil reserves.
    Ms. Emerson. Absolutely. But I would make a distinction 
that there are different kinds of producers. I wouldn't 
necessarily put Venezuela and Mexico which are having terrible 
problems for both political and institutional reasons with some 
of the Persian Gulf producers who are absolutely investing.
    Senator Sessions. Is production increasing in some of the 
Persian Gulf countries?
    Ms. Emerson. Their production capacity is increasing.
    Senator Sessions. They're taking advantage of these high 
prices.
    Ms. Emerson. Absolutely.
    Senator Sessions. A little more effective than some other 
countries. What is the average? I've heard various figures. I'd 
like to know what is generally considered to be a fair estimate 
of the profit that oil companies make today on a gallon of gas. 
How many cents per gallon?
    Mr. Eichberger, you're in the business of----
    Mr. Eichberger. Yes, Senator. Probably the best proxy you'd 
have is the Energy Information Administration breakdown on the 
retail price of gasoline. They do it each month. They break it 
down to what crude oil contributes, taxes, refining and then 
everything below refiner.
    If you look at the average for 2007 refinery operations and 
profit was 17 percent.
    Senator Sessions. 17 percent.
    Mr. Eichberger. 17 percent.
    Senator Sessions. So a $3 gallon is 30, 45 percent--45 
cents per gallon.
    Mr. Eichberger. A $3 gallon would be 51. It would be 51 
cents on a $3 gallon. But you have to keep in mind that's also 
their operation cost as well, not just profit.
    Senator Sessions. Right. I was at a town meeting and a 
local, one of your guys, I guess, pointed out to me at $100 a 
barrel at 42 gallons a barrel. He wrote it on a napkin and gave 
it to me. That's $2.52 right there plus all the other costs 
that go into it.
    But I'm told it only costs in Saudi Arabia about $8 a 
barrel to produce a barrel of oil to get it out of the ground.
    Mr. Cota. Probably less.
    Senator Sessions. So I mean this is a huge amount of money 
that's going now perhaps over 80 percent of the oil of the 
world today is owned by governments. Is that correct? So when 
the OPEC meets and they talk about production levels. They 
control their production. They are taxing the American 
consumer. That's what they're doing because this is not a free 
market price. It's a cartel.
    OPEC is, in itself, a price fixing mechanism. They work to 
fix the price. I think one sense of what we ought to do is 
focus on an inter-net foreign policy that deals honestly with 
that question.
    I would like to ask, whoever would like to comment on it, a 
question about diesel fuel. It's very troubling to me the price 
of diesel fuel is considerably higher, Mr. Eichberger, at your 
stations than gasoline. It should be less.
    Diesel automobiles get 35 to 40 percent better gas mileage, 
Ms. Emerson, which would be one of the ways to conserve. Fifty 
percent of Europe's automobiles are diesel. Why are we having 
such a high price for diesel fuel? Mr. Cota, I see you raise 
your hand.
    Mr. Cota. Part of it has to do with our new flavor of 
diesel, ultra low sulfur diesel. So we now produce the highest 
quality diesel on the planet. We were a net importer of diesel 
prior to having this new standard.
    Now with the arbitrage of the dollar and the Europeans 
having a higher demand. They import diesel and export gasoline. 
So because the Euro is so strong, our diesel in the United 
States is going to Europe. Much like our bio----
    Senator Sessions. I asked the Energy Department that a few 
weeks ago and they told me we're not exporting diesel to 
Europe.
    Mr. Cota. You can take a look, I, well, I'm not a trader. I 
don't work for the government. My understanding is that the 
arbitrage deals are encouraging cargoes in New York Harbor to 
go to Europe.
    Senator Sessions. Mr. Burkhard.
    Mr. Burkhard. I think a fundamental reason for that, for 
the increase in diesel prices, is that is where demand globally 
has been strongest, China and Europe in particular. The demand 
for diesel, globally, for several years has been much stronger 
than gasoline.
    Senator Sessions. My time is up. But I guess my question is 
why aren't we seeing any move to refinery? In the pure cost 
factor, even with the higher grade of diesel fuel that you 
referred to, it still should be produce-able at less cost than 
a gallon of gasoline, should it not?
    Mr. Cota. It's all what the crack spread is and the 
refiners say. That's a question for the API group. They can 
tailor outputs. We are the last economy to focus on gasoline. 
The rest of the world, as was stated, is moving toward the 
diesel because it's cleaner and higher efficiency.
    Senator Sessions. Mr. Chairman, I just hear that a lot from 
my trucking community.
    The Chairman. Go ahead if you have any additional 
questions.
    Senator Sessions. I would like to follow up a little bit on 
that. It seems to me that there's a slow transition. Would any 
of you comment on that? A slow transition to a diesel economy. 
When I ask about it, the Energy Department official said it was 
a lack of refinery capacity. Mr. Book and Ms. Emerson.
    Mr. Book. Senator, there's a transition from the light duty 
vehicle perspective is about 230 million cars and SUVs that 
have to cycle out of the fleet and diesel vehicles to cycle in. 
So from the fuel side of the story there is the part of the 
story have been discussed. The other part is how do you get 
higher efficiency vehicles into the fleet and get rid of the 
ones that were there before?
    Scrap yard rates for cars are now at about 5 percent, 5.5 
percent, which means you have a 15 to 20 year waiting period. 
In the 70s the height of that energy crisis, you were in the 12 
to 13 percent scrap rate. So to the extent that you can get 
into a different car, you need to not to just have the new car 
made, the fuel to put in it, but you've got to get the old one 
off the road.
    Senator Sessions. But it's still selling for substantially 
more than gasoline, which indicates to me that there's a large 
profit being made.
    Ms. Emerson.
    Ms. Emerson. Senator, you raise a really critical question. 
I think this is the big issue that needs to be addressed. The 
United States refining industry is configured with catalytic 
cracking and coking to take medium sour crude oil and turn it 
into gasoline. We're not configured to maximize diesel 
production. We're configured to maximize gasoline production.
    Right now refiners in the United States are working very 
hard with their gasoline configurations to make additional 
diesel because diesel demand is growing. It's growing. It's the 
only fuel right now that's growing in terms of--and it's 
growing fast. Part of the reason it's growing is because we're 
importing Chinese products in San Francisco and driving them to 
New England.
    So it is the trucking demand is what is--so we have a 
structural problem there in that we have a refinery kit that 
really wants to make the gasoline. So the refiners are doing 
what they can to bend and tweak that to make more. They 
absolutely want to make more. And at the same time we have a 
very strong demand for.
    Mr. Eichberger. Senator, if I could also add. I think you 
heard about the fleet turnover. I think we need also to look at 
Federal policy to a degree. The auto industry is not really 
being encouraged to produce a whole lot of the new diesel 
engines. They're being encouraged for just flexible fuel 
vehicles, hybrid vehicles, higher efficiency gasoline vehicles. 
The cars coming in imports are predominately going toward 
hybrid and the domestic auto manufacturers are going to 
flexible fuel vehicles.
    So there is a preference through Federal policy to go to 
biofuels, to go to higher efficiency gasoline, the electric 
hybrid cars rather than going to the cleaner, more powerful, 
more efficient diesel engines that we've been talking about the 
last 5 minutes. Until we figure out and get away from this 
prejudice against new generation, fossil fuel powered vehicles, 
diesel is not really going to take off in a consumer's mind 
when you look at vehicles they can purchase from auto 
manufacturers. I think we need to balance our priorities, 
looking long-term.
    We have a bio-fuel, renewable fuel standard we need to 
implement. But if we also want to increase fuel economy we need 
to look at all options and make sure they're all on the table 
and not prejudiced against one verses the other. I think that's 
a challenge that we have going forward from a policy 
perspective.
    Senator Sessions. My only bafflement is why, with this kind 
of margin for diesel, we aren't seeing more refining coming 
forward to meet the demand that already exists?
    Mr. Cota. Senator Sessions, with the profitability and 
refineries are measured in crack spreads. There's a gas crack 
and there's the distillate crack. Typically in the summer, in 
the spring and in the fall, refineries will switch their 
production to maximize whatever they think the seasonal demand 
is going to be. I think for the first time refineries are 
looking seriously hard, as was alluded to earlier, about 
maximizing more diesel.
    Truckers are pretty smart when they know about efficiency. 
Diesels run a lot more efficient. Otherwise we'd be running 
gasoline-powered tractor-trailers, but we're not. As this trend 
goes, if the profitability, I mean, the crack spread with 
distillates is going to remain very high, the refiners will 
switch the refining over time, but it takes a huge amount of 
time and a huge amount of capital investment in order to do 
that. The crackers like $400 million for a refinery or a coker.
    The Chairman. Thank you very much. I think it's been useful 
testimony. We will try to sort through it and figure if there 
are any initiatives we can pursue in this committee. Thank you 
very much.
    [Whereupon, at 11:47 a.m. the hearing was adjourned.]

    [The following statement was received for the record.]
     Statement of Victor J. Cino, President, Pyramid Oil Marketing
          I. The Clinton and Bush Administration have allowed mergers 
        of oil companies in the last ten years which have decreased 
        dramatically competition in the United States.
            Crude oil price began to rise dramatically after four 
        critical mergers of major oil producers, two during the Clinton 
        Administration, and two more during the Bush presidency. In 
        1998, BP merged with Amoco. In 1999, Exxon merged with Mobil. 
        In 2001, Chevron acquired Texaco, and in 2002, Conoco Inc. 
        merged with Phillips Petroleum. All these mergers reduced the 
        number of competitive oil producers in the marketplace. Less 
        competition led to an easier path to higher crude oil prices.
          II. The major oil companies utilized tragic events to foster 
        fear that oil supplies would be disrupted and allowed them to 
        increase prices at will, regardless of ample world supply.
            The major oil companies benefited enormously from 
        devastating and tragic events which hit the United States, and 
        which made it easier for them to increase crude oil prices: 9/
        11; the Iraq War, and Katrina. The average price of oil in 2001 
        was $17 per barrel, but after 9/11, the average price of crude 
        oil in 2002 went to $24 per barrel. Larger hikes in crude oil 
        occurred in 2003 and 2004 after the Bush Administration went to 
        war against Iraq. Crude prices shot up to $27 per barrel in 
        2003 and $36 in 2004, doubling the price of a barrel of oil in 
        just three years.
            The Iraq War kept prices climbing into the summer of 2005. 
        The price of oil continued its rise above $40 per barrel. Then 
        in the fall of that year, Hurricane Katrina devastated New 
        Orleans, disrupted for a few days, Colonial Pipeline supply 
        heading to the Northeast, shut down, for about two weeks, 20% 
        of refinery production in the Gulf of Mexico, and cut off 
        supply temporarily to the West Coast. Crude oil and gasoline 
        prices soared even though the Northeast and the West coast 
        possessed enough above ground stocks of crude and gasoline 
        supply to last 45 days.
            The media mistakenly suggested then that there would be 
        major long term supply disruptions resulting from Katrina, and 
        so the average price of crude oil in 2005 shot up even higher 
        to $50 per barrel. But even though oil and gasoline supply 
        began to flow normally within three weeks, crude oil remained 
        at $50, and oil prices never retreated after Katrina.
            Fed by doom and gloom news over oil supply by an 
        overzealous national media aching for shock news, and an oil 
        industry which continued to feed misinformation to the American 
        public. Oil commodity traders began to hike up the value of 
        crude futures, and thus the average price of oil artificially 
        rose again in 2006 to $56 per barrel, doubling the price of oil 
        from its average price in 2003.
            Oil traders have played an important role in driving up the 
        price of oil since they have recognized that the major oil 
        companies no longer have any restrictions on its ability to 
        raise prices here in the United States and elsewhere.
          III. Major oil companies have a national influence on the 
        media, the Executive branch of the U.S. government as well as 
        the Congress.
            Historically, major oil companies have effectively 
        influenced the national media by releasing information 
        conducive to generating fear that oil supply disruptions could 
        occur. This year is no different. A few months ago it was 
        Kurdish rebel attacks coming out of Iraq and into Turkey that 
        would disrupt oil supply. This past week oil strikes in 
        Scotland and Nigeria allowed Traders to hike up oil prices by 
        purchasing oil futures on that news, and oil companies 
        predictably followed suit and did just that, jumping to an 
        incredible $120 per barrel. On Tuesday, April 29, a New York 
        Times article claimed that oil supply was not keeping up with 
        rapidly rising global demand and ``the outlook for oil signaled 
        an unprecedented scarcity of oil.''
            That statement can be no further from the truth as 
        evidenced by the historical twenty five year ability of the oil 
        industry to meet demand world wide crude oil, gasoline and 
        distillates.
            The argument that major third world countries are 
        increasing demand so rapidly that oil supply cannot keep up 
        with demand is absolutely false and is not based on the 
        historical data. There is more than ample supply worldwide to 
        meet oil demand. The argument is being used by oil 
        propagandists to help drive up the price of oil worldwide.
            The growing economies of China and India would push global 
        energy demand for crude oil in the year 2030 beyond the limits 
        of oil producers to supply. The New York Times reported just a 
        few months ago, but the truth is that oil demand from these two 
        major economies is barely making a ripple in the ability of the 
        oil industry and OPEC to supply world needs.
            The price of crude oil also keeps rising because of the 
        political and financial influence of the major oil companies on 
        the Congress and the Bush Administration. Large amounts of 
        political contributions have created enormous oil industry 
        influence in Washington for politicians to stand on the side of 
        big oil and do nothing about rising crude oil prices. The 
        president is from an oil state and his family has strong ties 
        with the Saudis. His administration, consequently, will do 
        nothing to discourage higher crude oil prices.
          IV. There is a general apathy on the part of governments and 
        consumers when faced with rising oil prices because the major 
        oil companies have too much strength and financial clout to 
        fight, and now with recent mergers and huge profits, they are 
        more formidable.
            Oil and gasoline consumers have demonstrated a distinct 
        indifference to the rising prices of crude oil. It is an apathy 
        based on consumers' essential resignation to the idea that we 
        can do nothing about rising oil prices because of the 
        overwhelming power and financial strength of major oil company 
        producers and oil producing nations.
            Given these reasons why crude oil prices are so high, where 
        should the price be? I think the price of a barrel of crude oil 
        today should be close to $50, the price a barrel of crude oil 
        just after Hurricane Katrina hit New Orleans. This price takes 
        into consideration all three major events which adversely 
        affected crude oil prices, and were the events most responsible 
        for a doubling of price from year 2000 when a barrel of crude 
        was $23.
          V. Why the price of crude oil is close to $120 per barrel. 
        Oil price increases have been artificially induced to rise by 
        major oil producers, OPEC, oil lobbyists and media friends of 
        big oil. Historical data suggests that crude oil supply has met 
        demand easily.
            In the past ten years, worldwide oil demand increased by 
        12.7 million barrels per day, from 73.3 million barrels per day 
        (mbd) in 1997 to 86 mbd in 2007, but oil producers easily met 
        that additional demand, producing as much crude oil as demand 
        required.
            In fact, except for a few short term disruptions to the 
        supply of crude oil, producers have met crude oil demand 
        worldwide for the past thirty years, and have shown during this 
        period how sophisticated and efficiently balanced the system of 
        oil supply and demand has worked, almost to perfection
            That stated, there is no viable reason for the current 
        price of crude oil to be hovering at $120 per barrel. 
        Therefore, one must conclude that the current price of crude 
        oil has been artificially induced by the fear of short supply 
        as a result of the three major events that shook the world, and 
        which have provided the major impetus and opportunity for world 
        oil producers to continue to raise prices of crude oil 
        unchecked since 2005.
            With an existing balance of supply and demand prevalent, 
        there is no other reasonable explanation as to why oil rose 
        almost 400% from its level of $23 per barrel in year1999 to 
        almost $120, except that the control of oil by the major oil 
        producing countries and big oil, have trumped the law of supply 
        and demand. What can we expect in the near future?
          VI. New discoveries of crude oil are clearly demonstrating 
        the world's ability to meet crude oil demand and the record of 
        discovery proves that. It is nonsense for anyone to think that 
        we are running out of oil or in short supply, even for the 
        short term.
            I think the discovery of new oil reserves and increased 
        production of oil in African countries, Canada and elsewhere, 
        as well as the development of new technology for extracting oil 
        from the ground, combined with an expected global economic 
        slowdown, will create the conditions for lower oil prices over 
        the next five years.
            Angola, with eight billion barrels of proven reserves, is 
        already producing 1.4 million barrels per day, and while Sudan 
        produced a nominal 380,000 barrels per day, that figure is 
        expected to climb dramatically. Chad produced approximately 
        157,000 barrels per day. More oil producers in the marketplace 
        translates to more competition and lower prices.
            Also, the world is finding more oil. Proven crude oil 
        reserves are increasing yearly. Canada is now extracting oil 
        from sand and shale. The U.S. Energy Information Administration 
        asserts that Canada's proven oil reserves exceed 176 billion 
        barrels. Its market for this secure source of oil is the U.S. 
        More oil availability means lower prices.
            By contrast, Iraq boasts 115 billion barrels of crude 
        reserves, Iran has 136 billion barrels, and Saudi Arabia, 
        weighs in at 262 billion barrels. There is no doubt that the 
        Saudis can increase oil production at the turn of a spigot, and 
        since the U.S. is prepared to defend Saudi Arabia in an 
        overheated Middle East, it can aid the U.S. by cranking out 
        more oil.
          VII. Current levels of proven crude oil reserves worldwide 
        are more than ample to meet crude oil demand for thirty to 
        fifty years.
            Total proven crude reserves worldwide stand at an 
        incredible 1.31 trillion barrels. Can anyone seriously believe 
        then that these countries will not be able to meet any kind of 
        increased oil demand for the next fifty years, given the 
        extraordinary amount of oil reserves they have available? The 
        question still remains, however, at what price?
          VII. The major oil companies have shifted their refinery 
        production from gasoline to distillates because the refiner 
        gross profit on diesel and other distillate products have risen 
        dramatically to 61 cents per gallon , while the refiner gross 
        profit on gasoline is now just 20 cents per gallon.
            United States fuel oil needs are primarily based on the use 
        of consumer and industry demand for gasoline, while economies 
        overseas in Europe, China and India rely more heavily on crude 
        oil. Since the major oil companies are making more money on 
        distillates, they have shifted refinery production to 
        distillates and shipping this product overseas where they can 
        make 61 cents per gallon on diesel, for example.
            Consequently, there has been less buildup of gasoline 
        inventory from this shift in refinery production in the United 
        States which would have driven down the price of gasoline as a 
        result of current declining demand resulting from a slowing of 
        the economy.
          VII. What can our government do to halt the rising of oil 
        prices in the marketplace when traditional laws of supply and 
        demand are being trumped by the tragic and serious manipulation 
        how then can we as consumers become a factor in reducing oil 
        prices? What can we really do to thwart this seemingly 
        unstoppable rise in oil prices?

                  A. The government must immediately step in. as 
                President Nixon did in the early 70s and impose price 
                controls on the entire oil industry, particularly where 
                it affects United States consumers: at the refinery 
                gross profit level and at the gasoline pump.
                  B. Immediately demand the oil companies to begin 
                using their huge profits and vast resources to begin 
                constructing four and perhaps five refineries in 
                strategic locations throughout the United States. 
                Refineries will assist in production dramatically, 
                lessen the impact of shocks to the flow of oil and 
                gasoline into the economy, and make us more 
                independent.
                  C. Consider the breakup of recent oil mergers 
                mentioned earlier which have caused a complete lack of 
                oil competition and helped contribute to rising oil 
                prices and a downtown turn in the United States 
                economy. For the long term we can encourage Washington 
                to provide funding for the research and development of 
                hydrogen fuel cells which can replace fossil fuel as a 
                source of energy.
                  D. We can take seriously the role of renewable energy 
                in meeting our energy needs by demonstrating a serious 
                attitude to increasing the use of soft energy: solar, 
                biomass, that is, wood, landfill gas and ethanol, for 
                example, hydroelectric energy and wind energy. We can 
                express that attitude in a major effort to change our 
                energy sources. Soft energy accounts for 7% of our 
                total energy sources. We need to double that amount in 
                the next five years and oil prices will drop 
                accordingly.
                  E. We can think conservation by purchasing hybrid 
                automobiles. We can take public transportation in big 
                cities. We can turn off the lights at home and at the 
                office. We can turn down the thermostats at home, We 
                can ride bikes and walk instead of drive. Above all, we 
                need to think about cutting back on our energy usage. 
                If all these efforts come into play, the price of oil 
                will be declining and not rising.
                  F. The United States Senate needs to take a serious 
                look at commodity traders activities to determine if 
                there has been any manipulation of oil commodities 
                which have driven up the price of crude oil.
                                APPENDIX

                   Responses to Additional Questions

                              ----------                              

     Responses of Jeffrey Harris to Questions From Senator Bingaman
    Question 1. Do you disagree that increased market participation of 
institutional investors and increased volatility of oil prices are 
correlated?
    Answer. The Commodity Futures Trading Commission (CFTC) Office of 
the Chief Economist (OCE) agrees that market volatility can be affected 
by different traders in the futures markets. We monitor and measure 
volatility in a number of ways. These include volatility measures using 
daily and intraday prices from futures markets as well as implied 
volatility measures computed from prices in markets for options on 
futures. Generally speaking, we find that volatility in the NYMEX WTI 
Crude Oil contract has been relatively stable over the past five years, 
by each of these measures. While oil prices have been rising, the 
variability of price changes (volatility) on a daily or intradaily 
basis has not been rising concurrently.
    To examine the question of the role and impact of speculative 
activity in price changes from a year ago, OCE has closely tracked 
changes in speculative positions to determine if those changes have 
played a role in pushing prices upwards. We have done this multiple 
times for various time periods. We have not found a consistent 
relationship between the positions that speculators take and subsequent 
price moves, but we continue to closely monitor and test the data.
    Question 2. I am hoping you can further explain the CFTC's position 
on the role of institutional investors on oil prices. We had Guy Caruso 
testify before this committee last month that more than 10% of today's 
oil prices are likely the result of speculation. On Tuesday, we heard 
the major oil companies testify before the House Committee on Energy 
Independence and Global Warming that speculation is an important factor 
in today's high prices. The other five witnesses on this panel make 
compelling cases that institutional investors are playing a key role in 
determining the oil price. Your organization seems to be the lone voice 
arguing that increased market participants investing in commodities 
does not affect the price of those commodities.
    Answer. At the CFTC, we are very aware of the increase in the price 
of crude oil and its impact on Americans. We have also heard the 
statement by some that speculators are the cause of this increase and 
our analysis has looked very closely to try to find evidence of that. 
It is true that all futures market participants impact the overall 
prices of a commodity--that is the very essence of the markets. We are 
rigorously analyzing the markets daily to discover what is driving 
these high prices.
    Using some of the most comprehensive data available to market 
regulators anywhere in the world, OCE has closely examined the buying 
and selling behavior of every group of market participants in crude oil 
futures markets. Based on our analysis of this data, to date, CFTC 
staff economic analysis indicates that broad-based speculative or 
manipulative forces are not driving the recent higher futures prices in 
commodities across-the-board.
    Because our comprehensive data set allows the OCE to know what 
groups of traders are buying and selling each day and we know how 
prices change each day, many of our tests examine the relations among 
position changes by various trading groups, including managed money 
traders (this category includes hedge funds) and swap dealers (who 
bring the growing investments of commodity index funds to our markets). 
OCE has analyzed the behavior of these different trading groups in the 
crude oil markets over numerous time periods to see whether their buy 
and sell activities induce daily price changes in the market. The only 
consistent outcome from these analyses has been that speculative 
traders appear to react to price changes--that is, speculative traders 
will be net buyers in the market on the day following price increases 
and net sellers in the market on the day following price declines.
    We consistently find that crude oil price changes are related only 
to trading arising from groups within our commercial categories (which 
include producers, manufacturers, and others). On days when groups of 
commercial traders are net buyers in the market, subsequent prices 
increase and when these traders are net sellers, prices subsequently 
fall. We consider this evidence that markets are functioning properly. 
Comparing the various participant categories, commercial traders are 
the most likely to consistently have information about the fundamental 
value of oil.
    Question 3. Does the CFTC believe that other commodities are 
similarly unaffected by increased investment? For instance, does the 
CFTC maintain that the price of gold and agricultural commodities is 
affected only by supply and demand for the physical products?
    Answer. Generally speaking, the answer is yes. Based on our 
analysis, OCE believes that futures markets are generally reflecting 
supply and demand conditions for the physical products. The fundamental 
supply and demand conditions in many agricultural markets are very 
tight, and in many of these markets we have seen very high prices. 
Ethanol has increased demand for corn. The USDA projects that 
approximately 30 percent of the current year's corn crop will be used 
to produce ethanol. This demand increase has, by all accounts, resulted 
in higher corn prices. In addition, this demand increase is having 
ripple effects. Land diverted to corn tightens the available supply for 
other crops, raising the prices for those crops as well as inducing 
higher dairy and livestock prices because of the increased costs of 
feed. Poor growing conditions around the world, most especially two 
successive years of drought in Australia, have reduced wheat supplies. 
World demand for agricultural commodities continues to be very strong, 
even in the face of high prices. In addition, other fundamentals such 
as a weak dollar and increased demand from around the world has 
impacted the markets.
    Question 4. According to EIA, the fundamental supply-demand balance 
cannot explain more than $90 of the current price of a barrel of oil. 
How would CFTC explain the difference between that price and today's 
$100+ market prices? Does CFTC feel that it has a more thorough 
understanding of oil market fundamentals than EIA?
    Answer. We are very aware of the increase in the price of crude oil 
and its impact on Americans. We have also heard the statement by some 
that speculators are the cause of this increase and our analysis has 
looked very closely to try to find evidence of that. To date, OCE has 
not seen any analyses or data that point to a particular target price 
for oil. As you know, the CFTC is not a price-setting agency nor do we 
predict prices for commodities, rather the CFTC's mission is to oversee 
and regulate the trading of commodity futures and options in the U.S.--
in which price discovery occurs--and accordingly, our expertise is in 
this area.
    OCE believes the data we collect on a daily basis is adequate for 
supervising the futures markets and oil trading done on those markets. 
We have comprehensive and detailed data on various groups of 
speculators and, based on the buying and selling of these traders, our 
analysis shows little evidence that changes in speculative positions 
are systematically driving up crude oil prices.
    Question 5. Please describe to us the means by which the CFTC goes 
about educating itself on oil market issues. How many staff positions 
are dedicated to oil market issues? Does CFTC regularly engage either 
EIA or private oil market analysts as it seeks to better understand oil 
markets?
    Answer. The CFTC is organized into Divisions with specific areas of 
expertise, including the Office of the Chief Economist, the Division of 
Market Oversight, the Division of Clearing and Intermediary Oversight, 
the Office of the General Counsel, and the Division of Enforcement.
    The Commission program that is most directly involved in oil market 
issues is the Division of Market Oversight (DMO) surveillance program. 
Four economists are assigned to the oil complex as part of their 
surveillance responsibilities. (In addition, supervisors and support 
staff also work on assignments that involve the oil complex.) These 
market surveillance professionals closely and continuously monitor 
trading activity in the petroleum futures markets in order to detect 
and prevent instances of possible price manipulation. Surveillance 
staff members receive daily reports identifying all large long and 
short positions in NYMEX petroleum futures and options-on-futures 
markets. Using these reports, Commission economists monitor trading in 
the petroleum markets, looking for large positions and trading activity 
that reveal attempts to manipulate petroleum prices. In addition, our 
analysts monitor prices and price relationships, looking for price 
distortions evidencing manipulation. They also maintain close awareness 
of supply and demand factors and other developments in the petroleum 
markets through review of trade publications, and through industry and 
exchange contacts. CFTC surveillance staff routinely reports to the 
Commission on surveillance activities at weekly market surveillance 
meetings, including information about market fundamentals and 
monitoring of trading activity throughout the markets. In addition, 
surveillance staff, who continually monitor the markets for potential 
problems, will immediately alert the Commission and senior staff 
whenever there are significant, time-sensitive developments in the 
markets. Staff of the Energy Information Administration (EIA) has 
attended these surveillance meetings on several occasions. DMO also 
consults with relevant government agencies (such as EIA in the case of 
energy products), commercial participants (such as oil producers, 
consumers and marketers), and independent analysts and information 
providers (such as Platts or OPIS in the case of energy products).
    In addition, the Division of Enforcement (DOE) has a successful 
history of investigating and prosecuting energy cases. It currently has 
more than a dozen ongoing crude oil manipulation investigations. In the 
process of investigating energy cases, DOE trains its professionals on 
the various nuances of the market. Furthermore, in certain situations, 
DOE hires professional experts to assist in fully exploring both 
physical and derivative trading issues.
    In the other Divisions, staff work on a range of different market 
issues, including issues involving crude oil. Generally speaking, the 
CFTC employs a number of economists, surveillance experts, attorneys, 
enforcement investigators, and IT professionals who collectively work 
on crude oil market issues such as surveillance, new product approval, 
financial integrity, data gathering and analysis, and enforcement.
    Question 6. If CFTC believes that oil markets tightness alone 
justifies the current $100+ oil price, I would think that your 
organization must also believe that removing 70 thousand barrels per 
day from the market to add to the Strategic Petroleum Reserve is adding 
to upward price pressure. Could you tell us how much your organization 
believes the SPR fill is adding to the price of oil?
    Answer. Commission staff has not undertaken an analysis of the 
effect on the cash market for crude oil of removing 70 thousand barrels 
per day from crude supplies. The Commission's exclusive jurisdiction 
and thus the primary focus of its regulatory activities centers on the 
trading of commodity futures and options, rather than the physical 
market. The CFTC's mission is two-fold: to protect the public and 
market users from manipulation, fraud, and abusive practices; and to 
ensure open, competitive and financially sound markets for commodity 
futures and options. As part of our efforts to prevent manipulation, we 
monitor cash market information as part of our ongoing surveillance of 
futures markets, such as the NYMEX crude oil futures market. As a 
starting point for cash market information on crude oil, we typically 
look to the EIA.
    Question 7. It is my understanding that your organization has 
concluded that there is no relationship between increased market 
participation and increasingly volatile oil prices because you have not 
found a statistically-verified causal relationship. It strikes me that 
causality is very difficult to prove with statistics, and I suspect 
that no single variable could pass that test at the moment. Have you 
run similar kinds of statistical analyses on other single variables 
influencing oil prices--such as OPEC production decisions, or inventory 
levels--and compared the results?
    Answer. While I agree that statistically-verifiable causal 
relations can often be difficult to demonstrate, I am confident that 
OCE's analysis is rigorous. Noisy data and small data sets often lead 
to low power tests--the idea that a test may not be able to uncover a 
relation that actually exists, for example. As I have noted, however, 
our tests have uncovered statistically verified relations between 
groups of commercial traders and price changes, suggesting to me that 
our analysis is thorough and accurate. We have also taken steps to 
ensure our conclusions are rigorous, measuring positions of various 
combined groups (all non-commercial participants lumped together, for 
instance) and measuring the relation between speculative positions and 
price changes over different time periods (ranging from the late 1990s 
through the present) and over various futures contracts (examining 
positions in the nearby contract alone, positions in the nearby 
contract and the next month contract combined, etc.).
    The CFTC's mission is to oversee and regulate the trading of 
commodity futures and options in the U.S., and as such our focus and 
expertise is in that area. While we monitor inventory levels, spot 
market developments and other macroeconomic factors, our analysis has 
not included a similarly rigorous look at macroeconomic data.
    Question 8. Does your organization believe that it has sufficient 
oversight and regulatory authority to fully understand oil market 
trading activity? Can you have a complete picture of the market without 
data on trade in over-the-counter markets?
    Answer. As stated in testimony approved by the Commission and given 
before the Senate Homeland Security and Governmental Affairs Committee 
on May 20, 2008, ``The Commission has the authority it needs to 
continue to work to promote competition and innovation, while at the 
same time, fulfilling our mandate under the Commodity Exchange Act to 
protect the public interest and to enhance the integrity of U.S. 
futures markets.''
    There are amendments to the CEA that are now part of the Farm Bill 
conference report that largely reflect the Commission's recommendations 
on the need for some additional tools to oversee trading done on Exempt 
Commercial Markets, as well as the imposition of self-regulatory 
obligations on these markets. These provisions represent bipartisan 
efforts to find the right balance of enhanced market oversight and 
transparency while promoting market innovation and competition. 
Additionally, the Commission's anti-fraud authority over the 
transactions on these markets will be clarified and strengthened. 
Finally, the penalties that may be imposed for violating the anti-
manipulation prohibitions of the CEA will be raised from $100,000 to 
$1,000,000 per violation. The Commission strongly supports this 
legislation that would give it additional necessary oversight of the 
markets, particularly energy trading.
    The central focus of the Commission's oversight of oil market 
trading activity is, by mandate of the Commodity Exchange Act (CEA), 
futures trading activity in oil-related contracts on CFTC-regulated 
exchanges. The Commission does not have any direct regulatory authority 
over domestic or foreign oil cash markets, bilateral OTC oil 
derivatives transactions or oil futures contracts traded on foreign 
boards of trade.
    The CFTC's ability to monitor oil futures contracts traded on CFTC-
regulated markets, such as NYMEX's benchmark West Texas Intermediate 
(WTI) crude oil futures contract, is extremely robust. Traders with 
positions in regulated exchange contracts like the WTI contract are 
subject to a daily reporting requirement when their positions exceed a 
Commission-set ``large'' position threshold. Large trader position 
reporting enables CFTC staff to detect whether such traders may be 
engaging in manipulative conduct. Current position reporting thresholds 
ensure that about 85-90% of the outstanding open interest in any 
contract is subject to reporting. When the CFTC's surveillance staff 
finds that a trader's market behavior is troublesome, it has a number 
of available powers to correct the condition, including the forced 
liquidation of the trader's position.
    In addition to large trader position reports, the Commission also 
receives daily transaction data from all of its regulated exchanges. 
This data provides a complete audit trail of all trades that occur in 
the contracts listed on those exchanges. The CFTC's surveillance staff 
uses this data to closely scrutinize trading activity, especially 
during key trading periods such as the final trading day of a contract.
    Of course, with respect to oil products traded on CFTC-regulated 
exchanges such as NYMEX, the exchanges themselves have independent 
obligations, under Section 5 of the CEA, to actively monitor their 
contracts for manipulation and other abusive conduct and to takes steps 
to prevent such behavior. Given their mutual obligations and interests 
in this area, staff of the Commission and the exchanges traditionally 
work very closely together and buttress each other's efforts in 
deterring and detecting problematic conduct.
    Although the Commission does not have any direct regulatory 
authority over domestic or foreign oil cash markets, bilateral OTC oil 
derivatives transactions or oil futures contracts on foreign boards of 
trade, it does have tools that enable it to see a wide swath of 
activity in these markets. For instance, many bilateral OTC oil 
derivatives transactions are executed through voice brokers and brought 
to NYMEX's Clearport facility for clearing. Because all positions 
cleared through Clearport are subject to the Commission's large trader 
reporting requirements, the CFTC has a significant insight into who is 
holding large OTC oil derivatives positions at any one time.
    The Commission is likewise able to learn information about activity 
off of its regulated markets by virtue of the requirement that traders 
who are subject to the large trader reporting requirement in an 
exchange-listed futures contract, like the NYMEX WTI contract, must 
make available to the Commission, upon request, any pertinent 
information with respect to all other positions and transactions in the 
commodity in which the trader has a reportable position. This 
information can include, for instance, the trader's positions on other 
reporting markets, OTC positions held pursuant to any of the CEA's 
exemptive or excluding provisions, positions held on exempt commercial 
markets or exempt boards of trade, and positions held on foreign boards 
of trade.
    To the extent that a Foreign Board of Trade (FBOT) with direct 
access to US-based members lists any contract that settles off of the 
settlement price of a contract listed on a CFTC-regulated exchange, the 
Commission's policy has been to establish information-sharing 
arrangements with that FBOT or its regulator to gain position 
information about the linked contract. For example, ICE Futures Europe 
trades a WTI crude oil futures contract that settles off the benchmark 
NYMEX WTI contract. Accordingly, the CFTC has an information--sharing 
arrangement with the UK's Financial Services Authority (FSA) so that 
CFTC staff receives on a weekly basis position reports for the ICE 
Futures Europe WTI crude oil futures contract. During the last week of 
trading, the position data is reported on a daily basis. With this 
information, CFTC surveillance staff knows the positions and identities 
of members/customers who meet or exceed position-reporting requirement 
levels in the ICE Futures Europe WTI contract, and considers that data 
along with the large trader reporting information that it receives from 
NYMEX for its WTI contract.
    Question 9. Could you comment on whether the reporting requirements 
for the NYMEX could offer a competitive advantage to trading platforms 
that are not similarly regulated--such as foreign exchanges, or over-
the-counter markets?
    Answer. There is no indication that the reporting requirements for 
NYMEX offer a competitive advantage to trading platforms that are not 
similarly regulated. Reporting requirements are a necessary component 
of a good market surveillance program and are designed to prevent such 
problems as manipulation and artificial pricing. In October 2007, the 
Commission amended its Rule 18.05 to make explicit that ``reportable 
traders'' in the regulated futures markets must disclose all their OTC 
positions, as well as their cash market and forward market positions, 
in response to a request from the Commission. See Maintenance of Books, 
Records and Reports by Traders, 72 Fed. Reg. 60767 (October 26, 2007). 
In doing so, the Commission asserted that it was highly speculative to 
conclude, and very unlikely, that market participants would move their 
trading activity to unregulated or non-transparent venues, or trade at 
a level below the reportable level on the regulated exchange, in order 
to avoid the consequences of holding positions that were reportable to 
the CFTC. The Commission also noted that as traders in the OTC markets 
have become more aware of credit considerations and the benefits of 
transparency, they have been moving their positions onto exchanges 
where the exchange clearinghouse enhances creditworthiness, the market 
is transparent and reporting requirements are in place. Finally, it 
should be noted that some FBOTs, including ICE Futures Europe (which is 
regulated by the FSA), also impose position reporting requirements. 
Therefore, we believe that it would be highly unlikely that a trader 
would elect to trade a futures contract on ICE Futures Europe rather 
than on NYMEX solely because of reporting requirements.
     Responses of Jeffrey Harris to Questions From Senator Domenici
    Question 1. In your testimony, there are several charts that 
reference trading on the New York Mercantile Exchange. Do you have any 
information or data on transactions occurring on the Intercontinental 
Exchange?
    Answer. Yes. Although the CEA does not currently provide for direct 
CFTC regulatory oversight over activity on exempt commercial markets 
(ECMs), such as the Intercontinental Exchange of Atlanta (ICE), the 
CFTC does have the ability to collect considerable information 
regarding trading activity on these markets.
    Under CFTC Rule 36.3, ECMs are required to provide the CFTC with 
transaction data for those contracts that average five or more trades 
per day. This required data is essentially a contract's trade register 
reflecting the specifics of each trade executed in the contract, 
including the quantity, price and execution time for each transaction. 
This data must be provided to the CFTC by way of a weekly report 
reflecting the daily trading registers for the preceding week. CFTC 
staff currently receives trade register data for a number of contracts 
traded at ICE, as well as for contracts at other ECMs.
    In addition, the CEA provides the Commission with the authority to 
issue special calls to ECMs for certain purposes, including obtaining 
data that it deems necessary to enforce the anti-manipulation 
prohibition applicable to ECM transactions. In the case of ICE, the 
CFTC's Division of Market Oversight has issued three special calls 
requiring ICE to provide ongoing information related to its cleared 
natural gas swap contracts that are cash-settled based on the NYMEX 
physical delivery natural gas contract. In each case, the information 
requested has been analogous to information that the CFTC receives from 
regulated futures exchanges, including NYMEX.
    As noted above, Congress recently approved the Farm Bill conference 
report which contains, among other things, legislative provisions 
recommended by the Commission to require large trader position 
reporting for significant price discovery contracts on ECMs, require 
ECMs to adopt position limits or accountability levels for such 
contracts, impose self-regulatory responsibilities on ECMs with respect 
to significant price discovery contracts and establish CFTC emergency 
authority over these contracts. We are hopeful that this legislation is 
enacted soon to give CFTC these additional and necessary authorities.
    Question 2. To what extent does different regulatory treatment of 
the U.S. futures exchange as compared to the over the counter market, 
contribute to higher crude oil prices?
    Answer. The CFTC Office of the Chief Economist (OCE) analyzes some 
of the most comprehensive data available on trading in futures markets. 
Although there exists a large and robust market for over-the-counter 
trading in crude oil, the growing volume of trading on NYMEX suggests 
that U.S. futures exchanges are successfully offering contracts that 
are attractive to the marketplace. We find little evidence that changes 
in speculative positions are systematically driving up crude oil prices 
in these markets. Increased trading activity usually indicates a good 
level of liquidity in the marketplace. In turn, greater liquidity 
usually reflects more accurate prices. The OCE has no evidence that 
different regulatory treatment of exchange-traded futures contracts and 
OTC contracts leads to higher prices. Indeed, the U.S. regulatory 
structure in this area has remained largely unchanged during the past 
decade and yet oil prices have gone up, down and remained steady at 
various time during this period.
    Question 3. Can you quantify the number of commercial versus non-
commercial investors in the trading of oil contracts?
    Answer. Yes, the Commission receives daily reports on all large 
traders in all regulated futures markets. For the NYMEX WTI Crude Oil 
futures contract, these reports account for about 97 percent of the 
long open interest and 96 percent of the short open interest. On April 
22, 2008, there were 299 non-commercial traders in this market, who 
held 40 percent of the long and 35 percent of the short open interest, 
respectively. On this same date, there were 123 commercial traders, who 
held 58 percent of the long and 62 percent of the short open interest, 
respectively.
    Question 4. he characteristics of the typical commodity investor 
are changing. In your opinion, do you think this is beneficial for the 
market? Why or Why not? And what impact has it had on the price of 
crude oil?
    Answer. Markets, in general, provide more accurate prices when 
participation is high. As noted above, increased participation usually 
indicates a good level of liquidity in the marketplace, which, in turn, 
typically generates more accurate prices. Indeed, the increased 
participation in crude oil futures markets has been a positive 
development in our ability to monitor and surveil these markets. The 
CFTC's Division of Market Oversight (DMO) collects data on participant 
behavior precisely because we are concerned about the prospect for 
manipulation and other abuses in our markets. The addition of, or 
growth in, any group of market participants is closely monitored by 
CFTC staff in this light. The growth in commodity index trading in 
these markets has been largely mirrored by growth in commercial trading 
activity as well, and we continue to see a healthy mix of commercial 
and non-commercial activities in oil futures markets. Given the fact 
that we find little evidence that changes in speculative positions are 
systematically driving up crude oil prices in these markets, we see 
benefits but do not see corresponding negative implications of this 
growth.
    Question 5. What type of additional regulation, or oversight, of 
energy commodities trading would be the most damaging or most 
beneficial, to the interests of the U.S. consumer?
    Answer. Congress recently approved the Farm Bill conference report 
which contains, among other things, legislative provisions recommended 
by the Commission to give the agency additional regulatory and 
enforcement tools necessary to continue to effectively oversee the 
futures industry. Among other things, the legislation would provide the 
agency with essential oversight over contracts trading on Exempt 
Commercial Markets (ECMs)--a type of electronic trading facility 
offering (among other things) energy derivatives products. Under 
current law, ECMs are not subject to full CFTC regulatory authority. 
The new legislation outlines criteria for when an ECM contract should 
be considered a significant price discovery contract (SPDC) and gives 
the CFTC the authority to require large trader position reporting for 
SPDCs; require an ECM to adopt position limits or accountability levels 
for SPDCs; require an ECM to exercise self-regulatory responsibility 
over SPDCs in order to prevent manipulation (among other things); 
exercise emergency authority regarding SPDC transactions. We are 
hopeful that this legislation is enacted soon to give the CFTC these 
additional and necessary authorities.
    From my vantage point as the Commission's Chief Economist, the 
futures markets are functioning as intended--to provide risk management 
and price discovery for market participants. Any policy that would 
adversely affect these critical functions may have unintended 
consequences harmful to consumers. Competitive and open future markets 
require both hedgers and speculators so that commercial interests can 
hedge their commodity price risks and businesses can rely on discovered 
prices to plan and commit resources as needed.
    Question 6. What regulatory policies need to be implemented to 
assure the competitive workings of energy derivative markets?
    Answer. As discussed above, the CFTC is an independent agency with 
the mandate to regulate commodity futures and option markets in the 
United States. Broadly stated, the CFTC's mission is two-fold: to 
protect the public and market users from manipulation, fraud, and 
abusive practices; and to ensure open, competitive and financially 
sound markets for commodity futures and options. The Commission 
utilizes a principles-based regulatory structure. We rely on self-
regulation with rigorous federal oversight, which has a long history of 
ensuring properly functioning futures markets. Nevertheless, when 
abuses come to the attention of the Commission, they have been 
investigated and the appropriate enforcement actions taken. The 
Commission has very broad enforcement authority and during the past 
seven years the Commission has brought enforcement actions against 
Enron and BP, dozens of other energy companies, and more than one 
hundred energy traders. A list of cases filed by the Commission in the 
energy sector is attached. These cases were based on violations of the 
CEA ranging from manipulation to attempted manipulation and 
manipulative acts such as false price reporting.
    As noted above, Congress recently approved the Farm Bill conference 
report which contains, among other things, CFTC legislative provisions 
recommended by the Commission to require large trader position 
reporting for SPDCs on ECMs, require ECMs to adopt position limits or 
accountability levels for SPDCs, impose self-regulatory 
responsibilities on ECMs with respect to SPDCs, and establish CFTC 
emergency authority over these contracts. We are hopeful that this 
legislation is enacted soon to give CFTC these additional and necessary 
authorities.
    Question 7. Earlier this week the Secretary of Treasury, Henry 
Paulson put forth a proposal to combine the Securities Exchange 
Commission and the CFTC. Does the CFTC support or oppose this proposal? 
What impact if any would this proposal have on the commodity markets?
    Answer. The Commission has not issued a statement opposing or 
supporting the recommendations of the Secretary of the Treasury's 
``regulatory blueprint.''
    CFTC Acting Chairman Walt Lukken has made the following statement 
in response to the blueprint:

          It is essential to examine ways to enhance the 
        competitiveness of U.S. financial markets and seek improvements 
        to the regulatory structure. Policymakers all strive for good 
        government solutions that protect the public, reduce 
        duplication and enhance competition and innovation. While I am 
        still studying the Blueprint's many recommendations, I applaud 
        Secretary Paulson and the Treasury Department for their work on 
        this critical undertaking and for recognizing the CFTC model of 
        regulation as an advantageous one.
          The CFTC utilizes a flexible and risk-tailored approach to 
        regulation aimed at ensuring consumer protection and market 
        stability while encouraging innovation and competition. 
        Congress gave the CFTC these powers with the passage of the 
        Commodity Futures Modernization Act (CFMA) in 2000, which 
        shifted the CFTC's oversight from a rules-based approach to one 
        founded on principles. This prudential style is complemented by 
        strong enforcement against market abuse and manipulation as 
        evidenced by the $1 billion worth of penalties assessed by the 
        CFTC since the CFMA. The regulatory balance fostered by the 
        CFMA has enabled the futures industry to thrive and gain market 
        share on its global competitors with volumes on the U.S. 
        futures exchanges increasing over 500 percent since 2000. 
        During recent economic stress, these risk-management markets 
        have performed well in discovering prices and providing 
        necessary liquidity.

    At this stage, it is somewhat preliminary to state what impact the 
proposal could have on the commodity markets. Notably, the blueprint 
recommends that the SEC adopt a principles-based regulation of 
securities exchanges and clearing organizations modeled after the 
CFTC's principles-based approach, before contemplating combining the 
agencies.
      Responses of Jeffrey Harris to Questions From Senator Tester
    Question 1. Oversight is only as good as the information available 
to the overseers. As the chief economist of the CFTC, do you have all 
the information necessary to ensure that speculators cannot 
significantly affect the price of oil, irrespective of the market it is 
traded on? If not, what can we do to make sure you have all the 
information you need?
    Answer. As stated in testimony approved by the Commission and given 
before the Senate Homeland Security and Governmental Affairs Committee 
on May 20, 2008, ``The Commission has the authority it needs to 
continue to work to promote competition and innovation, while at the 
same time, fulfilling our mandate under the Commodity Exchange Act to 
protect the public interest and to enhance the integrity of U.S. 
futures markets.''
    There are amendments to the CEA that are now part of the Farm Bill 
conference report that largely reflect the Commission's recommendations 
on the need for some additional tools to oversee trading done on Exempt 
Commercial Markets, as well as the imposition of self-regulatory 
obligations on these markets. These provisions represent bipartisan 
efforts to find the right balance of enhanced market oversight and 
transparency while promoting market innovation and competition. 
Additionally, the Commission's anti-fraud authority over the 
transactions on these markets will be clarified and strengthened. 
Finally, the penalties that may be imposed for violating the anti-
manipulation prohibitions of the CEA will be raised from $100,000 to 
$1,000,000 per violation. The Commission strongly supports this 
legislation that would give it additional necessary oversight of the 
markets, particularly energy trading.
    The central focus of the Commission's oversight of oil market 
trading activity is, by mandate of the CEA, futures trading activity in 
oil-related contracts on CFTC-regulated exchanges. The Commission does 
not have any direct regulatory authority over domestic or foreign oil 
cash markets, bilateral OTC oil derivatives transactions or oil futures 
contracts traded on foreign boards of trade.
    The CFTC's ability to monitor oil futures contracts traded on CFTC-
regulated markets, such as NYMEX's benchmark WTI crude oil futures 
contract, is extremely robust. Traders with positions in regulated 
exchange contracts like the WTI contract are subject to a daily 
reporting requirement when their positions exceed a Commission-set 
``large'' position threshold. Large trader position reporting enables 
CFTC staff to detect whether such traders may be engaging in 
manipulative conduct. Current position reporting thresholds ensure that 
about 85-90% of the outstanding open interest in any contract is 
subject to reporting. When the CFTC's surveillance staff finds that a 
trader's market behavior is troublesome, it has a number of available 
powers to correct the condition, including the forced liquidation of 
the trader's position.
    In addition to large trader position reports, the Commission also 
receives daily transaction data from all of its regulated exchanges. 
This data provides a complete audit trail of all trades that occur in 
the contracts listed on those exchanges. The CFTC's surveillance staff 
uses this data to closely scrutinize trading activity, especially 
during key trading periods such as the final trading day of a contract.
    Of course, with respect to oil products traded on CFTC-regulated 
exchanges such as NYMEX, the exchanges themselves have independent 
obligations, under Section 5 of the CEA, to actively monitor their 
contracts for manipulation and other abusive conduct and to takes steps 
to prevent such behavior. Given their mutual obligations and interests 
in this area, staff of the Commission and the exchanges traditionally 
work very closely together and buttress each other's efforts in 
deterring and detecting problematic conduct.
    Although the Commission does not have any direct regulatory 
authority over domestic or foreign oil cash markets, bilateral OTC oil 
derivatives transactions or oil futures contracts on foreign boards of 
trade, it does have tools that enable it to see a wide swath of 
activity in these markets. For instance, many bilateral OTC oil 
derivatives transactions are executed through voice brokers and brought 
to NYMEX's Clearport facility for clearing. Because all positions 
cleared through Clearport are subject to the Commission's large trader 
reporting requirements, the CFTC has a significant insight into who is 
holding large OTC oil derivatives positions at any one time.
    The Commission is likewise able to learn information about activity 
off of its regulated markets by virtue of the requirement that traders 
who are subject to the large trader reporting requirement in an 
exchange-listed futures contract, like the NYMEX WTI contract, must 
make available to the Commission, upon request, any pertinent 
information with respect to all other positions and transactions in the 
commodity in which the trader has a reportable position. This 
information can include, for instance, the trader's positions on other 
reporting markets, OTC positions held pursuant to any of the CEA's 
exemptive or excluding provisions, positions held on exempt commercial 
markets or exempt boards of trade, and positions held on foreign boards 
of trade.
    To the extent that a Foreign Board of Trade (FBOT) with direct 
access to US-based members lists any contract that settles off of the 
settlement price of a contract listed on a CFTC-regulated exchange, the 
Commission's policy has been to establish information-sharing 
arrangements with that FBOT or its regulator to gain position 
information about the linked contract. For example, ICE Futures Europe 
trades a WTI crude oil futures contract that settles off the benchmark 
NYMEX WTI contract. Accordingly, the CFTC has an information-sharing 
arrangement with the UK's Financial Services Authority (FSA) so that 
CFTC staff receives on a weekly basis position reports for the ICE 
Futures Europe WTI crude oil futures contract. During the last week of 
trading, the position data is reported on a daily basis. With this 
information, CFTC surveillance staff knows the positions and identities 
of members/customers who meet or exceed position-reporting requirement 
levels in the ICE Futures Europe WTI contract, and considers that data 
along with the large trader reporting information that it receives from 
NYMEX for its WTI contract.
    Question 2. Is there any practical reason that the Enron loophole 
should not be closed immediately? Is there any reason that oil futures 
should be exempted from any CEA requirements, irrespective of the 
market they are traded on?
    Answer. With respect to the first question: No. Adoption of 
amendments to the CEA contained in the Farm Bill conference report, 
recently approved by the House and Senate, will close what some have 
referred to as the ``Enron Loophole.
    With respect to the second question: Oil contracts traded on 
regulated futures exchanges are subject to all the regulatory 
requirements outlined in the CEA. The CFTC amendments that are part of 
the Farm Bill conference report would require that any ECM contracts 
that serve a significant price discovery function be subject to 
regulatory requirements comparable to those that govern trades on CFTC-
regulated exchanges.
    Question 3. Are there any tools or authorities that could be given 
to the CFTC to better enable your organization to ensure both that the 
price of oil reflects the true market signals of supply and demand, and 
that there will not be a significant over investment, in the form of an 
oil bubble, that could put our economy or energy security at risk? Is 
your organization sufficiently capable of preventing over speculation 
and future oil bubbles?
    Answer. As discussed above, the CEA amendments that are part of the 
Farm Bill conference report would significantly enhance Commission 
oversight over the trading of significant price discovery contracts on 
ECMs. The Farm Bill amendments would thereby strengthen market 
surveillance, and also include separate provisions that would enhance 
CFTC anti-fraud coverage and penalties.
    The CFTC has several tools in place to prevent ``over 
speculation.'' The Commission has utilized its authority to set limits 
on the amount of speculative trading that may occur or speculative 
positions that may be held in contracts for future delivery. The 
speculative position limit is the maximum position, either net long or 
net short, in one commodity future (or option), or in all futures (or 
options) of one commodity combined, that may be held or controlled by 
one person (other than a person eligible for a hedge exemption) as 
prescribed by a regulated futures exchange and/or by the Commission.
    In conjunction with CFTC efforts, the exchanges themselves have 
independent obligations, under Section 5 of the CEA, to actively 
monitor their contracts for manipulation and other abusive conduct and 
to takes steps to prevent such behavior. Given their mutual obligations 
and interests in this area, Commission staff and the exchanges 
traditionally work very closely together and buttress each other's 
efforts in deterring and detecting problematic conduct.
    As part of its ongoing surveillance program, Commission staff 
monitor daily large-trader reports to ensure compliance with Commission 
and exchange position limits. In order to achieve the purposes of the 
speculative position limits, both the Commission and exchanges treat 
multiple positions on an exchange that are subject to common ownership 
or control as if they were held by a single trader. Accounts are 
considered to be under common ownership if there is a 10 percent or 
greater financial interest. The rules are applied in a manner 
calculated to aggregate related accounts.
    Question 4. Do you see increased trading of oil futures following 
events that may decrease the supply of oil, such as geopolitical events 
or natural disasters? Do these tend to be driven by the users/producers 
of oil or by the noncommercial investors? If they are driven by the 
noncommercial investors, would this be considered excessive 
speculation?
    Increased trading in oil futures markets does indeed result from 
fundamental supply and demand factors like natural disasters and 
geopolitical events. As risks increase around the world, commercial 
entities that rely on oil supplies extend their risk management 
operations further into the future. Recent research by the CFTC's 
Office of the Chief Economist highlights the fact that crude oil 
futures contracts now trade out beyond 8 years, whereas the longest-
term contracts in 2000 were only 4 years in duration. Participation in 
these longer-term contracts indicates that commercial traders are 
looking to lock in future delivery prices in an uncertain environment. 
Furthermore, in our research, non-commercial traders (including hedge 
funds) were largely net sellers in contracts beyond 4 years, suggesting 
that non-commercial traders are not speculating that oil prices will 
rise further.
                                 ______
                                 
       Responses of Kevin Book to Questions From Senator Bingaman
    Question 1. Do you disagree that increased market participation of 
institutional investors and increased volatility of oil prices are 
correlated?
    Answer. I do not dispute the positive correlation between rising 
noncommercial volumes and increased volatility, but due to the nature 
and motivation of noncommercial trading, I do not think the correlation 
is sufficient to suggest a causal link and I would suggest that reverse 
causation is possible and even likely. Traders who participate in 
commodities markets are attracted to volatility. Entire classes of 
institutional investors pursue ``special situations'' characterized by 
risk and uncertainty as a way to diversify their funds under management 
away from conventional market moves. They may be pursuing the oil 
market with greater interest as a result of uncertainty and price 
volatility derived from non-financial events.
    Question 2. I'd like to explore your statement that many 
institutional investors see the current price as evidence of the theory 
that we have reached the global peak oil production capacity. This 
strikes me as somewhat circular, in the sense that institutional 
investors are pushing the oil price upward, and then seeing that price 
increase as evidence of tight fundamentals, which then pushes the price 
further upwards. Is it your sense that the institutional investors, on 
balance, believe that we have reached peak oil production capacity? How 
important is this perception in the current marketplace?
    Answer. You are correct, Senator, that I intended to suggest a 
circularity--investors responding to price signals by investing and, in 
turn, perpetuating price signals--because that is the nature of the 
feedback loop that can underlie market bubbles. Your questions are 
extremely prescient because they get to the heart of what investors do. 
Investors make money buying and selling securities, not underlying 
fundamentals. Sometimes it can be more important to short-term 
investors to know what the market will do next than it is to know what 
the underlying fundamentals of the market are, or should be. In 
investment parlance, those who argue fundamentals in the face of market 
dynamics are often said to be ``fighting the tape''--because the nature 
of free and open markets is that they can fall prey to mobs. I do not 
believe that many of the better-educated, more-experienced investors I 
serve are convinced we are at either a geological or logistical 
``peak'' in global oil production, however, and many have expressed 
their reticence to reposition their portfolios as if this were the 
case. If more long-term, large-scale investors were convinced we had 
arrived at peak oil, I would suggest that the stocks of alternative 
fuels companies--ethanol producers, coal-to-liquids names, natural gas 
fueling services, as well as companies with advantages in alternative 
fuels, like Shell and ChevronTexaco--might have displayed tremendous 
appreciation relative to the market. This has not yet occurred.
    Question 3. You point out that oil is the most widely traded 
commodity in the world, as evidence that the oil market is not over-
saturated. While it is certainly true that oil is the most actively 
traded commodity, it is also still a small fraction of the equities 
market. It seems to me that a small percentage of equities investment 
moving into commodity markets is still a lot of new activity for the 
commodity markets. Could you elaborate on why you believe that oil 
markets are not saturated?
    Answer. I offer the volume of oil trading as evidence of market 
complexity, not as a comment on its saturation. My view that the oil 
market is not oversaturated derives from the size of the market eight 
years into the future relative to its size today--the oil market can 
hold about 100 times more money than it currently does. The out years 
in the market are less widely invested than contracts with nearer-term 
expiry dates. My computation in preparation for the hearing was that 
the open interest in NYMEX crude had an average expiration of 11.59 
months. Listed equities have far greater value than commodities, but it 
seems premature to conclude that wealth transfer from commodities will 
continue indefinitely. At higher prices, it gets more expensive to buy 
oil contracts. Selling out of stocks to generate those funds would 
cause prices of those stocks to fall. Before long, those cheaper 
stocks--some of which include reserves owned by investor-owned 
companies--might be better investments than crude itself, and funds 
flow could reverse.
    Question 4. How long do you see this strong relationship between 
the dollar and the price for oil remaining in tact? And, is it safe to 
say that this relationship would not be as strong without the 
proliferation of institutional investors in the oil market?
    Answer. I believe the inverse relationship between the U.S. dollar 
and oil futures is likely to continue as long as oil trades in dollars, 
for reasons that have much more to do with the investment needs of oil 
producers than the behaviors of non-commercial traders. Ultimately, the 
currency-adjusted value of oil sales must pay the oil producer's costs 
plus a reasonable return on investment. Middle-Eastern oil producers 
procure services, labor and products for related and supporting sectors 
of their economies in other currencies, including Euros and Pounds. 
They also continue to peg their native currencies to the U.S. dollar, 
not least because a large portion of their national wealth is held in 
dollars and dollar-denominated instruments. A falling dollar makes it 
more expensive for oil producers to produce oil and diminishes the 
value of their national wealth, ultimately encouraging producers to 
demand a higher price to maintain parity with expectations. I would not 
conclude that institutional investors necessarily accelerate the rise 
of crude vis-`-vis the dollar's fall; slower demand and a weaker 
currency basket in Europe could lower producers' indifference point at 
the same time that non-commercial traders sell oil futures.
    Question 5. Historically, we've become accustomed to thinking of 
high oil prices causing recessions. It seems that this time, we might 
well be seeing a recession that--through a weak dollar and weak 
financial markets--is causing high oil prices. In your opinion, would a 
more healthy U.S. economy, with a stronger currency and a lower risk of 
inflation, likely result in lower oil prices?
    Answer. The challenge of macroeconomic analysis of oil markets is 
the breadth of subject matter. I am no expert on government fiscal 
policy and would be hesitant to predicate my answer on the notion that 
a recession is causing high oil prices. In general, it is reasonable to 
believe that healthy economies consume more oil. On the other hand, it 
would be imprudent to discount the structural shift in consumer 
behaviors likely in the event of a sustained recession and full 
economic recovery. Drivers who feel the pinch of high prices now are 
likely, based on historical precedent, to switch into higher-efficiency 
cars when next they can afford to purchase them. Those cars might be on 
the road 10-15 years given the high quality of today's fleet and the 
policy changes to fuel economy standards enacted by this Committee. In 
this case, you might see a growing economy with flat and potentially 
even declining oil demand. Whether or not this would offset demand in 
other regions of the world, however, remains unclear. Countries without 
market prices for energy often rely on subsidies to maintain civil 
order, and consumption would need to slow everywhere--a likely outcome 
of a recession that spreads from the U.S. to its trade partners, not a 
global recovery--for demand effects to bring prices down.
       Responses of Kevin Book to Questions From Senator Domenici
    Question 1. Is there any benefit to the market for allowing non-
commercial investors (speculators) to participate? Do they lead or do 
they follow?
    Answer. Non-commercial investors generally make transactions 
cheaper. At the theoretical extreme, without non-commercial dollars, 
either the buyer or seller of oil would either sign longer-term 
contracts or put more money into every transaction. Longer-term 
contracts would give market power to sellers in this time of scarcity 
and could lead to high prices even if oil and oil products demand 
slowed. Putting more money into every transaction (either because the 
oil seller would need to borrow money for operations rather than 
selling forward or because the oil buyer would need to put the money up 
front first) would increase the cost of transactions even if interest 
costs were the only factor (about a 5% surcharge at a 10% cost of 
capital and the 11.59 months' average contract life, but potentially 
much, much more). As to your second question, speculation of any kind 
theoretically requires investors to ``lead'' because they are betting 
on their expectations of the future, but many of those expectations can 
be informed by past performance--rightly or wrongly--so it would be 
fair to say that non-commercials both lead and follow.
    Question 2. What would happen to the price for oil if the ability 
of non-commercial investors to participate in the market was limited?
    Answer. I would expect the price to rise somewhat, but the effect 
would depend on the extent of the limits. My prior reply addresses the 
range of potential price effects at the logical extreme--somewhere 
between 5% cost of capital effect and perhaps a 100-fold price increase 
if each barrel sold today incorporated every noncommercial dollar (both 
ends of the range are unlikely). Any incremental change to the margin 
requirement or participation rules might produce subtle effects that 
might take anywhere from one year to eight years to play out given the 
extent to which the market is invested into the future.
    Question 3. Does the trading of oil derivatives benefit the 
American consumer, and if so, how?
    Answer. In my view, the American consumer benefits from oil 
derivatives trading in two principal ways. First, refiners can buy 
options for oil to hedge against price and supply disruptions. Second, 
oil sellers--many of whom are publicly traded companies--earn income 
from derivatives sales that pass through to common shareholders, 
including American consumers.
    Question 4. Some analysts see financial flows continually moving 
from the stock market to commodity markets, seeking the best return at 
the lowest risk. If this is an accurate characterization of the futures 
market, to what extent does it raise the average price and volatility 
of crude oil?
    Answer. I echo the conviction that asset managers will always, in 
the long run, allocate investment capital to its highest-return, risk-
adjusted use, but there are short-term limits to the merchantability of 
different classes of securities, and investors who are chasing returns 
in any one asset class--whether it be stocks in general, stocks of a 
certain type, bonds, venture investment, real estate or commodities--
may discover that rising prices lower returns and uncertain ``exit'' 
windows make the commodities markets unattractive for more than a small 
portion of their funds under management.
        Responses of Kevin Book to Questions From Senator Tester
    Question 1. Oil has become essential to our everyday lives, our 
economy and our security. Should national security concerns be 
considered in how oil is regulated and managed? Do you have any 
concerns with oil becoming the new gold?
    Answer. While I appreciate the ways in which oil and gold are 
similar--as a currency-neutral repository for wealth--I do not think 
the analogy holds in scale or scope. Gold has valid industrial 
applications for electronic circuits, but derives its scarcity premium 
from its value as a precious metal. Oil is useless to most of the world 
in its raw form--only refiners of oil can typically extract value for 
themselves--and it takes 420 gallons of oil to add up to a single ounce 
of gold at today's prices. As a result, I would expect that most of the 
world's wealthiest people will probably prefer to keep gold in the safe 
deposit box and the vault, rather than oil.
    Moreover, oil's importance to economic security derives from its 
availability, not its scarcity. The greatest risk the U.S. economy can 
suffer is a supply interruption severe enough to prevent transportation 
and industrial activities from occurring. Sudden price changes are also 
disruptive, but only for the short term. Over the long haul, the U.S. 
economy is one of the best positioned purchasers of crude oil at any 
price as long as it is available to markets. As global markets become 
better supplied and better managed, U.S. wealth becomes its own form of 
energy security. The best hedge against unanticipated events remains 
the U.S. Strategic Petroleum Reserve, followed closely by aggressive 
conservation strategies, alternative fuels programs and end-user 
education.
    Question 2. If speculation is found to be artificially inflating 
the price of oil, what can we do to reduce this? In your opinion, is 
the CFTC sufficiently capable both of regulating all markets on which 
oil futures are traded to ensure speculation is not affecting the price 
of oil and of acting quickly and effectively when problems arise?
    Answer. The Committee rightly identified one of the ``throttles'' 
that control how funds flow into and out of the commodities market--the 
margin requirements imposed on traders. To the extent that price levels 
and volatility occasion a regulatory response, I believe existing CFTC 
powers are adequate and, in the event the current language of the 
Senate Farm Bill passes into law, likely to be augmented to include 
reporting on positions on the Intercontinental Exchange. To your second 
question, I would offer a somewhat cautionary response: the greater the 
regulatory burden imposed on any market, the higher the transaction 
costs associated with trading on that market. As the world continues to 
globalize outside of the reach of U.S. regulation, I would urge this 
Committee and its peers to be careful not to drive commerce outside the 
U.S. to less-well-regulated, less free, less open markets.
                                 ______
                                 
       Responses of Sean Cota to Questions From Senator Bingaman
    Question 1. Do you disagree that increased market participation of 
institutional investors and increased volatility of oil prices are 
correlated?
    Answer. Increased market participation of institutional investors 
and increased volatility of oil prices are correlated. As an ever 
increasing number of non-commercial investors enter the market to buy 
commodities as an inflation hedge against the weak dollar, the demand 
for commodities increases which results in increased volatility and 
excessively high prices. The weak dollar tends to raise prices for 
commodities denominated in that currency. They become relatively cheap 
for non-dollar buyers and offer investors, such as hedge funds, a way 
to hedge themselves from any further weakening of the U.S. Dollar. 
Until the dollar appreciates against other currencies, we will continue 
to see investors flock to U.S. commodities, and their continued 
investment in commodities will only serve to further dislocate the cost 
of energy from the very economic fundamentals to which the markets were 
intended to look for direction.
    Currently, there is no regulatory authority or federal law that 
would limit the amount of money flowing into energy commodities from 
non-commercial investors. That is why the New England Fuel Institute 
(NEFI) and the Petroleum Marketers Association of America (PMAA) are 
looking at possible increases in margin requirements for non-commercial 
investors to pay up-front before they enter into futures contracts. 
Stock market investors generally are required to keep more cash in 
margin accounts (around 50%) whereas futures investors only post 
margins between 5-7%.
    Question 2. I understand that your operating costs are 
substantially increased, and that holding inventory is much more 
expensive in this high price environment. But could you explain to us 
why you don't simply pass on the cost to consumers? Why does this 
affect your margins so strongly?
    Answer. Several reasons, some competitive, some due to the lack of 
sophistication of the small businesses that make up the industry, and 
some are due to the increased underwriting requirements of banks.
    The retail petroleum industry marks up product on a cents per 
gallon basis, not on a percentage basis. As prices have doubled or 
tripled, the margins as a percentage have gone down dramatically. On a 
cents per gallon margin basis, other costs have increased and retailers 
are slow to recognize them. These expenses include:

   Diesel and other transportation costs have risen and do not 
        show up until after the sales to the consumer have occurred. 
        The average dealer has one day supply of fuel, and these costs 
        appear later.
   Credit limits with suppliers have not increased, yet cost 
        (heating oil specifically but others are similar) have gone 
        from around $1.00 per gallon in 2004 to around $3.50 currently. 
        Limits which allowed payment in 30 days are now reached in 10 
        days or less. This requires increased Lines of Credit with the 
        local banks and the corresponding increased costs.
   As prices are increasing, it is taking longer for customers 
        to pay for the fuel, further increasing credit line requirement 
        needs.
   Customers are running out of disposable income, and are 
        increasingly using their credit cards for payment. This cost is 
        another 10 cents per gallon which is often not accounted for in 
        the dealer margins. It also increases the cost of credit card 
        transaction fees, a major burden for petroleum marketers, as 
        mentioned in testimony by fellow panelist John Eichberger from 
        the National Association of Convenience Stores.
   Wholesale prices to dealers today change as much as 3 times 
        per day. Dealers often deliver products at higher cost without 
        the corresponding increase to consumers because they do not 
        know what the cost is until after the sale occurs.
   Dealer competition further erodes margin as dealers are 
        reluctant to increase prices in our very competitive 
        marketplace. Our segment of the energy market (retail heating 
        fuel and motor vehicle fuel dealers) is the only one with 
        direct contact with the consumer. Consumers complain, and fuel 
        dealers (wrongly) are reluctant to pass along the increased 
        costs. Finally, at a time when dealers need to rely on their 
        banks more, banks are more rigorous with their underwriting for 
        loans.

    These are just some of the reasons why margins are affected, and 
why the consumer will continue to see increases in costs even if and 
when prices begin to stabilize.
       Responses of Sean Cota to Questions From Senator Domenici
    Question 1. How much of the recent $100-plus oil prices we have 
been seeing can be contributed to speculation?
    Answer. While there is much debate on the actual percentage or 
dollar amount per barrel or per gallon that can be attributed to what I 
term the ``speculative premium,'' it is clear that the numbers are 
significant. This is the general consensus of a majority economic 
analysts and market experts, including OPEC and major American oil 
companies (as evidenced by Exxon-Mobil's statements before the House of 
Representative's Select Committee on Energy Independence and Global 
Warming, only days prior to my own appearance before your committee).
    I've have come to the conclusion that excessive speculation on 
energy commodity markets have excessively driven up the price of crude 
oil (and, consequently, all refined petroleum products) without the 
supply and demand fundamentals to justify the recent run-up from about 
$50-60 dollars per barrel in early 2007, to over $110 today. We have 
now moved beyond the previous inflation adjusted high of $104 in 1979, 
but without an equivalent disruption to oil availability that was 
experienced during that decade. The numbers don't add up.
    However, to be able to accurately ``add up'' all of the numbers, 
you must have full market transparency. Unfortunately, this is perhaps 
the biggest barrier to obtaining an accurate percentage calculation of 
the per barrel cost of non-commercial speculative investment in crude 
oil, natural gas and other energy products. As I mentioned in my 
testimony, much of the non-commercial involvement in the commodities 
markets is isolated to the over-the-counter markets and foreign boards-
of-trade, which, thanks to a series of legal and administrative 
loopholes, are virtually opaque. The U.S. Congress needs to work 
urgently to remedy this issue and bring full transparency to all 
trading environments.
    Several other energy analysts and national trade ground and 
consumer groups have agreed with the above and are asking for margin 
increases. According to Fadel Gheit, Managing Director and Senior Oil 
Analyst at Oppenheimer & Co. Inc., who testified before the Senate 
Committee on Homeland Security and Governmental Affairs Permanent 
Subcommittee on Investigations at the hearing entitled, ``Speculation 
in the Crude Oil Market,'' stated that ``Oil prices were close to $60 
in August 2007 and rose sharply to almost $100 in November 2007, 
although there were no changes in world oil supply or demand. Oil price 
volatility has attracted a large and growing number of speculators 
seeking the highest profit in the shortest time. Volatility, however, 
has an adverse impact on the oil industry because it increases 
uncertainty, and distorts market fundamentals, which could result in 
poor investment decisions in securing adequate reliable supply to meet 
global energy demand.''
    Question 2. In your testimony you mention legislation that 
Congressman John Larson introduced, which would eliminate non-
commercial investors in the commodities market. Do you support this 
legislation?
    Answer. While NEFI and PMAA support efforts to rein in the 
excessive speculation in order to level the playing field between non-
commercial and commercial players, we are still considering Congressman 
Larson's (D-CT) proposal. NEFI and PMAA's goal is to minimize the role 
of non-commercial investors in energy commodity markets and return the 
market power back to the physical players. Congressman Larson's efforts 
should be further analyzed by a bi-partisan commission or a non-
partisan agency (such as the GAO) so that Congress obtains the 
necessary information to formulate effective policy solutions.
    Question 3. In your testimony, you discuss regulatory gaps. What 
regulatory policies do you believe need to be implemented to assure the 
competitive workings of energy derivative markets, including those that 
are not regulated under the Commodities Exchange Act?
    Answer. First and foremost, Congress must pass the 2007 Farm Bill 
(H.R. 2419) which includes a very significant amendment added by 
unanimous consent in the Senate, the ``Commodity Futures Trading 
Commission (CFTC) Reauthorization Act of 2008'' (Title XIII). The 
legislation is an accumulation of numerous studies done by the Senate 
Permanent Subcommittee on Investigations, the Presidential Working 
Group on Financial Markets (PWG) and input from the CFTC's 
Commissioners, energy commodity exchanges, market participants, energy 
consumers and members of our coalition.
    Secondly, revisit the use of the so-called, ``no-action letters,'' 
issued by the CFTC which allows foreign boards of trade (FBOT) to 
virtually circumvent U.S. regulatory policy. NEFI and PMAA are 
especially concerned that the current no-action letter process may have 
opened a door to domestic exchanges and financial interests looking to 
trade U.S. Commodities overseas with the intent of circumventing U.S. 
federal oversight. According to Michael Greenberger, who was previously 
the Director of the Division of Trading and Markets at the CFTC from 
September 1997 to September 1999, the ``FBOT no action process was 
initiated for exchanges that were organized and operated in foreign 
countries. It was never intended for the no action process to apply 
when foreign exchange obtaining no action FBOT status is bought by a 
U.S. entity; operated in the U.S. with trading engines in the U.S.; and 
with U.S. delivery contracts being traded on that exchange. This is now 
the trading exemption the Intercontinental Exchange (ICE) based in 
Atlanta, Georgia is operating with U.S. trading engines in the U.S. 
while trading, inter alia, West Texas Intermediate crude oil 
contracts.'' ICE is essentially regulated by the U.K. Financial 
Services Authority's regulatory requirements which are generally 
believed by Michael Greenberger to have lax regulatory policy as 
compared to CFTC's regulation of exchanges and transactions.
    Congress should revisit the use of no-action letters by the CFTC. 
It should determine if legislative correction is necessary in order to 
bring full transparency and accountability to FBOTs that trade U.S. 
destined commodities and/or allow U.S. access to their platforms. It 
should especially examine existing no-action letters to determine if 
any need be withdrawn in order to preserve stability in the energy 
markets and in order to protect the American consumer and the economy 
at-large.
    Question 4. What type of commodities trading oversight, would be 
the most damaging or most beneficial, to the interests of the U.S. 
Consumer?
    Answer. The most beneficial type of commodities trading oversight 
for the interests of the U.S. Consumer would be to restore the 
authority to the CFTC before the passage of the Commodity Futures 
Modernization Act (CFMA) of 2000 (Public Law 10-554). NEFI and PMAA 
consider the definition of ``Enron Loophole'' to be the collective 
statutes found in this law that aim to exempt energy commodities from 
portions of the act and deregulate energy trading.
    Of most concern are the following:

   7 U.S.C. Sec. 1(a)(14) which defines energy and metals as 
        ``exempt commodities.''
   7 U.S.C. Sec. 2(d)(2), (h)(3) and (g), exempt most over-the-
        counter energy derivatives trades, trading on electronic energy 
        commodities markets and energy swaps.

    Additionally, as mentioned above, Congress should review CFTC 
Regulation 140.99, setting forth the requirements for issuance of no-
action letters and other letters of exemption and interpretation. 
Congress should also evaluate existing no-action letters for 
withdrawal, as mentioned in the prior answer.
    It is our belief that full transparency and accountability 
requirements, such as those that apply to traditional markets like 
NYMEX, should apply to all trading environments. What is good for NYMEX 
is good for ICE, and all OTC and derivatives exchanges.
                                 ______
                                 
    Responses of John Eichberger to Questions From Senator Bingaman
    Question 1. Are there any panelists who disagree that increased 
market participation of institutional investors and increased 
volatility of oil prices are correlated?
    Answer. I am not a crude oil market analyst and NACS does not focus 
its research on the upstream side of the business, therefore my ability 
to accurately answer this question is severely limited. I can say that 
if reports are true and investors are indeed shifting their portfolios 
to the commodities market to offset the risks inherent in the stock and 
bond markets, this influx of capital would have an inflationary effect 
on the price of those commodities. However, I am not qualified to make 
a definitive cause and effect correlation regarding the actual observed 
behavior of the crude oil market.
    Question 2. I understand that your operating costs are 
substantially increased, and that holding inventory is much more 
expensive in this high price environment. But could you explain to us 
why you don't simply pass on the cost to consumers? Why does this 
affect your margins so strongly?
    Answer. Retailers would like nothing more than to pass on to their 
customers any additional costs incurred in the system. However, 
competition makes this increasingly difficult. Today's consumer is 
acutely aware of retail prices and aggressively shops for the best 
available price.
    According to a national survey of more than 1,200 individuals 
conducted on behalf of NACS between December 2007 and January 2008, 73% 
of consumers say that price is the most important factor when selecting 
a retailer from which to buy gasoline. In addition, a sizeable portion 
of consumers will inconvenience themselves to save money on gasoline: 
32% will turn left across a busy intersection for 1 cent per gallon and 
29% will drive 10 minutes out of their way to save 3 cents.
    According to the NACS State of the Industry reporting financial 
performance for 2006, motor fuel sales generated two-thirds of a 
store's revenues but comprised only one-third of gross margins. Sales 
of in-store items, like coffee and sandwiches, are the primary profit 
center for a convenience store. To generate sufficient sales inside the 
store, a convenience store must generate sufficient customer traffic. 
This necessitates competitive prices at the pump. Retailers are 
constantly under-pricing one another in an effort to generate greater 
customer volume with the hopes of selling them more items from inside 
the store.
    Competitive pressures determine what price a retailer may charge 
for motor fuel and still generate sufficient customer volume. 
Meanwhile, costs determine a retailer's profitability at the pump. Yet 
costs can be very different for every retailer and, consequently, the 
motor fuel margin required to sustain a business model can likewise be 
quite different. For example, one retailer may experience an increase 
in wholesale costs of 10 cents per gallon while his competitor's costs 
increased only 5 cents. Further, each retailer may receive deliveries 
at different times of the week, thereby exposing each to different 
wholesale costs (wholesale prices often change several times in one 
day). Rents and lease terms for each retailer may be different, as 
might the strength of their inside the store sales, each of which would 
affect the break-even calculations on the motor fuel business. Each of 
these variations in cost structure between competing retailers affects 
their competitive positioning in the market and potentially compromises 
their ability to pass through increases in cost while remaining 
sufficiently competitive in motor fuels prices to attract the requisite 
number of customers.
    Responses of John Eichberger to Questions From Senator Domenici
    Question 1. Can you explain why the price of gasoline did not track 
oil prices in the last quarter of 2007? Crude oil prices increased by 
$29 per barrel or the equivalent of $.69 cents a gallon but gasoline 
prices have increased by $.32 cents per gallon or by half as much. Can 
you explain the disconnect here, especially when we are seeing the 
opposite trend since the beginning of the year, when gasoline prices 
increased by a greater percentage than crude oil prices?
    Answer. According to the U.S. Energy Information Administration, 
the retail price of gasoline can be broken down into four components: 
crude oil, taxes, refining, and distribution/marketing. The follow 
chart replicates EIA's reported data:

 
----------------------------------------------------------------------------------------------------------------
                                                    Retail Price   Crude Oil     Taxes     Refining    Dist/Mktg
----------------------------------------------------------------------------------------------------------------
July 2007                                                $2.965       56.8%       13.4%       18.4%       11.4%
----------------------------------------------------------------------------------------------------------------
August 2007                                              $2.786       60.4%       14.3%       13.5%       11.8%
----------------------------------------------------------------------------------------------------------------
September 2007                                           $2.803       64.3%       14.2%       12.8%        8.6%
----------------------------------------------------------------------------------------------------------------
October 2007                                             $2.803       67.6%       14.2%       10.1%        8.1%
----------------------------------------------------------------------------------------------------------------
November 2007                                            $3.080       68.3%       13.0%       10.0%        8.7%
----------------------------------------------------------------------------------------------------------------
December 2007                                            $3.018       68.1%       13.2%        8.1%       10.5%
----------------------------------------------------------------------------------------------------------------
January 2008                                             $3.043       67.9%       13.1%        7.8%       11.1%
----------------------------------------------------------------------------------------------------------------
February 2008                                            $3.028       69.7%       13.2%        9.9%        7.2%
----------------------------------------------------------------------------------------------------------------
March 2008                                               $3.244       71.8%       12.3%        8.0%        7.9%
----------------------------------------------------------------------------------------------------------------


    As can be seen, the refining sector's contribution to the retail 
price of gasoline during the last half of 2007 diminished greatly while 
the contribution of crude oil escalated. This was largely the reason 
why retail prices remained relatively stable during this six-month 
period--profitability at the refining level was diminishing. 
Consequently, wholesale prices for gasoline were not tracking upwards 
with crude oil because most of these raw material costs were being 
absorbed at the refinery.
    It is not reasonable to expect that any corporation could continue 
operations while sustaining diminishing returns, especially not in the 
long-term. By the beginning of 2008, the decline in the refining 
sector's contribution to the retail price of gasoline stabilized. 
Meanwhile, wholesale prices for gasoline began to climb at the 
beginning of February. One can look at data reported by the Oil Price 
Information Service for insight into what has happened thus far in 
2008.

 
----------------------------------------------------------------------------------------------------------------
                                                                                               National Average
                                                       National Average    National Average      Retail Gross
                                                       Wholesale Price*      Retail Price           Margin
----------------------------------------------------------------------------------------------------------------
January 7, 2008                                                  $2.514              $3.078              $0.096
----------------------------------------------------------------------------------------------------------------
January 14, 2008                                                 $2.417              $3.074              $0.189
----------------------------------------------------------------------------------------------------------------
January 21, 2008                                                 $2.327              $3.016              $0.222
----------------------------------------------------------------------------------------------------------------
January 28, 2008                                                 $2.340              $2.983              $0.176
----------------------------------------------------------------------------------------------------------------
February 4, 2008                                                 $2.383              $2.976              $0.126
----------------------------------------------------------------------------------------------------------------
February 11, 2008                                                $2.341              $2.954              $0.146
----------------------------------------------------------------------------------------------------------------
February 18, 2008                                                $2.444              $2.992              $0.081
----------------------------------------------------------------------------------------------------------------
February 25, 2008                                                $2.560              $3.112              $0.083
----------------------------------------------------------------------------------------------------------------
March 3, 2008                                                    $2.573              $3.153              $0.111
----------------------------------------------------------------------------------------------------------------
March 10, 2008                                                   $2.613              $3.195              $0.112
----------------------------------------------------------------------------------------------------------------
March 17, 2008                                                   $2.682              $3.269              $0.115
----------------------------------------------------------------------------------------------------------------
March 24, 2008                                                   $2.629              $3.257              $0.156
----------------------------------------------------------------------------------------------------------------
March 31, 2008                                                   $2.708              $3.268              $0.090
----------------------------------------------------------------------------------------------------------------
                                                                       Change: + $0.194    ChangAverage: $0.131
----------------------------------------------------------------------------------------------------------------
* OPIS Rack prices do not include taxes and freight.

    The wholesale price of gasoline has increased to the same degree as 
has the retail price of gasoline, although not always on the same 
schedule as can be seen looking at the volatility in retailer gross 
margins over the first quarter of 2008. Part of the reason for the 
increased price at wholesale could be found by analyzing the trends in 
EIA data which show that the refining sector's contribution to the 
retail price of gasoline stopped its downward spiral in 2008, thereby 
more completely transferring increases in the price of crude oil to the 
wholesale price of gasoline.
    It is also instructive for Congress to consider the annual cycle of 
gasoline prices when considering the influences on the current market. 
NACS has been tracking the retail price of gasoline on a weekly basis 
since January 2000, using data reported by EIA. Analyzing this data, 
one can identify certain times throughout the year during which retail 
prices have historically escalated. One of these periods is February 
through June, during which time the motor fuels supply transitions from 
winter-specification fuel blends to summer-specification blends.
    In the winter, gasoline is formulated with a higher evaporative 
tendency. This makes it easier for vehicles to start in the cold winter 
months. In the summer, however, these fuel formulations combine with 
warmer weather to contribute to the formation of smog. Therefore, in 
the summer months, the evaporative nature of gasoline (measured in 
terms of Reid Vapor Pressure and expressed as volatility) must be 
reduced. This requires refiners to remove additional components from 
their gasoline blends, leading to fewer gallons available from each 
barrel of oil and a higher cost of production.
    In February, refineries begin the process of drawing down winter-
blend fuels, which typically can't be delivered to wholesale outlets 
after May 1. (Some fuel blends are required weeks or months earlier, 
further complicating the system.) To accommodate these deadlines, 
refiners must estimate fuel needs months in advance and begin producing 
the more expensive summer-grade gasoline in February. Consequently, any 
unexpected increase in demand can significantly decrease the supply of 
winter-grade gasoline, causing the retail price of gasoline to increase 
while stocks of the more expensive summer-grade gasolines are built up.
    The duration and the severity of the spring price increase has 
varied over the past eight years. Between 2000 and 2006, prices 
increased an average of 30-plus cents each spring from early February 
to the seasonal peak. In the past two years, increases in crude oil 
prices have likely contributed more to the retail price than has the 
spring transition and separating the two is very difficult. However, 
during the time frames in question the retail price of gasoline has 
increased $0.707 in 2006 and $1.044 in 2007.
    Understanding how environmental policy, such as that establishing 
seasonal volatility standards, affects the production and supply of 
motor fuels is important when considering the overall performance of 
the market.

    Question 2. In your testimony, you state that the price of crude 
oil is a significant factor in the retail price of gasoline and that 
consumers feel the pressure of higher gasoline prices. In your opinion 
what is the key to making gasoline prices cheaper?
    Answer. Regardless of external influences, economics dictates that 
when supplies for any object are greater than the relative demand, 
prices will decline. For years, retailers have been constant advocates 
for more plentiful and fungible motor fuel supplies. NACS led the 
charge to stop the further proliferation of boutique fuels because the 
resulting patchwork of fuel regulations inhibited the efficient 
distribution of fuels to market, thereby increasing costs. There are 
several examples in which additional supplies have mitigated increasing 
prices. Three such examples include:

   When the fuel additive MTBE was removed from the gasoline 
        pool in the spring of 2006 and the reformulated gasoline 
        markets on the eastern seaboard had to switch to ethanol, there 
        was not enough supply in that particular market at that 
        particular time and ethanol prices spiked to more than $200 per 
        barrel on the spot market. An influx of Midwestern and 
        Brazilian ethanol offset the supply shortage and prices came 
        back down.
   In the aftermath of Hurricanes Katrina and Rita, the 
        Environmental Protection Agency utilized its newly authorize 
        authority to waive certain regulations concerning on-road 
        diesel fuel. This successfully increased supplies and mitigated 
        price spikes, keeping America's trucks on the road.
   Also in the aftermath of Hurricanes Katrina and Rita, the 
        rapid escalation of retail gasoline prices resulted in a 
        substantial increase of imported gasoline from Europe and other 
        locations. The surge in imports helped balance supplies with 
        demand and put downward pressure on retail prices.

    If substantial inventories of additional crude oil were brought 
onto the market, despite the non-commercial activities in the 
commodities exchanges, I believe that prices would begin to withdraw 
from their highs. Furthermore, if additional supplies were to have a 
dampening effect on prices, it is conceivable that non-commercial 
investors would begin to transfer their capital away from the crude oil 
commodities market and invest in markets with more favorable economic 
indicators for long-term return.
    The United States Congress must consider opportunities to increase 
the physical supply of transportation fuels. The Energy Independence 
and Security Act of 2007 created a bold program to require the use of 
36 billion gallons of renewable fuels. This is a component of the 
solution, but even with revolutionary developments in the production of 
these renewable fuels, petroleum-based fuels will continue to be the 
primary energy source for the United States for the foreseeable future 
and policies must not discount this fact.
    The market will respond to additional supplies of transportation 
fuels, but it will respond more quickly to additional supplies of 
transportation fuels which are compatible with the existing 
distribution infrastructure. The more investment required to 
accommodate a new fuel product, the slower and more costly will be its 
adoption by the market. Congress would do its constituents a great 
service by focusing its efforts on promoting the availability of 
fungible and compatible transportation fuels. This can be and should be 
done concurrently with efforts to develop and market the next 
generation of energy sources.
                                 ______
                                 
     Responses of Sarah Emerson to Questions From Senator Bingaman
    Question 1. Do you disagree that increased market participation of 
institutional investors and increased volatility of oil prices are 
correlated?
    Answer. No, I agree that the increased market participation of 
institutional investors has contributed to crude oil price strength in 
the futures markets. Under a strict definition of price volatility 
(frequency of price changes), I am not certain that the institutional 
investors have specifically influenced volatility.
    Question 2. You note that ``the physical oil market has not 
discouraged or disciplined investors . . . '' I agree with this 
statement, and believe that OPEC has failed to calm markets to the 
maximum extent of its ability. Could you talk to us about why OPEC 
might not be making a concerted effort to calm markets, as it has done 
in the past?
    Answer. OPEC's ability to calm markets is limited by all the other 
bullish factors affecting price. With tight capacity all through the 
supply chain, any disruption or event related to oil markets is 
interpreted in a bullish manner. OPEC adding crude to the market to 
soften prices does not have the significant impact it had back in the 
1980s and 1990s when spare capacity in the supply chain made the entire 
market more sensitive to supply increases. In other words, from a 
supply/demand point of view, there was more downside price risk in the 
past than there is today. So, for OPEC to calm the markets today they 
would have to embark on a significant campaign to soften markets, 
raising production significantly and discounting their prices. At this 
point, there is not enough consensus in OPEC to embark on this 
campaign. That lack of consensus is in part because OPEC is worried 
about a recession in the US and more broadly in the rest of the world. 
They don't want to add crude to the market if demand is slowing down. I 
think it is clear that there are differences of opinion within OPEC as 
to the optimal price level. Some countries are very concerned that the 
high prices will destroy demand. Other countries with more pressing 
fiscal requirements are less concerned about the long term impact on 
demand and alternative fuels of high prices. The other point to keep in 
mind is that the majority of OPEC crude oil is medium sour quality and 
yet the growth in demand is in clean sweet transport fuels, so 
additional OPEC crude does not provide a substitute for WTI which is a 
light sweet crude oil. As a result, additional OPEC crude is helpful to 
the degree that it can go through the sophisticated refiners of the 
world to make the clean petroleum products. That's not to say 
additional OPEC crude isn't helpful, it just has more of an arm's 
length impact on light sweet oil prices on the futures exchanges.
    Question 3. You refer to government policy as an unknown variable 
that will affect future oil prices. Is it reasonable to predict that 
government policy success in reducing U.S. oil demand--reaching what 
Mr. Book referred to as our ``peak appetite for oil''--would lead to 
downward pressure on oil prices?
    Answer. To the degree that we can slow our demand growth for 
transportation fuels, we would remove a significant component of global 
oil demand growth (not withstanding the current slowdown in economic 
growth and oil demand). Oil demand growth would be concentrated in Asia 
and the Middle East. Oil prices would be weaker than if we did nothing 
and our economy would be more insulated from oil prices.
    Question 4. How long do you see this strong relationship between 
the dollar and the price for oil remaining in tact? And, is it safe to 
say that this relationship would not be as strong without the 
proliferation of institutional investors in the oil market?
    Answer. I do not have any idea how long this will last, but as the 
Fed continues to lower interest rates and the US economy slows, it is 
hard to see any reason for the dollar to strengthen, so I believe we 
are stuck in the current mutually-reinforcing situation between the 
weak dollar and strong oil for some time to come.
    Question 5. Historically, we've become accustomed to thinking of 
high oil prices causing recessions. It seems that this time, we might 
well be seeing a recession that--through a weak dollar and weak 
financial markets--is causing high oil prices. In your opinion, would a 
more healthy U.S. economy, with a stronger currency and a lower risk of 
inflation, likely result in lower oil prices?
    Answer. Absolutely, we are at today's situation in part because our 
economy is suffering in so many different ways. A healthy economy and a 
stronger dollar might remove this investor desire to hedge against 
inflation by buying commodities.
     Responses of Sarah Emerson to Questions From Senator Domenici
    Question 1. As you know, China is experiencing double-digit gross 
domestic product growth on a consistent basis. The 2004 economic surge 
in that country brought on a tangible significant rise in oil 
consumption at a pace unexpected by oil producers. What impact has this 
economic growth had on the price of global commodities . . .  
specifically oil?
    Answer. China's oil demand growth has been striking, although it 
has moderated from 2004 levels. That growth coupled with China's 
building and filing its own SPR has absolutely contributed to strong 
demand for oil, but we have seen other periods in history when global 
oil demand has grown faster than the last couple of years and prices 
have not risen this high. China is a medium sized piece of the puzzle. 
There are many other factors that are also contributing to the strong 
oil prices.
    Question 2. To what extent is the falling value of the U.S. dollar 
contributing to keeping the price of crude oil high?
    Answer. I believe this has been a significant factor since late 
summer/early fall 2007 and continues to be a factor which keeps 
institutional investors interested in commodities (inc. oil) and will 
continue to do so for the foreseeable future.
    Question 3. What would be the likely effects on the U.S. economy 
and financial markets if the crude oil transactions took placed in a 
different currency?
    Answer. This would add one more layer of complexity to pricing and 
given the weak dollar would most likely increase the cost of oil to 
Americans because, in essence, we would have to buy euros (or Yen, etc) 
to buy oil and our realized price would reflect not only the cost of 
the oil but the cost of the euro. On the other hand, this would also 
increase the cost of oil to everyone else in the world who has been 
buying cheap dollars to buy oil. To the degree that higher costs 
accelerate a slowdown in oil consumption elsewhere, oil prices might 
actually drop in the global market. This could yield benefits for the 
American economy. But this is a truly complicated question. Defining 
the overall impact on the US economy is difficult.
    Question 4. To what extent are Japan and Europe, countries with 
major currencies, protected from increases in the price of oil, and is 
this protection likely to result in major changes in competitiveness 
that might damage the U.S. economy?
    Answer. Any country, against whose currency the dollar weakens, 
benefits when they buy a dollar denominated good such as oil. So, they 
absolutely benefit from having currencies stronger than the dollar and 
this must enhance their competitiveness. On the other hand, US exports 
are cheaper and that enhances our competitiveness. Again it is 
difficult to define the overall impact of stronger currencies in other 
countries.
      Responses of Sarah Emerson to Questions From Senator Tester
    Question 1. If speculation is found to be artificially inflating 
the price of oil, what can we do to reduce this? In your opinion, is 
the CFTC sufficiently capable both of regulating all markets on which 
oil futures are traded to ensure speculation is not affecting the price 
of oil and of acting quickly and effectively when problems arise?
    Answer. I do not have enough knowledge of the CFTC's activities, 
structure or mandate to comment on their capabilities.
    Question 2. Oil has become essential to our everyday lives, our 
economy and our security. Should national security concerns be 
considered in how oil is regulated and managed? Do you have any 
concerns with oil becoming the new gold?
    Answer. I do not equate oil with gold. Oil is a strategic commodity 
that has a significant impact on the everyday lives of every American. 
Gold is not. But, I do see the desire to ``hold'' oil as a hedge 
against inflation as an interesting new development. I do think the 
U.S. must think of oil in terms of its national economic security. This 
means thinking more boldly about conservation and alternative fuels, 
and it means having a more defined use of the SPR. It also means 
looking more closely at how these financial markets for oil are 
regulated. I believe in unregulated markets and in free and unfettered 
trade, but oil is special. The oil markets need widely set boundaries 
so that they do not become a hazard to the economy.
                                 ______
                                 
    [Responses to the following questions were not received at 
the time the hearing went to press:]

           Questions for James Burkhard From Senator Bingaman
    Question 1. Do you disagree that increased market participation of 
institutional investors and increased volatility of oil prices are 
correlated?
    Question 2. How long do you see this strong relationship between 
the dollar and the price for oil remaining in tact? And, is it safe to 
say that this relationship would not be as strong without the 
proliferation of institutional investors in the oil market?
    Question 3. Historically, we've become accustomed to thinking of 
high oil prices causing recessions. It seems that this time, we might 
well be seeing a recession that--through a weak dollar and weak 
financial markets--is causing high oil prices. In your opinion, would a 
more healthy U.S. economy, with a stronger currency and a lower risk of 
inflation, likely result in lower oil prices?
           Questions for James Burkhard From Senator Domenici
    Question 1. Is there any benefit to the market for allowing non-
commercial investors (speculators) to participate?
    Question 2. Does the trading of oil derivatives benefit the 
American consumer and the economy? If so, how?
            Questions for James Burkhard From Senator Tester
    Question 1. In your testimony, you stated that oil is becoming the 
new gold. I would like to know whether commodities that are essential 
to our economy and national security should be open to speculators. I 
understand that they bring liquidity to the market and allow for the 
reallocation of risk, however are there other mechanisms that could be 
used to effectively manage the oil futures market without placing the 
price of oil at the whim of speculators and hedge fund managers?
    Question 2. What can be done to protect our economy and our country 
from an over investment in oil? Is there a possibility of over 
investment or speculation leading to an unsustainable oil bubble?
    Question 3. If speculation is found to be artificially inflating 
the price of oil, what can we do to reduce this? In your opinion, is 
the CFTC sufficiently capable both of regulating all markets on which 
oil futures are traded to ensure speculation is not affecting the price 
of oil and of acting quickly and effectively when problems arise?

                                    

      
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