[Senate Hearing 111-17]
[From the U.S. Government Publishing Office]
S. Hrg. 111-17
ENERGY MARKET TRANSPARENCY AND REGULATION
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HEARING
before the
SUBCOMMITTEE ON ENERGY
of the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
TO
RECEIVE TESTIMONY ON DRAFT LEGISLATION TO IMPROVE ENERGY MARKET
TRANSPARENCY AND REGULATION
__________
MARCH 25, 2009
Printed for the use of the
Committee on Energy and Natural Resources
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COMMITTEE ON ENERGY AND NATURAL RESOURCES
JEFF BINGAMAN, New Mexico, Chairman
BYRON L. DORGAN, North Dakota LISA MURKOWSKI, Alaska
RON WYDEN, Oregon RICHARD BURR, North Carolina
TIM JOHNSON, South Dakota JOHN BARRASSO, Wyoming
MARY L. LANDRIEU, Louisiana SAM BROWNBACK, Kansas
MARIA CANTWELL, Washington JAMES E. RISCH, Idaho
ROBERT MENENDEZ, New Jersey JOHN McCAIN, Arizona
BLANCHE L. LINCOLN, Arkansas ROBERT F. BENNETT, Utah
BERNARD SANDERS, Vermont JIM BUNNING, Kentucky
EVAN BAYH, Indiana JEFF SESSIONS, Alabama
DEBBIE STABENOW, Michigan BOB CORKER, Tennessee
MARK UDALL, Colorado
JEANNE SHAHEEN, New Hampshire
Robert M. Simon, Staff Director
Sam E. Fowler, Chief Counsel
McKie Campbell, Republican Staff Director
Karen K. Billups, Republican Chief Counsel
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Subcommittee on Energy
MARIA CANTWELL, Washington, Chairman
BYRON L. DORGAN, North Dakota JAMES E. RISCH, Idaho
RON WYDEN, Oregon RICHARD BURR, North Carolina
MARY L. LANDRIEU, Louisiana JOHN BARRASSO, Wyoming
ROBERT MENENDEZ, New Jersey SAM BROWNBACK, Kansas
BERNARD SANDERS, Vermont JROBERT F. BENNETT, Utah
EVAN BAYH, Indiana JIM BUNNING, Kentucky
DEBBIE STABENOW, Michigan JEFF SESSIONS, Alabama
MARK UDALL, Colorado BOB CORKER, Tennesse
JEANNE SHAHEEN, New Hampshire
Jeff Bingaman and Lisa Murkowski are Ex Officio Members of the
Subcommittee
C O N T E N T S
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STATEMENTS
Page
Cantwell, Hon. Maria, U.S. Senator from Washington............... 1
Cochrane, Anna, Acting Director, Office of Enforcement, Federal
Energy Regulatory Commission................................... 8
Gruenspecht, Howard, Acting Administrator, Energy Information
Administration................................................. 3
Johnson, Hon. Tim, U.S. Senator From South Dakota................ 3
McCullough, Robert F., Jr., Managing Partner, McCullough
Research, Portland, OR......................................... 14
Ramm, Gerry, Senior Executive, Inland Oil Company, Ephrata, WA,
on Behalf of the Petroleum Marketers Association of America.... 18
Risch, Hon. James E., U.S. Senator From Idaho.................... 2
APPENDIXES
Appendix I
Responses to additional questions................................ 33
Appendix II
Additional material submitted for the record..................... 41
ENERGY MARKET TRANSPARENCY
AND REGULATION
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WEDNESDAY, MARCH 25, 2009
U.S. Senate,
Subcommittee on Energy,
Committee on Energy and Natural Resources,
Washington, DC.
The committee met, pursuant to notice, at 2:08 p.m. in room
SD-366, Dirksen Senate Office Building, Hon. Senator Maria
Cantwell presiding.
OPENING STATEMENT OF HON. MARIA CANTWELL, U.S. SENATOR FROM
WASHINGTON
Senator Cantwell. This hearing will come to order. I want
to thank Senator Risch for being here today and my colleague
Senator Johnson. I hope that this will be the first of many
subcommittee hearings that we have working together in trying
to make progress on our Nation's energy challenges.
We're here today to examine two pieces of proposed
legislation that will help prevent future energy price bubbles
and market manipulation. We have worked with many stakeholders
in developing these bills and have received a lot of positive
feedback.
For instance we've heard from the Industrial Energy
Consumers of America whose membership are significant consumers
of natural gas and from every major energy intensive
manufacturing sector. We've also received positive feedback
from other organizations that we'll make part of the record.
The first piece of legislation which was S. 672 adds real
teeth for FERC's anti-manipulation authority. It provides FERC
with the tools to stop bad actors before they wreak havoc on
energy consumers and the economy. One of the lessons we learned
from the Western Energy Crisis in 2000 and 2001.
The committee, then led by Chairman Domenici, gave the
Federal Energy Regulatory Commission important anti-
manipulation authority in the Energy Policy Act of 2005. To
date FERC has used this new authority to conduct a 135
investigations resulting in 27 settlements totaling over almost
$65 million in civil penalties. One example of FERC's work is
the enforcement actions the Commission took for alleged market
manipulation against AMARANTH.
These actions yielded 291 million in civil penalties along
with 167 in penalties from energy trading partners. However I
understand that in this case of AMARANTH the hedge fund
liquidated its assets before FERC could complete its
enforcement action leaving little left for FERC to collect on
its penalties it originally sought. That falls quite short of
what an estimated nine billion of AMARANTH shenanigans really
cost natural gas consumers.
AMARANTH is a notable example of why we need to strengthen
and clarify FERC's enforcement powers to protect consumers and
deter manipulation. S. 672 would empower FERC with cease and
desist authority to stop manipulative schemes currently in
progress. The Securities and Exchange Commission and the
Commodities Futures Trading Commission already have this
authority. It would allow FERC to act more like a cop stopping
the robbery in progress instead of trying to piece together
what happened at a crime scene after the fact.
Second, the bill empowers FERC to freeze assets of any
entity that is suspected of market manipulation and creating a
bright line on deterrent so that bad actors know if they
attempt to manipulate the market there will be a penalty.
Finally in order to give more effectively recover unjust
and unreasonable rates the law would allow a refund to occur
from the time that FERC brings the case. Currently FERC can
only recover damages to the time that they actually prove the
case.
We're also going to consider important legislation that
would increase transparency in data collection in oil markets.
I know that some of you are here specifically to testify on
that. Mr. McCullough as you have testified in the past before
this committee.
Mr. McCullough was one of the many experts that released
independent reports that helped show a bright line in these oil
markets. These reports demonstrated the tight correlation
between physical and financial oil markets. Thanks to several
of the hearings this committee has had in previous years, we've
learned that we don't have all the necessary data collection or
the focus to understand what has really been going on in energy
markets.
To that end the committee has drafted legislation that
would establish an office within the Energy Information
Administration to collect and analyze information from both the
physical and paper markets. It will improve their ability to
predict future energy prices which will help businesses and
consumers plan for the future. It will also empower regulators
to more effectively police the markets.
So I look forward to hearing the testimony of the witnesses
today. Now I'd like to turn it over to the ranking member,
Senator Risch for his opening statement.
STATEMENT OF HON. JAMES E. RISCH, U.S. SENATOR
FROM IDAHO
Senator Risch. Thank you very much, Madame Chairman. We all
know that free markets and free people have delivered the most
successful and fluent society that's ever existed on the face
of this Earth. We also know that free markets only work when
they're free from monopolies and from market manipulation.
So in that context I think we need to examine all these
things and make sure the balance stays in place that indeed we
have free markets. But at the same time that we don't have
people that are involved in market manipulation.
Thank you, Madame Chair.
Senator Cantwell. Thank you.
Senator Johnson.
STATEMENT OF HON. TIM JOHNSON, U.S. SENATOR FROM SOUTH DAKOTA
Senator Johnson. Thank you, Senator Cantwell for holding
this important hearing to gather information in how to improve
energy market transparency in regulation.
Senator Cantwell. Thank you, Senator Johnson.
Senator Shaheen.
Senator Shaheen. I don't have a statement.
Senator Cantwell. We'll turn to our witnesses. I want to
welcome them.
Dr. Howard Gruenspecht, is that right? Ok. Acting
Administrator of the Energy Information Agency.
Anna Cochrane, Acting Director of the Office of Enforcement
for the Federal Energy Regulatory Commission.
Robert McCullough, Managing Partner at McCullough Research.
Finally, Gerry, no, sorry, Gerry Ramm, representing the
Petroleum Marketers Association of America.
Thank you all for being here and for your testimony today.
So we're going to start with you, Dr. Gruenspecht. I just will
say for my colleagues I know there's a possibility of a vote
coming up sometime in the next hour.
So we'll just have to work through that. So we ask in
advance the indulgence of those testifying.
So, Dr. Gruenspecht.
STATEMENT OF HOWARD GRUENSPECHT, ACTING ADMINISTRATOR, ENERGY
INFORMATION ADMINISTRATION
Mr. Gruenspecht. Madame Chairman and members of the
committee, I appreciate the opportunity to appear before you
today to discuss draft legislation entitled the Energy Market
Transparency Act of 2009. The Energy Information Administration
is the independent statistical and analytical agency within the
Department of Energy. We do not promote, formulate or take
positions on policy issues, and our views should not be
construed as representing those of the Department of Energy or
the Administration.
Since the proposed legislation aims to improve our
understanding of the effects of interactions between energy and
financial markets, I'll start by describing some of the efforts
that we're already undertaking in this area. Earlier this
month, EIA held a workshop on the relationships between futures
and financial market activity and the underlying physical
market for crude oil. Participants included staff from Federal
agencies and experts from the academic community. The
presentations and the discussions highlighted several points
including the need for better and more accessible data on
trader activity in futures markets, the importance of examining
alternative theories of trader behavior, and the need to
continue examining the role of supply and demand fundamentals
using better and more accurate data. EIA staff also presented
its research into the use of implied volatilities from the
options markets as a measure of uncertainty in short-term price
forecasts. Following further review by the Committee on Energy
Statistics of the American Statistical Association, we plan to
report these calculations in each edition of our monthly, short
term outlook to provide additional context for our analysis. We
plan to continue our dialog on this issue at a session on
financial markets and short-term energy prices at the EIA
annual energy conference in early April.
Based on our current knowledge, EIA staff believes that
improved insight into the relationships between trader behavior
and fundamentals in forming prices will require building
insight into the full process of price formation, from
developing theory through the analysis of pertinent data. Such
data might in some cases be purchased from commercial sources,
but additional data collection, whether by EIA or other
agencies, could also be warranted. A major investment of
resources and time is likely to be required, and the
difficulties are such that conclusive results are unlikely to
be quickly obtained.
Let me now turn to our specific comments on the March 18
draft of the Energy Market Transparency Act of 2009, focusing
on three main issues: First, the feasibility of the specific
data collection called for in the draft legislation; second,
providing a broader perspective on other potentially relevant
data sources; and finally, data confidentiality.
Our initial assessment is that the data collections
proposed in subsection (n) could be both difficult and
expensive. This suggests a need to consider whether other, more
readily obtainable, data might provide comparable or even
better insights into energy markets. In part, the answer may
depend on an even more basic question--the intended uses of the
data which are not described in the legislation.
A key issue with subsection (n) is the feasibility of the
collection. EIA currently surveys crude and product stocks at
petroleum terminals, for instance, but those stocks are held on
a custody basis, and terminal operators may not know the
identity of the owners. With the assistance of other agencies,
EIA may be able to identify and survey at least a subset of
owners, who may include entities other than the refineries,
pipelines and terminal operators--who usually report to EIA.
However, such an activity should be recognized as involving far
more than simply adding questions about ownership to surveys
that are currently completed by those having custody of
inventories. We suggest that a limited threshold of respondents
be used rather that owners of ``all'' oil and natural gas
inventories.
Turning to the role of other Federal agencies, the CFTC and
the Internal Revenue Service, among others, may already have
some of the desired information or have lists of entities that
would constitute a portion of those that would need to be
surveyed in order to collect it. For example, the IRS already
collects some data by ownership, such as end-of-month product
inventory at petroleum terminals, for tax purposes. Ownership
matters there.
The IRS has also established a Joint Operations Committee
to enable State and Federal motor fuel tax compliance
activities, and that committee has in turn established a
national data center that provides a technical foundation for a
common motor fuel data repository.
Given our lack of involvement with holders of energy
futures contracts or energy commodity swaps to date, we're
inclined to defer to the CFTC regarding those types of
entities. We agree therefore with the language in subsection
(n) stating that the plan should be developed in consultation
with other Federal agencies. However, for reasons discussed in
my written testimony, the proposed timelines on page two of the
legislation don't seem realistic.
Turning to confidentiality of proprietary information, the
draft legislation applies Section 12(f) of the Federal Energy
Administration Act of 1974. At times respondent-level data
collected under this authority has been the subject of Freedom
of Information Act requests including requests from private
parties that anticipate opportunities for using the survey data
for private gain. An alternative approach would be to make
these data collections subject to the Confidential Information
Protection and Statistical Efficiency Act. Ultimately the
choice of which data collection authority to cite will depend
on the intended uses of the data, how sensitive the reported
information is to respondents, and the purposes for which the
information may be shared with other agencies. These
considerations are not specified in the draft legislation.
Turning finally to resources, any new mandated data
collections would be handled by existing staff that would need
to be pulled from previously planned activities pending the
availability of additional staff and resources. This could lead
to delays in current high-priority projects such as integrating
ethanol into our weekly data petroleum program, collecting
custody-based petroleum data at the individual terminal level
rather than across an entire Petroleum Administration for
Defense District, and addressing other existing data quality
issues.
This concludes my statement, Madame Chairman. I'd be
pleased to answer any questions you or the other Members may
have.
[The prepared statement of Mr. Gruenspecht follows:]
Prepared Statement of Howard Gruenspecht, Acting Administrator, Energy
Information Administration
Madam Chairman and Members of the Committee, I appreciate the
opportunity to appear before you today to discuss draft legislation
entitled the ``Energy Market Transparency Act of 2009,'' received from
Committee staff on March 18.
The Energy Information Administration (EIA) is the independent
statistical and analytical agency within the Department of Energy that
produces objective, timely, and relevant data, projections, and
analyses to assist policymakers, help markets function efficiently, and
inform the public. We do not promote, formulate, or take positions on
policy issues, and our views should not be construed as representing
those of the Department of Energy or the Administration.
Because concerns regarding volatility in oil prices and the factors
that have contributed to it appear to be the motivation for the
proposed legislation, I will start by briefly describing some recent
and ongoing activities that EIA has undertaken to improve its
understanding of the effects of interactions between energy and
financial markets. I will then turn to specific comments on the draft
legislation.
Earlier this month, EIA held a workshop on the relationships
between futures and financial market activity and the underlying
physical market for crude oil. Participants included staff from the
Commodity Futures Trading Commission (CFTC), the Federal Reserve Board,
the Government Accountability Office, and the International Monetary
Fund, as well as staff from EIA, other Department of Energy offices and
experts from the academic community. Topics discussed included: Can
information obtained from futures and financial over-the-counter
markets enhance the understanding of the underlying physical markets?
Can activity in futures and financial over-the-counter markets cause
short-term price fluctuations in spot markets, even in the absence of
change in underlying oil market fundamentals? What kind of models and
data are most appropriate to fully understand the relationships between
financial and physical markets? The presentations and resultant
discussion highlighted several points, including the following: there
is a need for better and more accessible data on trader activity in the
futures markets; it is important to examine alternative theories of
trader behavior; and there is a need to continue examining the role of
fundamentals using better and more accurate data.
We know that members of this Committee, other EIA customers, and
EIA analysts have considerable interest in quantifying the uncertainty
surrounding short-term price forecasts. At the workshop, members of
EIA's Short-Term Energy Outlook (STEO) team presented research into the
use of implied volatilities from the New York Mercantile Exchange
options markets as a measure of uncertainly in short-term price
forecasts. Group discussion of this research coalesced around a
particular method for calculating probability distributions for future
oil prices using implied volatilities reflected in prevailing prices of
options contracts. The American Statistical Association's Committee on
Energy Statistics is scheduled to provide a further review of this
method at its April meeting. By mid-year, we intend to report these
calculations in each edition of the STEO to provide additional context
for our own analysis.
EIA has also included a session on financial markets and short-term
energy prices as a part of its annual energy conference, scheduled for
April 7-8, 2009. We hope that the discussion among the panelists will
further inform our research agenda and advance the ongoing dialogue in
the broader community.
Looking ahead based on our current understanding, EIA staff believe
that effective analysis of the effects of trading on resulting prices
will require not only better data, but a much stronger theoretical
approach as well. Analysts within and outside EIA continue to grapple
with understanding the gap between very short-term and longer-term
price formation. A comprehensive theory of how trader behavior affects
longer-term prices is simply not well developed and without a well-
developed theory, analysts are reduced to data mining and testing
unformed hypotheses.
The limited availability of aggregate data that can be used to
track trader strategy and behavior compounds the challenge faced by
analysts In the most obvious example, the position information that the
CFTC publishes is separated into categories of commercial and non-
commercial traders; categories that do not map cleanly to hedgers and
speculators. Without a way of identifying trades and positions taken
for speculative purposes, direct analysis of the effects of speculation
on price formation is not really possible. Since the EIA and CFTC
staffs maintain a cooperative relationship, we know the CFTC has been
struggling with this problem, and may have made some advances, but
those CFTC data have not been made public.
EIA staff believe that an improved understanding of the
relationships between trader behavior and fundamentals in forming
prices will require the gathering and deployment of strong analytic
capabilities focused on building insight into the full process of price
formation, from developing theory through the analysis of pertinent
data. Such data, assuming they exist, might in some cases be purchased
from commercial sources. In other cases, additional data collection,
whether by EIA or other agencies, may also be warranted. A major
investment of resources and time is likely to be required, and the
difficulties are of sufficient magnitude that conclusive results are
unlikely to be quickly obtained.
comments on the draft energy market transparency act of 2009
As a Federal statistical agency, EIA strongly supports data
transparency as a means of achieving its mission and agrees that
additional data on physical and financial oil and natural gas markets
would be helpful in increasing understanding of oil price discovery.
EIA's comments, which follow, focus on three main issues: first, the
feasibility of the specific data collection called for in the draft
legislation; second, providing a broader perspective on other
potentially relevant data sources; and, finally, data confidentiality.
Comments on Section 3
General.--EIA's initial assessment is that the data collection
efforts proposed in subsections (n) and (o) could be both difficult and
expensive. This does not, in itself, mean that they are inappropriate,
but it does suggest the need to consider whether other, more readily
obtainable, data might provide comparable or even better insights into
energy markets. In part, the answer may depend on an even more basic
question--the intended uses of the data, which are not described in the
draft legislation. These questions are important to consider, and so
are intertwined with EIA's more specific comments that follow.
Ownership of energy commodities.--A key issue with subsection (n)
is the feasibility of the proposed data collection, i.e., how to
determine who are the owners of ``all'' inventories and therefore who
should report to EIA. EIA currently surveys stocks at petroleum
terminals, for instance, but those stocks are held on a custody basis,
not an ownership one. Terminal operators may not know who the owners of
the stocks are. These operators would know who brought the product to
the terminal and who leases the tanks, but the product could have been
subsequently sold--something that can occur daily--and still remain in
the same tanks. Ownership would also be difficult to identify in the
cases of minority position owners and joint ventures. The universe of
actual owners (i.e., intended survey respondents) is unknown and
perhaps unknowable, particularly outside of the physical market
participants EIA usually deals with such as refiners, pipelines, and
terminal operators. With the assistance of other agencies, EIA might be
able to identify and survey at least a subset of owners, but such an
activity should be recognized as involving far more difficulty than
simply adding questions about ownership to the surveys that are
currently completed by those having custody of inventories.
The universe of owners could include those entities covered by
subsection (n)(2) as well, i.e., ``any person holding or controlling
energy futures contracts or energy commodity swaps. . . .''. Some of
the issues prompted by trying to identify the owners of petroleum
inventories apply to natural gas inventories as well. We suggest that a
limited threshold of respondents be used, rather than owners of ``all''
oil and natural gas inventories called for in proposed subsection
(n)(1). The language in subsection (n)(1)(A) that calls for information
collection ``to the maximum extent practicable'' is reflective of our
concern but the inclusion of ``all'' is problematic.
Other Federal agencies.--Federal agencies such as the CFTC and the
Internal Revenue Service (IRS) may already have some of the desired
information and/or have lists of entities that would constitute a
portion of the entities that would need to be surveyed in order to
collect ownership and transaction information.
In terms of existing data sources, EIA is aware that the IRS
already collects some data by ownership, such as end-of-month product
inventory at petroleum terminals, for tax purposes. It is not clear,
however, if the ownership definition IRS uses for tax collection would
be useful for increased understanding of trading-price relationships.
It should also be noted that the IRS has established a Joint
Operations Committee (JOC), a partnership of dedicated Federal and
state fuel tax administration resources, to enable state and Federal
motor fuel tax compliance activities, foster interagency and multi-
national cooperation, and to provide strategic analyses of domestic and
foreign motor fuel distribution trends and patterns. The JOC works
toward those ends through the innovative use of technology and other
means to collect, analyze and share information, and conduct joint
compliance initiatives. To support analysis related to its missions,
the JOC has established a National Data Center consisting of a
technical foundation for a common motor fuel data repository. More
specifically, the JOC can incrementally identify, acquire and integrate
State, Federal and other commercial third-party data sources that bear
on the national fuel inventory. The compiled data can be used to track
and trend fuel movement within the nation's Fuel Distribution System\1\
for the purpose of developing improved baselines for measuring fuel
supply, fuel distribution and fuel consumption.
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\1\ The U.S. Fuel Distribution System is an extensive
infrastructure that connects buyers and sellers of fuel within the
financial market. The physical infrastructure encompasses a vast array
of capital, including drilling rigs, pipelines, ports, tankers, barges,
trucks, crude oil storage facilities, refineries, product terminals,
and retail storage tanks and pumps which are used to refine, produce,
and distribute fuel to the consumer.
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Since EIA has had no prior involvement with holders of energy
futures contracts or energy commodity swaps, we are inclined to defer
to the CFTC regarding those types of entities. We agree, therefore,
that the language in subsections (n)(1) and (n)(2) that states that the
plan should be developed ``in consultation with other Federal agencies
(as necessary)'' is the appropriate approach to take. It is quite
likely that an interagency task force would be needed to develop and
implement the plan for the proposed collections, considering the scope
of the proposal.
Timelines.--The level of effort needed to develop and implement the
plan envisioned in the draft legislation would be quite substantial,
and is likely to require a great deal of EIA and interagency work It
also could well involve the modification of existing surveys or the
creation of new ones, which are time consuming processes in their own
right and include both an initial 60-day public comment period as well
as a lengthy review by the Office of Management and Budget that
provides an additional opportunity for public comment. Thus, the
deadlines on page 2 of the legislation do not appear to be realistic
and would need to be extended. It is difficult to specify alternative
time periods at this early stage of consideration; one alternative
would be to say ``as soon as practicable after the date of enactment. .
. .'' and take the same approach for the time period after the date on
which notice is to be provided.
Protection of Proprietary Information.--The legislation applies
section 12(f) of the Federal Energy Administration Act of 1974 to
information collected under subsection (n). This statute authorizes EIA
to share company-level data with all Federal agencies as well as with
the Congress and the courts. At times, respondent-level data collected
under this authority has been the subject of Freedom of Information Act
(FOIA) requests by private, non-governmental parties. This includes
requests from private organizations that anticipate opportunities for
utilizing EIA respondent-level data for private gains. An alternative
approach would be to make these data collections subject to the
Confidential Information Protection and Statistical Efficiency Act
(CIPSEA) which requires additional safeguards for protecting the
identity of reported information and for sharing individual respondent
(i.e., company-specific) information. For data collected under CIPSEA,
sharing company-level data is restricted to statistical use only and
cannot be released for non-statistical, including regulatory or FOIA,
purposes. Ultimately, the choice of which data collection authority to
cite will depend on the level of protection that is required, the
intended use of the data, how sensitive the reported information is to
respondents in identifiable form, and the purposes for which the
information may be shared with other agencies. These considerations are
not specified in the draft legislation.
We cannot speak to the detailed information protection policies and
statutes in place in other Federal agencies, including CFTC and IRS,
which generally are more stringent than EIA's and do not require an
affirmative obligation to share data with other Federal agencies. They
would, of course, also have to be taken into account in the development
and implementation of the proposed information collection plan,
providing yet another reason for extending the deadlines mentioned
previously.
Funding.--Though no cost estimate could be provided until the
details of the plan required under the draft legislation are finalized,
the proposed section 3 activities would likely be both time-consuming
and expensive. It should also be noted that, pending the availability
of additional staff and resources, these activities would be handled by
existing staff that would need to be pulled from their previously
planned activities, which could lead to delays in current high-priority
projects such as integrating ethanol into our weekly petroleum data
program, collecting custody-based petroleum data at the individual
terminal level rather than across an entire Petroleum Administration
for Defense District, and addressing other existing data quality
issues.
Financial Markets Analysis Office.--Proposed subsection (o) creates
a Financial Markets Analysis Office within EIA, the director of which
reports directly to the Administrator. EIA would prefer to have the
latitude to restructure EIA as necessary, rather than have a new office
designated by statute. Expertise in energy markets is located across
several EIA offices, the staff of which work together across office
lines to produce forecasts and analyses. Cross-office teams are created
as needed, including for work on financial markets.
Comments on Section 4
Section 4 of the draft legislation establishes an interagency
Working Group on Energy Markets, the membership of which is composed of
the Secretary of Energy (who serves as chairperson), the Secretary of
the Treasury, the heads of four independent agencies (CFTC, Federal
Energy Regulatory Commission, Federal Trade Commission, and the
Securities and Exchange Commission), and the EIA Administrator. The
Working Group is tasked with several purposes and functions, one of
which is to make recommendations to the President and the Congress
regarding laws and regulations that may be needed to ``prevent
excessive speculation in energy commodity markets. . . .'' While we
agree that EIA could make a valuable contribution in advancing many of
the identified purposes and functions, EIA's role as a policy-neutral
statistical agency may lead a future EIA Administrator to avoid taking
an active role in making any recommendations on laws and regulations.
This concludes my prepared testimony, Madam Chairman. I would be
pleased to answer any questions you and the other Members may have.
Senator Cantwell. Thank you.
Ms. Cochrane, thank you for being here.
STATEMENT OF ANNA COCHRANE, ACTING DIRECTOR, OFFICE OF
ENFORCEMENT, FEDERAL ENERGY REGULATORY COMMISSION
Ms. Cochrane. I'm sorry. Madame Chairman and members of the
subcommittee, thank you for the opportunity to appear before
you today. I note that I appear before you as a staff witness
and do not speak for individual members of the Commission.
Transparency in our Nation's electric and natural gas
energy markets is critically important to the Commission in
fulfilling its statutory responsibilities to ensure just and
reasonable wholesale rates for electric and natural gas
customers. The subcommittee's review of this important topic is
a timely one. The commission has undertaken a number of
initiatives to increase transparency in the Nation's energy
markets, including some that predate the Energy Policy Act of
2005 and some based on the authority Congress granted to it in
EPACT 2005.
I have described these initiatives in more detail in my
written testimony, but would like to highlight some of the most
significant initiatives. To make electric transmission service
more transparent the Commission issued regulations in 1996
requiring public utility transmission providers to implement an
open access, same time information system or OASIS to share
information about the electric transmission system with all
users of the system at the same time. OASIS is an important
tool to ensure that there is no undue discrimination in the
provision of transmission services in interstate commerce and
to help prevent the exercise of market power.
In 2001, the Commission issued a final rule that requires
all public utilities including power marketers to file an
electric quarterly report summarizing data about their
currently effective contracts and wholesale power sales made
during each calendar quarter including transaction specific
information. This publicly available data is particularly
useful for monitoring markets for indications that market power
may be being exercised and provides an insight into pricing
trends throughout the electric industry.
In 2003, the Commission issued a policy statement on
electric and natural gas price indexes that explained the
Commission's expectations of natural gas and electricity price
index developers and the companies that report transaction data
to them. The Commission has recently undertaken two initiatives
pursuant to the new transparency authority which Congress
granted the Commission in EPACT 2005. These initiatives taken
together will provide the Commission with a more complete
picture of the wholesale natural gas market and the supply and
demand fundamentals underlying that market.
The Commission's oversight staff in the Office of
Enforcement conducts daily oversight and monitoring of energy
markets as well as research and analysis facilitated by
customized reports prepared from the information available to
us. If we discover a market anomaly we analyze the situation
further to determine if it can be explained by market
fundamentals. If not, we refer the matter to our investigation
staff.
Staff also works closely with the RTO and ISO market
monitoring units. The Commission recently enhanced the
independence of the market monitors, extended their scope of
reporting and required the RTOs and ISOs to provide the market
monitors with adequate resources and full access to market
information. Much of our oversight staff's research and
analysis is shared with the public through website postings,
regional monthly calls with State regulatory officials and
presentations at open Commission meetings and other public
conferences.
Transparency in energy markets is important to ensure just
and reasonable rates under the FPA and NGA and to protect
customers. Much has been done by the Commission to increase
transparency in wholesale electric and natural gas markets
especially over the last few years. The Commission will
continue to be vigilant in this area.
The Commission's new market manipulation authority granted
by Congress in EPACT 2005 also helps us protect customers. A
few additional tools could help the Commission better ensure
that customers are protected. For example, congressional action
to give the Commission cease and desist authorities for
violations of the FPA and NGA. The ability to freeze assets of
entities that violate the market manipulation rules would give
the Commission the same enforcement tools that both the SEC and
CFTC have long possessed.
In addition authority to temporarily suspend market rules
on file under the FPA when necessary to protect against
potential abuse of market power could also be useful. If
Congress determined that it was appropriate to provide the
Commission with such authorities it is likely that they would
be used only in rare circumstances, if at all. However their
statutory existence would have a deterrent effect.
Thank you again for giving me the opportunity to appear
before you today. I'd be happy to answer any questions you
might have.
[The prepared statement of Ms. Cochrane follows:]
Prepared Statement of Anna Cochrane, Acting Director, Office of
Enforcement, Federal Energy Regulatory Commission
Madam Chairman, and Members of the Subcommittee:
My name is Anna Cochrane, and I am Acting Director of the Federal
Energy Regulatory Commission's (Commission) Office of Enforcement.
Thank you for the opportunity to appear before you today to discuss
energy market transparency and regulation. I appear before you today as
a staff witness and do not speak for individual members of the
Commission. Transparency in our nation's electric and natural gas
energy markets is critically important to the Commission in fulfilling
its statutory responsibilities to ensure just and reasonable wholesale
rates for electric and natural gas customers. The Subcommittee's review
of this important topic is a timely one.
the commission's efforts to promote transparency
The Commission has undertaken a number of initiatives to increase
transparency in the nation's energy markets, including some that
predate the Energy Policy Act of 2005 (EPAct 2005) by over a decade. It
has used its Natural Gas Act (NGA) and Federal Power Act (FPA)
authorities to collect information and require reporting of market
information to improve transparency in wholesale natural gas and
electric markets and in electric transmission and natural gas
transportation. In addition, the Commission has used the specific
Natural Gas Act transparency authority Congress granted to it in EPAct
2005 to improve transparency in natural gas markets. These efforts are
discussed below.
To make electric transmission service more transparent, the
Commission issued regulations in 1996 requiring public utility
transmission providers to implement an Open Access Same-time
Information System, or OASIS, to share information about the electric
transmission system with all users of the system at the same time.
Through the OASIS, transmission customers can view information
regarding the availability of transmission capacity and the usage of
the transmission system by other wholesale power customers. The terms
and conditions of service are clearly posted on the OASIS, including
the prices for each type of service offered and reserved. If the
transmission provider discounts its price for a particular customer, it
must announce that discount to all wholesale customers through an OASIS
posting. The transmission provider also must post the reason for
denying any request for service, along with information regarding
curtailments and interruptions of service to those that have confirmed
reservations. These OASIS requirements were patterned on similar
requirements that had been earlier implemented for interstate natural
gas transportation. OASIS requirements remain an important tool to
ensure that there is no undue discrimination in the provision of
transmission services in interstate commerce and to help prevent the
exercise of market power.
The Commission also has taken several important steps to increase
the transparency of electricity and natural gas commodity prices. For
example, in 2001, the Commission issued a final rule that requires all
public utilities, including power marketers, to file an Electric
Quarterly Report (EQR) summarizing data about their currently effective
contracts and wholesale power sales made during each calendar quarter,
including transaction specific information. EQR data is public and
available for use on the Commission's website. EQR data is particularly
useful for monitoring markets for indications that market power may be
being exercised and provides an insight into pricing trends throughout
the electric industry. For example, the information reported in the EQR
(1) assists in corroborating or refuting evidence of market power
submitted by sellers seeking market-based rate authority, (2) assists
addressing on the record protests involving regional market conditions,
and (3) helps determine whether sellers are complying with Commission-
imposed price mitigation measures.
In addition, in 2003, the Commission issued a Policy Statement on
Electric and Natural Gas Price Indices that explained the Commission's
expectations of natural gas and electricity price index developers and
the companies that report transaction data to them. The Policy
Statement, among other things, directed the Commission's staff to
continue to monitor price formation in wholesale markets, including the
level of reporting to index developers and the amount of adherence to
the Policy Statement standards by price index developers and by those
who provide data to them. In adhering to this directive, Commission
staff documented improvements in the number of companies reporting
prices from back offices, adopting codes of conduct, and auditing their
price reporting practices. These efforts resulted in significant
progress in the amount and quality of both price reporting and the
information provided to market participants by price indices.
In 2005, the Commission issued Order No. 668 which, among other
things, revised its Uniform System of Accounts (USofA) to accommodate
the restructuring changes that are occurring in the electric industry
and to provide uniformity and transparency in accounting for and
reporting of transactions and events affecting public utilities,
including Regional Transmission Organizations (RTO). These changes in
accounting and financial reporting should improve cost recovery
practices by providing details concerning the cost of RTO functions,
and increased assurance that the costs are both legitimate and
reasonable. In addition, in 2008, the Commission further enhanced the
transparency of the business activities of natural gas companies and
public utilities by requiring them to provide greater detail in their
annual financial forms filed with the Commission. Public utility
customers, state commissions, and the public now have more detailed
information on wholesale sales to allow them to better assess the
justness and reasonableness of interstate natural gas pipeline and
electric utility rates.
In EPAct 2005, Congress enhanced the Commission's authority to
facilitate price transparency in both the electric and natural gas
markets. Such authority was given to the Commission ``for the public
interest, the integrity of . . . markets, fair competition,'' as well
as for the protection of consumers. New Section 23 of the NGA and new
section 220 of the FPA enhance the Commission's authority to ensure
confidence in the nation's electric and natural gas markets. The
Commission's market-oriented policies for the wholesale electric and
natural gas industries require that interested persons have broad
confidence that reported market prices accurately reflect the interplay
of legitimate market forces. Without confidence in the fairness of
price formation, the true value of transactions is very difficult to
determine. Further, price transparency makes it easier for the
Commission to ensure that jurisdictional prices are ``just and
reasonable.''
Pursuant to its new transparency authority under NGA section 23,
the Commission issued Order No. 704-A to require natural gas wholesale
market participants, including a number of entities that may not
otherwise be subject to the Commission's traditional NGA jurisdiction
to identify themselves and annually report summary information about
their physical transactions that contribute to natural gas price
indices. The reported information will make it possible for the
Commission to assess the formation of index prices and the use of index
pricing in natural gas markets. The first annual reports will be filed
on May 1 for transactions that occurred during the 2008 calendar year.
Also pursuant to the NGA section 23 authority, the Commission
recently revised its regulations to improve the transparency of
wholesale natural gas markets in the United States, by requiring the
dissemination of greater information about scheduled natural gas flows
throughout the national pipeline network. The Commission has long
required interstate natural gas pipelines to post on their internet web
sites substantial information about their natural gas transportation
business. On November 28, 2008, the Commission issued Order No. 720, in
which it found that it is also necessary to obtain information from
major non-interstate natural gas pipelines in order to obtain a
complete picture of the wholesale natural gas market and the supply and
demand fundamentals underlying that market.
Specifically, Order No. 720 required major non-interstate pipelines
to post on their publicly accessible websites daily operational
information, such as scheduled volume information and design capacity
for each receipt and delivery point with a design capacity greater than
15,000 MMBtu per day. Order No. 720 defined a major non-interstate
pipeline as a pipeline that is not classified as a natural gas company
under the Natural Gas Act and delivers on average more than 50 million
MMBtu of gas annually over a three-year period. Order No. 720 also
required interstate pipelines to post similar information regarding
their no-notice transportation services. Order No. 720 is currently
pending on rehearing. Major non-interstate pipeline companies are
currently required to comply with the new rules 150 days after the
issuance of an order on rehearing.
While the Commission does not regulate financial commodity market
trading, activities in financial commodity markets can affect the
electric and natural gas physical markets that the Commission
regulates. It is therefore important that the Commission coordinate
closely with the Commodity Futures Trading Commission (CFTC), which is
responsible for the day-to-day regulation of commodity futures. In an
effort to ensure coordination of overlapping jurisdiction between these
two agencies, Congress directed in EPAct 2005 that the two Commissions
execute a Memorandum of Understanding (MOU) related to information
sharing. Specifically, it directed that the MOU include provisions
ensuring that information requests to markets within the respective
jurisdiction of each agency are properly coordinated to minimize
duplicative information requests, and provisions regarding the
treatment of proprietary trading information. The agencies signed an
MOU shortly after enactment of EPAct 2005. Pursuant to the provisions
of this MOU, the staffs of the two agencies have worked closely
together to help ensure that both have the information necessary to
perform their statutory functions. These efforts have contributed to
more effective enforcement and oversight by our Commission over the
physical energy markets.
The Commission's oversight staff within the Office of Enforcement
conducts daily oversight of energy markets through regularly scheduled
morning meetings, as well as research and analysis conducted throughout
the day and as part of long-term projects. This research is facilitated
by customized reports prepared from the information available to the
oversight staff as well as information and analysis developed by third-
party information providers. The oversight staff's long-term projects
include developing tools to automate and enhance analysis of the
information that will become available through the Commission's
transparency efforts, like Order No. 704-A and Order No. 720.
In addition to maintaining an oversight staff, the Commission
requires all RTOs and Independent System Operators (ISOs) to maintain a
market monitoring function to analyze the state of the markets and
refer to the Commission any suspected market violations. In October
2008, the Commission took action through Order No. 719 to enhance the
independence of the market monitors and extend the scope of reporting
required of the market monitors. The Commission's independence reforms
included requiring the market monitors to report to the RTO or ISO
board of directors rather than to management and requiring the RTOs and
ISOs to provide the market monitors with adequate resources and full
access to market information. The Commission's reporting reforms
required production of a quarterly report that broadened the scope of
recipients of market data produced by the market monitors, and
shortened the lag time for release of bid and offer data.
In addition to the formal reporting required of the RTO and ISO
market monitors, Commission oversight staff have almost daily contact
with the market monitors to discuss issues identified during the
oversight staff's market monitor activities. In addition to routine
contacts with the RTO and ISO market monitors, the Commission's
oversight staff have several structured interactions with the market
monitors including semi-annual meetings with all of the market monitors
and regularly scheduled monthly meetings between the Commission staff
and individual market monitors.
Finally, it is important to note that the information collected by
the Commission is analyzed and, when appropriate, is shared with the
public. The staff does this by posting material on the oversight
section of the FERC website and making presentations at open Commission
meetings and other public conferences. The information posted on the
oversight website includes a monthly ``snapshot'' report that provides
information about market outcomes during the previous month. The
Commission staff use the ``snapshot'' report as the basis for monthly
conversations about energy markets with state regulatory officials.
During these calls, state regulatory officials often share their
insights into factors influencing their local energy markets. In
addition, the oversight staff publishes an annual State of the Markets
report that summarizes major events in natural gas and electricity
markets during the previous year. The oversight staff present the
findings from its State of the Market report, as well as its Winter and
Summer Assessments, at open Commission meetings.
potential improvements to the commission's ability to protect customers
In addition to the role of transparency in energy markets to help
ensure just and reasonable rates for wholesale sales and transmission
of electric energy and wholesale sales and transportation of natural
gas, there are other tools the Commission uses to help monitor markets
and protect customers. Among those are the market rules the Commission
approves or establishes under its FPA section 205 and 206 authority for
organized electric markets administered by ISOs and RTOs and the
implementation of the Commission's new market manipulation authority
granted by Congress in EPAct 2005. In this regard, there are certain
additional legislative changes that could further facilitate the
Commission's ability to protect against market manipulation and more
timely ensure that market rules contained in FERC tariffs do not cause
unexpected harm to the marketplace. If Congress determined it
appropriate to provide the Commission with such authorities, it is
likely that they would be used only in rare circumstances, if at all.
However, their statutory existence would have a deterrent effect.
First, Congress could give the Commission ``cease and desist''
authority under both the FPA and NGA. The Commission could use this
authority if it determines that a market participant's behavior was
ongoing and significantly harming the public interest. While the
Commission currently has the ability to seek United States District
Court injunctive relief, direct cease and desist authority would expand
the Commission's enforcement tool box to match those of the SEC and the
CFTC.
Second, Congress could consider giving the Commission authority
that would allow it to prevent the dissipation of assets by a company
under investigation for violating market manipulation rules under the
FPA or NGA. If the Commission had the authority to freeze assets, it
could prevent a company from frustrating the Commission's ability to
order disgorgement or restitution after determining that there was a
violation of the anti-manipulation rule. The SEC and the CFTC have
comparable authority.
Third, Congress could consider giving the Commission authority, in
emergency circumstances, to temporarily modify or suspend market rules
on file at the Commission under the FPA if those market rules were
unexpectedly allowing market power to be exercised or causing other
serious problems in the organized markets. This could be followed by
normal FPA procedures for long-term changes to the market rules.
conclusion
In summary, transparency in energy markets is important to ensure
just and reasonable rates under the FPA and NGA and to protect
customers. Much has been done by the Commission to increase
transparency in wholesale electric and natural gas markets, especially
over the last few years, and the Commission will continue to be
vigilant in this area. In addition to transparency, there are other
regulatory tools that could be used by the Commission to help ensure
that customers are protected. For example, Congressional action to give
the Commission cease and desist authority for violations of the FPA and
NGA, and the ability to freeze assets of entities that violate the
market manipulation rules, would give the Commission the same
enforcement tools that both the SEC and the CFTC have long possessed.
In addition, authority to temporarily suspend market rules on file
under the FPA when necessary to protect against potential abuse of
market power could be useful.
Thank you again for giving me the opportunity to appear before you
today. I would be happy to answer any questions you may have.
Senator Cantwell. Thank you very much.
Mr. McCullough, thank you for being here.
STATEMENT OF ROBERT F. MCCULLOUGH, JR., MANAGING PARTNER,
MCCULLOUGH RESEARCH, PORTLAND, OR
Mr. McCullough. Good afternoon. Thank you very much for the
opportunity to be here today.
In preparing for this I went back to page 485 of the Wealth
of Nations. That's the page that uses the term ``invisible
hands.'' It's been often quoted. It's been seldom read.
The passage was not simply praise of the market. It was
warning against market participants who say that they are
performing their trades for the public good. The point is
without understanding the market, without the data to review
the market, we don't know whether they're telling the truth or
not.
Two centuries ago Adam Smith was worried enough about it to
write a page on this issue. I think we should actually make a
few people read the full page, not just the one quote. I'm
talking today about the oil peak that we had last year. At our
office we've taken to calling that the ``Pickens' Peak.'' I've
put it up on a poster board today.
We lived through the price of oil doubling and then falling
back by a factor of four. That is a level of volatility we'd
never seen in our history. At the time we had variety of
explanations. We were told it was having to do with the Chinese
and the Indians who apparently are easy to blame for things,
exchange rates, surging demand.
Luckily the Energy Information Administration provides a
lot of data. It's very useful data. It is extremely important
in this process.
Can I get the next poster board?
We've been through this process trying to review. Now that
we have the data what has occurred?
The first thing that we discover is that there was no
demand spike. In point of fact the EIA's forecast of quantities
was exceedingly good. It was, frankly, astonishingly good.
We had a net increase in production, production over our
requirements in the spring. Then we had a decrease in
inventory, production less than requirements in the fall. That
may surprise some people since it goes the wrong direction.
Let's turn to the next slide which shows the price forecast
of the EIA. The problem with this slide is that that the EIA's
price forecast was just flat wrong. Now when I say that, it's
not to make fun of them, I had no possible explanation of the
spike either.
But what we had was a spot on forecast of quantities and an
absolute inability to forecast prices. This is in spite of the
fact that we've got a large staff of very bright people who had
followed every barrel of oil as closely as they could. The
difficulty we have is not that someone did a bad job. The
difficulty is that we don't have the right model.
Economists will tell you that this could not happen in
perfect competition. If we were talking about farmers in Iowa
raising rye and wheat, it wouldn't happen. However if we're
talking about an oligopoly, relatively few players, it makes
perfect sense.
You intend to hold inventory when prices were increasing
hoping to be able to sell it at a much higher price. It may not
be criminal. It could in fact simply be even cagey.
But the key is that we have almost no data to follow this
through. In reviewing the legislation before you I was very
pleased to find that you'll be accumulating inventory data.
Because with the increases in world inventory it would have
been very interesting to find out who actually were the players
that held that inventory.
We found out mid-summer by the CFTC reclassifying one
player that a single firm of brokers from Switzerland held a
very high percentage of the foreign contracts on the NYMEX.
That amazed all of us. Not one of us had considered that they
had taken such a strong position.
We'd be very interested to find out that they'd had a
strong position in inventory as well. Quite frankly until we
start tracking the numbers, we're not going to know what's
happening. The worst part is because we don't think oil will
become more plentiful in the near future we are likely to see
more of these spikes with high volatility and even more
unfortunate those travel through the entire economy directly to
natural gas which is a competing energy source and then on to
electricity.
We're in the midst of the most major recession of our
lifetimes. A large component of that was the destruction of the
automobile industry. The impact on low income homeowners of
heating prices that doubled last winter. If I had my way I
would go much further than this bill.
I would certainly praise FERC for the quarterly electric
reports. That's a very valuable tool. The best way to
discourage bad actions is to make them public. The quarterly
reports do that. I think they've had a tremendous impact on the
industry. I'd like to see an extension all the way through the
energy industry, through natural gases and certainly to oil.
Thank you very much.
[The prepared statement of Mr. McCullough follows:]
Prepared Statement of Robert F. McCullough, Jr., Managing Partner,
McCullough Research, Portland, OR
Thank you for the opportunity to testify today before the Energy
Subcommittee.
America's most significant import, crude oil, has such strong
connections with natural gas and electricity that it affects the entire
economy. It is also the import we know the least about. U.S. regulators
do not collect data on any spot transactions, and data is available on
only a portion of forward transactions. Although we fear that the oil
market may have become dominated by speculators, we do not know who
they are, or their possible impacts. We do know that oil prices are
frequently anomalous. For example, on March 15, 2009, OPEC decided to
maintain output at levels agreed to before the onset of the current
recession. This was good news for oil consumers. Unfortunately,
however, oil prices have risen significantly in the ensuing ten days.
On January 30, 2008, T. Boone Pickens predicted that oil prices
would reach $100.00 a barrel during the first half of 2008.\1\ By July
23, he predicted that oil prices would reach $300.00 a barrel by the
year 2018.\2\
---------------------------------------------------------------------------
\1\ T. Boone Pickens shares his views on energy, politics, the
Olympics, OSU's new president, The Daily Oklahoman, January 30, 2008.
\2\ Pickens warns of $300 oil, Herald News Services, July 23, 2008.
---------------------------------------------------------------------------
But oil prices in 2008 did not obey Mr. Pickens. On July 3, oil
peaked at $146.00 a barrel, only to fall precipitously to a yearly low
of $31.00 a barrel on December 22.
At McCullough Research, we have taken to calling the anomalous
prices in 2008 the ``Pickens' Peak'' in honor of Mr. Pickens'
forecasting initiatives.
Because of the linkages among the nation's fuel markets, retail
gasoline, natural gas, and electricity followed similar trajectories
during 2008. Pressure on household budgets accentuated the subprime
financial crisis, and the change in automobile economics brought a
steep decline in car sales.
While oil is arguably the U.S. economy's most important commodity,
it is ironic that no agency of the U.S. government has been assigned
the task of investigating and explaining the extraordinary price
changes of last year.
Current responsibilities are allocated among the Federal Energy
Regulatory Commission (pipelines), the CFTC (some, but not all, forward
contracts), and the EIA (forecasting.) On June 10, 2008, the CFTC
announced the formation of an interagency task force, including the
CFTC, the Federal Reserve, the Department of the Treasury, the SEC, the
DOE, and the Department of Agriculture, to study commodity markets. The
task force expeditiously published an interim report, but apparently
stopped its activities soon thereafter.\3\
---------------------------------------------------------------------------
\3\ Interim Report on Crude Oil, Interagency Task Force on
Commodity Markets, July 23, 2008.
---------------------------------------------------------------------------
It is surprising that not one of the three lead federal agencies
has expressed much in-terest in Pickens' Peak. A review of materials
issued by FERC, which regulates natural gas and electricity trades, but
not oil trades, also reveals little interest in the dramatic run-up in
the price of oil in the first half of 2008.
Like the market surveillance of electricity and natural gas prices,
reviews of pricing anomalies largely rely upon third parties, such as
McCullough Research, that are retained to examine whether the markets
are reflecting fundamental supply and demand conditions.
the eia's short term energy outlook (steo) forecasts
The preeminent independent forecast of world oil markets is
performed monthly at the Energy Information Administration. Curiously,
this resource was largely ignored by apologists for the 2008 price
spike, who relied instead on anecdotes concerning exchange rates,
Chinese and Indian oil imports, and surging U.S. demand. Now that data
from 2008 is in hand, it is useful to compare the EIA's quantity
forecasts with actual historical quantities.
On January 8, 2008, the STEO forecasted supply shortfalls at the
beginning and the end of 2008.
The chart* shows the EIA's forecasted additions (blue line) to
world oil inventories in the spring and early summer of 2008, followed
by drawdowns in the fall and winter of 2008. Actual data (red line)
shows that while the EIA accurately predicted the basic pattern, it
underestimated the inventory build-up during the price spike and the
reduction in inventories during the autumn when oil prices were
falling.
---------------------------------------------------------------------------
* Charts have been retained in subcommittee files.
---------------------------------------------------------------------------
It is worth noting that the EIA had correctly forecasted all of the
fundamentals that supposedly drove up last year's market prices,
including:
Demand from China (which did not change materially during
the run-up in prices)\4\
---------------------------------------------------------------------------
\4\ EIA STEO Table 3a, http://www.eia.doe.gov/emeu/steo/pub/
contents.html
---------------------------------------------------------------------------
Demand from the U.S. (which declined during the run-up in
prices)\5\
---------------------------------------------------------------------------
\5\ Ibid.
Yet the EIA's price forecast was very poor.
Examining the numbers the way a statistician would approach this
problem, the EIA's forecast of quantities is statistically significant
at 99%, i.e. very good. The EIA's forecast of prices, however, is not
statistically significant at any level.
We may conclude therefore that the basic assumptions underlying the
EIA's forecast require careful examination. It appears likely that
price responses to changes in supply and demand are more complex than
those modeled in the EIA's price forecast.
the economic theory of oligopolistic markets
The heart of the problem is the assumption that the global crude
oil market reflects a competitive market with a large number of buyers
and sellers. Very little research has been performed concerning the
degree of competition in the oil market. Although we know that mergers
have reduced the number of very large players, there is almost no real
data about the degree of market concentration.
Understanding the degree of competition is crucial, because
economic theory gives very different predictions under different market
structures:
1. Perfect Competition
In perfect competition the presence of many buyers and many
sellers make it impossible for any one supplier (or a small
group of suppliers) to set prices. To forecast prices in
perfect competition, economists rely upon the years of
experience that have established the use of supply and demand
curves.
1. Oligopoly
Oligopoly is a market with relatively few sellers.
Forecasting prices in an oligopoly is far more complex since a
few large players can--and do--exert control over prices.
Inventories are important in an oligopoly. A market with only a few
large participants is likely to experience situations where market
participants will accumulate inventory rather than sell their products
at prices they see as less than their long-term prospects.
An extreme case of oligopoly is a market with a few pivotal
suppliers. A pivotal supplier can exert strong control over prices
because its output is absolutely required to meet demand even after all
alternative supplies have been purchased.
In a dynamic economic model we would expect an oligopolist in a
market with increasing prices to accumulate inventory to sell during
later periods. If the market for oil experienced prices increasing 6%
per month--as happened in the first six months of 2008--only a very
altruistic competitor would not be tempted to increase its inventory in
anticipation of higher prices later. If other competitors made similar
decisions, their inventory changes would also alter the supply of oil
available to the market and increase oil prices.
If a pivotal supplier was present, its inventory decisions could
directly set the price in the market. Decisions to withhold supply are
frequently observed in the nation's wholesale electricity markets. This
was the case during the Western Market Crisis of 2000-2001 when major
suppliers in California reported only 50% availability for their plants
during periods of high demand.
Given the data now available from the EIA, the assumption of
oligopoly is a better candidate for a model of the world oil market
than perfect competition. Inventories rose during the period of rising
prices and then fell when prices were falling.
Statistically, the relationship between prices and net world
production has been positive since 2006.
Increases to world inventories--production larger than current
needs--has been correlated with higher prices. This is more consistent
with oligopolistic behavior than perfect competition. Given the extreme
levels reached during July 2008, it is very possible that the oil
market had one or more pivotal suppliers.
recommendations
The inability of the federal government to fully investigate oil
price behavior in 2008 is fundamentally a data problem. Perhaps it is
not a coincidence that oil is the most opaque of our nation's energy
supplies.
The transparency legislation that you are discussing today is a
step in the right direction, because it will expand the EIA's ability
to track oil inventories within the U.S. by owner.
We know so little at this point that any information is useful.
There are, however, limitations to having only a small amount of the
information available. The oil inventories in the U.S. in 2008 averaged
only 37% of total OECD inventories. They do not include data from
either Russia or OPEC.
As with the current problems with the CFTC's oversight being
limited to just a fraction of the total forward markets, inventory data
for the U.S. will not identify inventory decisions from our major
trading partners. I recommend that another useful step is to direct the
EIA to identify data-sharing arrangements with our OECD partners,
including Canada, our single largest oil supplier.
Over the last decade, and especially after 9-11, Americans have
been told that the concept of secrecy applies to many types of energy
transactions. There has been little public debate about the heightened
levels of secrecy in energy transactions, or studies of the impact of
this secrecy on energy prices and on our national economy.
The American economist, Paul Samuelson, always included
transparency in markets as one of the conditions for perfect
competition. If we are seeking more efficient oil markets that are less
vulnerable to manipulation, we may want to re-examine a concept of
secrecy that may be taking us in the opposite direction.
My testimony before the Senate Energy and Natural Resources
Committee on September 18, 2008 stated that we have a double standard
for reporting market data. While some energy sources are relatively
transparent, other competing energy sources are largely opaque. FERC's
Web site openly publishes the electricity trades within the U.S. on a
quarterly basis, and is a good model for reporting other energy
sources.\6\ The creation of an Oil Quarterly Report modeled after
FERC's Electric Quarterly Report would give regulators, decision-
makers, and the public a better sense of whether oil markets are
dysfunctional.
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\6\ Depending On 19th Century Regulatory Institutions to Handle
21st Century Markets, http://www.mresearch.com/pdfs/355.pdf
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This completes my testimony today.
Senator Cantwell. Thank you, Mr. McCullough.
Mr. Ramm, welcome to the committee. Thank you for being
here.
STATEMENT OF GERRY RAMM, SENIOR EXECUTIVE, INLAND OIL COMPANY,
EPHRATA, WA, ON BEHALF OF THE PETROLEUM MARKETERS ASSOCIATION
OF AMERICA
Mr. Ramm. Chairman Cantwell, Ranking Member Risch and
distinguished members, I want to thank you for this invitation.
I appreciate the opportunity to provide some insight. Draft
legislation entitled, Energy Market Transparency Act is a good
start toward a lot of the things that we've been trying to do
as an industry.
I'm also pleased to speak to the detrimental effects that
inadequately regulate the commodity markets and the abusive
trading practices that have had a devastating effect on the
independent fuel markers in the Nation. I want to thank the
chairwoman and the committee for your efforts to bring greater
transparency and accountability to the commodity markets.
Without your dedication this issue would never get any
attention that it needs.
I serve as Vice Chairman of the Petroleum Marketers
Association of America. PMAA is a national federation of 47
State and regional trade associations representing over 8,000
independent fuel marketers. These marketers account for
approximately half of the gasoline sold in the United States
and nearly all the distillate fuels consumed by motor vehicles
and home heating oil users.
Chairwoman, it was 4 years ago when PMAA members first sat
in your office to discuss our concerns regarding this price
volatility. The correlations that we were seeing in the under
regulated energy commodity market and we appreciate your strong
commitment to resolving this issue. Unlike the other panelists,
I'm just a small businessman. I'm not an economist. I don't
work for the Federal Government, just a small business person
in Eastern Washington.
Large scale institutional investors speculating in the
energy markets are a driving force behind energy prices today.
The rising crude oil prices, which reached $150 a barrel for
December delivery in July of last year only to fall
dramatically to as low as $33 when that fuel was delivered on
the spot price in December, was not completely a result of
supply and demand fundamentals, but was unduly influenced by
excessively leveraged speculators, index investors and hedge
funds. Futures prices should operate on real data and not to be
driven by surges in buying.
Last week futures prices on motor fuel went up 20 cents a
gallon. In Iraq prices also rose 20 cents a gallon. Did supply
and demand in Seattle, L.A., Houston or New York change? That
price increase happened when supplies are at an all time high.
Just this last week, distillate fuels went up another 10 cents.
According to the hedge fund managers, Michael Masters,
during the first 6 months of 2008 index speculators in hedge
funds poured about 55 billion into commodity indexes which
resulted in the buying of between 130 to 170 million barrels of
West Texas intermediate crude oil in the futures market.
However by late July and early August index speculators began
to pull out money of the commodity indexes. Approximately $70
billion were withdrawn from these commodity indexes resulting
in the selling of around 230 million barrels of crude oil by
the end of the year.
Oil should not have skyrocketed to previously mentioned
records last year only to see prices dramatically collapse a
few months later. Investors were looking not to actually buy
oil futures, but to make a fast buck in a paper trade. This
practice caused oil prices to rise faster and fall harder than
could ever be explained by ordinary market forces.
Consumers, small businesses and economy were forced into a
roller coaster ride of greed and fear. The commodity markets
need the ability to determine a fair and predictable price for
energy. Commodity markets were not designed as investment
classes. They were set up for price discovery and for physical
hedgers to manage risk by entering into a futures contract in
order to lock in a price for future delivery.
Index funds managers who believe commodities are an asset
class are speculators. They are so large and generally lack
fundamental commodity market knowledge that they have
dramatically distorted these markets we rely on. This abuse of
this original intent must end now.
Often times you hear the argument that for every buyer
there is a seller to justify that there is a market for any
price. Even though that is true, oftentimes the buyer and
seller are both speculators, who set the commodity price
determined by the enthusiasm of the buyer compared to the
enthusiasm of the seller. Unfortunately for consumers they have
to buy that commodity both gasoline and diesel fuel.
When the prices have ratcheted up by speculators thus
drivers and farmers and all consumers have to buy this fuel at
today's price and that has been driven up by speculators
playing a futures game. PMAA member's companies rely on these
markets to provide the consumer with a quality product that a
price reflective of market fundamentals.
Traditional speculators serve an important role by
providing liquidity in the commodity markets for this to be
accomplished. However investment in hedge funds have wreaked
havoc on the price discovery mechanism that commodity futures
markets provide to bonafide physical hedgers. PMAA urges
Congress to expedite commodity markets reform legislation
through the legislative process. If Congress does not act and
another excessively leverage speculative bubble occurs again,
how do you think that's going to affect our economy?
Regarding the draft legislation, PMAA strongly supported
language in the 2005 Energy Policy Act that required DOE to
examine the amount of useable storage that is available in the
United States. We believe there has been a dramatic reduction
of useable storage and that policymakers may not be aware of
the extent of that reduction. Part of the reduction has been
caused by overly aggressive underground storage tank
requirements, specifically related to spill regulations that
render much storage unusable. Therefore PMAA supports efforts
to obtain data on storage availability.
Regarding section three, enhanced information on ownership
of critical energy supplies, data collection would have to
occur on a frequent basis. Reporting requirements on the amount
of commercially held oil should have a minimum threshold.
Particularly in regard to heating oil contracts which should
not be included in the reporting requirements that we believe.
We support the intent of the committee's legislation to
bring transparency to help eliminate excessive speculation in
the energy commodity markets. In addition beyond the
committee's jurisdiction in order to bring greater transparency
to the energy commodity futures market legislation must impose
aggregate position limits on non-commercial traders including
over the counter markets. Distinguish between legitimate
hedgers in the business of actually delivering the fuel to the
consumer and those in the market purely for speculative
purposes.
We need to close the end in the swaps loopholes and
increase staff and resources at the CFTC. PMAA and our
customers need our public officials to take a stand against
abusive trading practices that artificially inflate energy
prices and severely damage our economy.
We support free interchange on community futures markets in
an open, well regulated and transparent exchange that are
subject to the rules of accountability and law. Reliable
futures markets are crucial to the entire petroleum industry
and the American economy. Let's make sure that these markets
are competitively driven by supply and demand and not purely
the speculative limits and the whims and greed of Wall Street.
I want to thank you for this opportunity to testify. I'll
answer any questions I can.
[The prepared statement of Mr. Ramm follows:]
Prepared Statement of Gerry Ramm, Senior Executive, Inland Oil Company,
Ephrata, WA, on Behalf of the Petroleum Marketers Association of
America
Honorable Chairwoman Cantwell, Ranking Member Risch and
distinguished members of the committee, thank you for the invitation to
testify before you today. I appreciate the opportunity to provide some
insight on draft legislation entitled the ``Energy Market Transparency
Act of 2009.'' I am also pleased to speak to the detrimental effects
that inadequately regulated commodities markets and abusive trading
practices have had on our nation's independent fuel marketers and home
heating fuel providers.
I thank the Chairwoman and the committee for your efforts to bring
greater transparency and accountability to commodity markets. Without
your dedication, this issue would never have gained the attention it
deserved.
I serve as Vice Chairman of the Petroleum Marketers Association of
America (PMAA). PMAA is a national federation of 47 state and several
regional trade associations representing over 8,000 independent fuel
marketers. These marketers account for approximately half of the
gasoline and nearly all of the distillate fuel consumed by motor
vehicles and home heating equipment in the United States.
Chairwoman, it was four years ago when PMAA members first sat in
your office to discuss our concerns regarding price volatility and the
correlations that we were seeing in the under-regulated energy
commodity market, and we appreciate your strong commitment to resolving
the issue.
Large-scale, institutional investors speculating in the energy
markets are a driving force behind energy prices. The rise in crude oil
prices, which reached $150 a barrel for December delivery in July of
last year, only to fall dramatically to as low as $33 in December, was
not completely a result of supply and demand fundamentals. But was
unduly influenced by excessively-leveraged speculators, index investors
and hedge funds.
Futures prices should operate on real data and not be driven by
surges in buying. Last week futures prices on motor fuel went up 20
cents and rack prices also rose 20 cents. Did supply and demand change
in Seattle, L.A., Houston, and New York? And that price increase
happened when supplies are at an all time high.
According to hedge-fund manager Michael Masters, during the first
six months of 2008, index speculators and hedge funds poured around $55
billion into commodity indices which resulted in the buying of between
130 and 170 million barrels of West Texas Intermediate crude oil in the
futures market; however, by late July and early August, index
speculators began to pull money out of commodity indices. Approximately
$70 billion dollars were withdrawn from these commodity indices
resulting in the selling of around 230 million barrels of crude oil by
the end of the year.
According to a January 11, 2009 CBS News' 60 Minutes investigation
titled, ``Did Speculation Fuel Oil Price Swings?,'' oil should not have
skyrocketed to previously mentioned record levels last year, only to
see prices dramatically collapse a few months later. The piece
highlighted how investors were looking not to actually buy oil futures,
but to make a fast buck in a ``paper trade.'' This practice caused oil
prices to rise faster and fall harder than could ever be explained by
ordinary market forces alone. American consumers, small businesses and
the broader economy were forced onto a roller coaster ride of greed and
fear. However, the greatest victim of the 2008 energy crisis was
consumer confidence in these markets' ability to determine a fair and
predictable price for energy.
Commodity markets were not designed as an investment class--they
were set up for physical hedgers to manage price risk by entering into
a futures contract in order to lock in a price for future delivery.
These index funds managers who believe commodities are an asset class,
are really unwitting speculators. They are so large and lack
fundamental commodity market knowledge, that they have dramatically
distorted these markets we rely on. This abuse of this original intent
must end now.
Oftentimes you hear the argument that for every buyer there is a
seller to justify that there is a market for any price. Even though
that is true, oftentimes the buyer and seller are both speculators who
set the commodity price determined by the enthusiasm of the buyer
compared with the enthusiasm of the seller. Unfortunately for
consumers, they have to buy the commodity (gasoline, distillates) when
the price has been ratcheted up by speculators. Thus, drivers, farmers,
and all consumers have to buy the fuel at today's price that has been
driven by speculators playing a futures game.
PMAA member companies rely on these markets to provide the consumer
with a quality product at a price reflective of market fundamentals.
Traditional speculators serve an important and healthy role by
providing needed liquidity in the commodities market for this to be
accomplished. However, investment and hedge funds have wreaked havoc on
the price discovery mechanism that commodity futures markets provide to
bona-fide physical hedgers.
Congress should act quickly to restore the transparency and
oversight needed for secure and stable commodities markets and help
restore the confidence in these markets that physical hedgers and
consumer once had. If Congress does not act, and another excessively
leveraged speculative bubble occurs again, how do you think it will
affect the economy?
Therefore, PMAA urges Congress to expedite commodity markets reform
legislation through the legislative process. Please do not allow the
bill to be stalled by the financial services regulatory overhaul
debate.
Specifically regarding the draft legislation, PMAA strongly
supported language in the 2005 Energy Policy Act that required DOE to
examine the amount of useable storage that is available in the U.S. We
believe there has been a dramatic reduction in the amount of useable
storage in the U.S., and that policy makers may not be aware of the
extent of the reduction. Part of the reduction has been caused by
overly aggressive under-ground storage tank requirements, specifically
related to spill regulations that render much storage un-useable.
Therefore, PMAA supports efforts to obtain data on storage
availability.
Regarding Section 3, Enhanced Information on Ownership of Critical
Energy Supplies, data collection would have to occur on a frequent
basis and reporting requirements on the amount of commercially held oil
should have a minimum threshold. We support the Committee's
legislation. In addition, beyond the Committee's jurisdiction, in order
to bring greater transparency to the energy commodities futures market,
legislation must:
Impose aggregate position limits at the control entity level
on non-commercial traders, and across all trading environments,
including over-the-counter markets that do not have physical
connection to the underlying commodity;
Distinguish between legitimate hedgers in the business of
actually delivering the fuel to consumers, and those who are in
the market for purely speculative purposes;
Close the ``London Loophole'' by requiring foreign exchanges
with energy contracts for delivery in the U.S. and/or that
allow U.S. access to their platforms to be subject to
comparable U.S. rules and regulations;
Close the ``Swaps Loophole'' which allows so-called ``index
speculators'' (who now amount to one-third of the market) an
exemption on position limits which enable them to control
unlimited amounts of energy commodities;
Increase staff and other resources at the CFTC.
PMAA and our customers need our public officials to take a stand
against abusive trading practices that artificially inflate energy
prices and severely damage our economy. We strongly support the free
exchange of commodity futures on open, well regulated and transparent
exchanges that are subject to the rule of laws and accountability.
Reliable futures markets are crucial to the entire petroleum industry
and the American economy. Let's make sure that these markets are
competitively driven by supply and demand and not purely the
speculative whims and greed of Wall Street.
Thank you again for allowing me the opportunity to testify before
you today.
Senator Cantwell. Thank you, Mr. Ramm. Thank you for again,
for all the witnesses being here. I know some of you have been
before the full committee before or other committees talking
about this important issue. So we appreciate your expertise and
knowledge on it.
I think we're going to do 5-minute rounds. Hopefully we can
get through a few questions before the votes occur this
afternoon. But Ms. Cochrane, I think I'll start with you
because in 2009 then Chairman Kelliher recommended to the
committee several of these legislative proposals that we are
considering as part of a larger energy package, the cease and
desist authority, the dissipation in assets, the emergency
authority.
I'm sitting here with my colleague from Idaho thinking
about what if we would have had these powers in place prior to
the Western energy crisis. What do you think would have
happened in that instance as opposed to what transpired there
over a several year period of time, if we would have had these
kinds of authorities?
Ms. Cochrane. I think specifically with regard to the
authority that would allow us to, on an emergency basis, modify
or revise market rules. That would have been a useful tool to
have at the time. Specifically during the Western energy crisis
when the Commission found significant market flaws such as the
requirement for the three IOUs to buy 100 percent of their
energy in spot markets. We had to first propose market rule
changes. Then allow notice and comment before requiring the
changes.
So I think that rule in particular would have helped with
the energy crisis.
Senator Cantwell. How long a period of time was that?
Ms. Cochrane. I don't have an answer.
Senator Cantwell. From the comment period and the rule, was
that several months or?
Ms. Cochrane. It would have been several months, yeah. We
would have had to go through a process, a notice and comment
process before changing a rule.
As far as the other language, during the Western energy
crisis, we didn't have the authorities that we have now under
EPACT 2005 to police against market manipulation. I think it
was because of that crisis that the Congress gave us that
authority in 2005. So the other two authorities of, in
particular the freezing assets, we would only apply if market
manipulation was found. So that wouldn't have been availing at
the time.
Senator Cantwell. FERC has brought several cases. I can't
remember the number right now. So what are you finding in these
cases that FERC has been successful in bringing forward?
Ms. Cochrane. As far as in all our enforcement actions we
have. I would note that we have an annual report on enforcement
that we provide. We look at what we do each fiscal year. I note
that during fiscal year 2008, we did open 20 investigations
involving allegations of market manipulation.
Many of those investigations and the numbers that you
provided are still ongoing. So they're non-public
investigations that I can't really talk about at this time.
Senator Cantwell. How many have been settled?
Ms. Cochrane. I do have these numbers. We have settlements
with 27 companies for a total of 64.67 million. Many of those
were involved tariff violations or other violations in addition
to market manipulation.
Senator Cantwell. Ok. Mr. McCullough, on this point of
information and how valuable in can be on the data collection,
do you know of any government reporting right now that informs
regulators, both about the, you know, the interconnection
between the financial and physical market. I mean the reason
why I ask that is because so much of the physical aspects of
the oil market are also connected, you know, to the holders on
the futures side.
So do you know anybody that is connecting that information
now as far as government reporting?
Mr. McCullough. No. The best we have at the moment are the
EIA statistic report of the STO. They're good. They're very
useful.
But the fact is no one is following the spot oil market.
There's a fair amount of academic research including in the
interesting paper recently brought out by the CFTC concerning
the impacts of term structures. I think most of us believe that
spot and forward are highly correlated.
What that means is that we are only watching one door of
the Department's door. The shoplifters have figured out which
door to leave by. It's not a good situation at all. It's not a
practical solution to understanding why we had these sudden
shifts in oil prices.
There's just too much we're not following on. I believe,
frankly, I was going to say day to day basis, on any basis.
Senator Cantwell. What, in the collection of this data will
allow us to do what? What will it allow us to see?
Mr. McCullough. We are still hypothesizing why we had to
run up to 143. By the way we all have a different number for
that high peak. But I think we'd all agree it was big.
There are a variety of things that could have happened
there. If I had a quarterly oil report what I would have been
looking for is a fair amount of concentration in oil. I would
have certainly been looking for major players who had changed
their purchasing strategies in the spring of last year.
If this was in fact a spot for a gamut and we've seen a
fair number of those over the years that I would have expected
to have seen the inventories increasing because traditional
suppliers, major suppliers, were actually choosing to sell less
during that high price period. Now let me stress that might not
be criminal. It's only criminal if there's a conspiracy. Since
we don't have a clue what's going on, we have not a clue to
know whether it's a conspiracy.
But in terms of public policy, even if it isn't criminal it
would be critical for us to understand that behavior so that we
could prepare for it and perhaps create measures to discourage
it.
Senator Cantwell. Thank you.
Senator Risch.
Senator Risch. Thank you, Madame Chairman. Mr. McCullough,
excuse me for not knowing more about the details of this. This
is a complex area. It's hard for us to keep on the simple
stuff, let alone the complex stuff.
But let me ask you this. Why is this done in the oil
market, but yet not in copper or wheat or something like that?
I mean it seems to me that there's so much trading and so much
bigger in oil that it would be harder to do than in one of the
smaller markets. Help me out.
Mr. McCullough. It is, Don. We're all used to the Hunt
Brothers attempt to corner the silver market 20 years ago.
There's nothing new to this.
The United States has the CFTC and the Department of
Agriculture have reviewed commodity markets for many years.
We've seen efforts to corner commodity markets in many years.
We have however seen a shift in oil. We used to have seven
sisters and now depending on how you count it, we have four or
five. So we've leveled concentration there.
We've seen a dramatic shift in where the oil is produced.
We used to be the major oil producer in the entire world for a
long period in our history. Now we're major importers.
So we've seen enough changes that we begin to suspect that
we might have a market shift. The one thing I comment on was
last summer the CFTC had changed their statistics enough that
we could puzzle through what one player was. We were amazed to
find that that player had 20 percent of the net long positions
in the NYMEX.
This is a Swiss broker. They're probably fine people and
not proposing anything criminal. I'm just noting people most of
us had never heard of before suddenly turned out to be major
players in the entire U.S. oil market.
That's in sort of information that's useful for us to have.
Senator Risch. Ms. Cochrane, help me out here. Tell me
where the breaking point is? Where do you cross the line
between being a legitimate trader who is trying to make the
biggest profit that they possibly can. I mean, that's what
traders do verses a market manipulator?
Where does somebody cross the line?
Ms. Cochrane. The big difference is the legal definition of
speculation, I mean of market manipulation. It's really a fraud
statute. So what we have to show is that the trader had an
intent to manipulate the market if the trader is taken
advantage of a market rule or a market loophole then we don't
have authority to go after them. But if they're intentionally
trying to manipulate the market then that's where we can go
after them.
Senator Risch. So this all comes down to a matter of
intent.
Ms. Cochrane. Yes, it does.
Senator Risch. A trader who is trading and happens to
manipulate the market just because their idea is going here,
going there doesn't commit an offense. It's only a person who
sets out to actually manipulate the market. Is that what you're
telling me?
Ms. Cochrane. We view it that if they knew or should have
known that their actions could have had an impact on the
physical markets that are under our jurisdiction then they
acted recklessly and resulted in the manipulation that would
also be market manipulation. We could also look at reckless----
Senator Risch. I'm losing something in the definition
because by its very nature every trade is going to have an
effect, some way, on the market, is it not?
Ms. Cochrane. Our authority is only over manipulation of
the physical markets under our jurisdiction. So a trade, you
know, again if they have legitimate reasons. If they're hedging
or they're just engaging in, you know, speculative behavior.
Hedging, in and of itself, is not illegal and is not
necessarily bad for the market. It can increase liquidity and
increase transparency. But it's a very fact intensive inquiry
to determine whether it's a fraud in fact, is taking place.
Senator Risch. Indeed really, every market needs market
makers. Thank you very much. Thank you.
Senator Cantwell. Thank you, Senator.
Senator Shaheen.
Senator Shaheen. Thank you, Madame Chairman, thank you all
for being here this afternoon. I especially appreciate hearing
and seeing the graphs that show the market and the manipulation
of the market. Because for many of us who, particularly in the
Northeast in New Hampshire where we live through the high
heating oil prices and saw the impact of those on families and
on people trying to keep their cars operating.
It's reassuring to see that what some of said was happening
at the time is actually, given the analysis, what we see did
happen because, as you know, there's been a lot of debate about
that. To pick up a little bit on Senator Risch's questions
about, you know, how do you determine whether fraud was
involved and, you know, where do you cross the line with
manipulation. Shouldn't the goal of our oversight of markets be
to avoid or prevent the kind of manipulation that we saw over
the last year, regardless of whether there was intent involved
or not?
I mean, shouldn't the goal be to avoid that kind of
manipulation of the markets? I would direct that at whoever
would like to answer.
Mr. McCullough. Regulating markets retroactively is the
single most expensive and most inefficient way to do it. With
all due respect to Ms. Cochrane, who I hope will protect me in
many different ways.
I don't want to see her go into action. I want to see the
market be just and reasonable on the way in. The best possible
way to avoid manipulation is to bring that market in the light
of day.
Senator Risch, you asked is there a bright shining light on
fraud? Often there is. Case in point, throughout the electric
and gas markets we've had many cases where traders will create
artificial trades.
In fact ENRON had a book. They called it the fake trade
book. That was used to fool market price indexes either put
together by the Federal Government or put together by
individual sources. That's simple fraud.
They lied to the press. They lied to the Federal Government
to set prices at the wrong level, people thought and then to
take a profit from it. Those people should go to jail.
How do I find out if they're lying? I find out if we have a
quarterly electric report. I could actually see what the trades
were.
If they said one thing here and they did another thing
there. It's self evident. It's also self enforcing. You're not
going to make that lie if you're going to be discovered
immediately.
When we don't have that transparency then we have people
lying. You know, we used to say good neighbors and good fences.
But I will tell you, bad fences make bad neighbors. So when we
don't have the data we're encouraging people to undertake those
manipulations.
Senator Shaheen. Just to follow up a little bit on that.
Given the fluidity of financial markets and the commodities
markets that we're talking about, how do we ensure that the
data that's collected is accurate and timely?
Mr. McCullough. There's always a chance that people will be
lying under oath on their submissions to the U.S. Government. I
think that's a possibility. But once we have that in place we
know the person signing those reports is putting his freedom on
the line.
So I think to the degree we make those reports enforced by
the full weight of the law we're going to have an impact. At
the moment in many of these markets we never know whether any
of the data is correct. So we will never have a way of finding
out if they're lying or not.
But in a few cases and the EQR is one of them. We do have a
chance, later on, to figure out whether they were telling the
truth or not.
Senator Shaheen. I am almost out of time, but just very
quickly because the recommendation by a couple of you has been
to close the loopholes on London and on the swaps market. Is it
your assessment that closing the ENRON loophole has been
successful in addressing the abuses that we saw with that
loophole? Again, I'm happy to have any of you respond or is
there more we need to do there?
Mr. Ramm. As far as the ENRON loophole of course that does
with electrical markets end. But it does plan to a little bit
more of the fact that of the electronic trading that happened
in the commodity markets at the time that the Commodity
Modernization Act was enacted in 2000. What we've seen and
maybe to speak to your first question was these markets were
not designed to have all of the speculative money poured into
them.
They aren't an equity market. So when you pour all of this
money in, it's hard for the market to respond in a way that's
fundamental in the ways that it happened before. If you look at
the commodity trading that happens in the NYMEX even. You look
at what gets traded on the floor verses what gets traded
electronically.
Electronically is happening fast and furious and with a lot
of money. I think that in some of the questions about fraud and
manipulation in general the markets weren't designed for this
excessive speculation in the marketplace. There was always a
balance.
The CFTC has an obligation to see that speculation doesn't
injure price discovery. I would offer that speculation has
injured price discovery of what the markets were designed for.
Senator Shaheen. Thank you.
Senator Cantwell. Senator Dorgan, thank you for joining us.
Senator Dorgan. Thank you very much. I'm sorry I was late.
But thank you to all of the witnesses.
I think, Mr. McCullough when I walked in you said something
that I think is prescient. You said we don't have a clue. I
thought, well that's accurate. I don't think any of us in this
room have a clue as to what drove the price of oil up like a
roman candle to $147 a barrel in day trading 1 day, then back
down.
We've had hearing after hearing on this. Energy Information
Administration, I have pounded you like you were on a meat rack
trying to get out of you what do you think happened because
we're spending $100 million on your agency for information. The
answer with Mr. Caruso is a, we don't know. We think it's the
fundamentals, kind of.
But there was nothing in the fundamentals that could ever
justify the run up in these prices and the run back down. What
we know is that 37 percent of the oil future market traders in
2,000 were speculators. In a few short years 80 percent were
speculators.
Mr. Ramm, I think you said it. That market was not designed
for that kind of unbelievable speculation. I think that the
Commodity Futures Trading Commission did, in my judgment, a
shameful job of regulating. They actually provided their own
blind folders, which is pretty bizarre for a regulatory agency.
So I think the purpose of this hearing is to find out what
do we do about all this to prevent it from happening again? We
don't have a clue. You're right about that.
That's because so much of what has happened is on the dark
money side of things. We can't see it. We don't know where it
is.
It's so dark out there. We ought to bring it all into the
light to be able to understand it. Who's trading what? What are
the consequences?
We do know just little snippets. We know that at a time
when investment banks still apparently had a little money, they
were buying oil storage capability to buy oil and take it off
the market and store it and sell it later. So you know, we knew
some of the players. But we knew just snippets of information.
But there's much more we don't know then what we do know.
Senator Cantwell has done a lot of work on this, as have I.
I've chaired hearings on this subject.
I hope we can find a way to effectively establish
regulation transparency and then have regulators who care about
their work so that we have a market that works. We need an oil
futures market that works. You can't get rid of the market.
You must have a market. It's a very important market.
Normal hedging is an important part of what we're doing.
But when you run speculators up from 37 percent of the
market to 80 percent of the market, that changes the oil
futures market in a very significant way, and not for the
better. That's why we had, I think, this huge spike.
Mr. McCullough, are you speaking for all of us in this room
when you said we don't have a clue?
Mr. McCullough. I found that at 58 I know a lot less than I
did when I was 21, Senator. Can I show you one chart?
Senator Dorgan. Yes.
Mr. McCullough. The next chart up here. Yes. This is an x/y
chart. Along the horizontal axis we've put the net contribution
to world inventories. Along the vertical axis we've put the
price of WTI crude.
Now we believe that when we've got more supply, the price
should be going down. This is a statistical analysis over the
last 2 years. Over that period the world has turned on its
head.
By the way, this is significant at 99 percentile which in
statistics taught me would say, oh wow, results. What we've
ended up with for the last 2 years is the exact opposite of the
relationship we would expect. Now if we were talking about dark
energy and dark matter and a physicist came into here and said
my new super accelerator is giving the exact wrong answer.
You'd be saying I'm about to create new science. This would be
a Nobel Prize moment.
For us, either analysts or policymakers, this is a very
exciting result. It says that our basic hypothesis about the
market is wrong. We're not talking about Ma and Pa Kettle
rising over a week. We're talking about a very, very different
world from the one we saw before.
Senator Dorgan. But we're not talking about dark matter.
We're talking about dark money.
Mr. McCullough. We're talking about--I'm sorry, Senator.
Senator Dorgan. Go ahead. No, that's fine.
Mr. McCullough. We're talking about something that
indicates that we desperately need to know about this because
every prediction we're making is going to be wrong until we get
to the bottom of why having a surplus of production in world
markets is getting correlated with rising prices.
Senator Dorgan. Yes. Dr. Gruenspecht, my time is up, and I
really owed you a question. But you've testified before.
Mr. Gruenspecht. That's all right, sir.
[Laughter.]
Senator Dorgan. I understand you're pleased my time is up.
[Laughter.]
Senator Dorgan. Yes, but thank you for being with us. We're
expecting some real help out of Energy Information
Administration. I found that through the Energy and Water
Subcommittee that I chair in Appropriations. We need some real
help.
What I got from Mr. Caruso, who is an awfully nice guy. But
he was just sitting there saying, you know what? It's the
fundamentals.
That is sheer nonsense. Nothing had changed in the
fundamentals to justify what happened. The American people are
the victims of what happened.
Let me say this, Senator Cantwell. Thanks for holding the
hearing and hanging on to this subject because we need to fix
it.
Senator Cantwell. Thank you, Senator Dorgan. I know you
have chaired many hearings on this subject as well. So we
appreciate your leadership and your attention to this as well.
I want to go back to the issue about once we actually find
somebody at fault of market manipulation. How do we stop them
from dumping all their assets? Because we can see from the
AMARANTH case that once the penalties were assessed the ability
to collect on them, which I would assume if people in the
marketplace don't think that there really is a strong
deterrent.
I mean there isn't a strong issue there, they might
continue these practices. So how do we actually stop them from
dumping these assets?
Ms. Cochrane. Senator, currently we don't have the
authority to stop them from dumping their assets.
Senator Cantwell. How would this new authority help you in
that?
Ms. Cochrane. Oh, yes. The new authority would allow us, at
some point during the process the Commission would be able to
issue an order directing them to freeze their assets and would
help us preserve the status quo in order to ultimately disclose
profits and perhaps settle a penalty.
We would issue an order and direct them to, you know,
basically cease and desist.
Senator Cantwell. So FERC would issue the order. At that
point in time----
Ms. Cochrane. Yes.
Senator Cantwell [continuing]. They would have to freeze
their assets until any resolution of the situation.
Ms. Cochrane. Right.
Senator Cantwell. So unlike AMARANTH who by that point in
time had already gone through a process of liquidating their
assets, so to speak.
Ms. Cochrane. Right.
Senator Cantwell. In this case, AMARANTH would have been
stopped at an earlier point by FERC on concerns of their
activities in the natural gas market and would have been
required then to set aside revenue in fact if they were found
guilty of those actions. Is that correct?
Ms. Cochrane. Right. We would have been able to take action
to prevent the dissipation or dispersion of the assets if the
Commission had the authority at that time and had chosen to do
so would have been able to.
Senator Cantwell. Do other agencies have any authority to
stop manipulators from avoiding penalties that you know of?
Ms. Cochrane. In my understanding is that the CFTC and the
SEC also have this authority.
Senator Cantwell. So it's authority that has been used and
used successfully by those agencies?
Ms. Cochrane. My understanding is that these authorities
are used very rarely. As far as the CFTC, my understanding is
that they've used the cease and desist authority only about
four times in the last 20 years. So it is used rarely.
Senator Cantwell. Who did you say?
Ms. Cochrane. The CFTC.
Senator Cantwell. I think maybe we could say with some
conjecture they should have been using it a little more
aggressively given what's transpired.
I want to go back to the data question again, Mr.
McCullough because this information you've provided in your
latest chart. Is this information that you collected, your
organization, McCullough Research?
Mr. McCullough. This is taken from a short term electric
outlets of the EIA. It's available on about a 1-month flag. So
we didn't have it in front of us in September.
Senator Cantwell. So how would this information been
collected in a more timely basis or shared? Are you saying this
is EIA responsibility?
Mr. McCullough. It's good data. It's EIA data. We rely on
it. It's very important for forecasting, you know, the status
of overall world production levels.
What it doesn't tell us is the case that Senator Dorgan
just raised which is if people were trying to acquire storage
facilities in order to store physical product in order to
create a short term corner. If that was true that was the sort
of thing then we would be able to turn over to the Department
of Justice or the CFTC. But at the moment all I know is that on
this very high level summary data, we have a situation where
the net production levels appear to be completely opposite
everything we've ever learned about economics in terms of their
impact on price.
If we found that there was a major player who seemed to be
at the scene of each crime, so to speak. Then we would actually
know that we would have to pursue that and get an explanation
why. If we'd have had that data for ENRON, for example, we
might have caught some of the times that they had spot forward
gamuts back in 2000 and 2001.
Senator Cantwell. Is this information that CFTC is
collecting because you know, there's been a little dispute
about, you know, roles and responsibilities here. Is this
information being collected or analyzed by someone?
Mr. McCullough. No. You know, we have talked about
AMARANTH. I'm very glad that FERC took a role in AMARANTH. But
the fact is that AMARANTH took manipulations were in forward
markets.
It would not have been accessible to FERC to have
intervened at the appropriate moment because that was data that
was sitting in CFTC files. The CFTC itself didn't react until
AMARANTH went under. So the manipulations at AMARANTH, they
effectively tried to corner North American natural gas for
certain months, would not have been accessible to the
regulators to move on in a timely fashion.
So we really need to get that data out there as well as
giving people the power to react to it.
Senator Cantwell. So the data collection in this case would
have been EIA's responsibility but shared with agencies like
FERC is what you're saying.
Mr. McCullough. For AMARANTH it would have been CFTC. Then
I would hope it would be shared with FERC because frankly the
only way we found out about this is when we found out that Mr.
Hunter had tried to corner the market and failed. His entire
hedge fund went under.
Senator Cantwell. I meant on this actual.
Mr. McCullough. Oh, on this one.
Senator Cantwell. Yes, on the WTI market.
Mr. McCullough. Unfortunately FERC doesn't have oil
authority. It's oil's responsibility at the top of the pipeline
as I understand it. I don't want to get in trouble with
different Federal agencies, but I would love them to have oil
authority.
Frankly they've got some of the skills they've built up in
the agency for electric and gas. These are, when all is said
and done, in Siamese twin commodities. Natural gas prices and
oil prices are very highly correlated.
Electricity prices and natural gas prices are very highly
correlated. I think I've just proposed something rather beyond
my ability to affect unfortunately.
Senator Cantwell. Yes. Thank you. There is a vote on. So I
want to see if my colleagues have further questions.
Senator Risch. You know there is a vote. We're going to
need to run in a minute. But can somebody answer this question
briefly?
What is the oil market like compared to other commodities
in number of traders, number of dollars and what have you? Who
can take a run at that real quick? I mean how does it compare
to wheat or corn or whatever the biggest?
Mr. Gruenspecht. I think it's very big for a commodity
market, and small relative to something like the currency
markets. But relative to other commodities, I think there's a
significant amount of trading.
Senator Risch. Ok. Mr. McCullough? Thirty seconds. How'd
this happen that the market turned upside down, exactly the
opposite prices for supply and demand?
Mr. McCullough. My hypothesis is real straight forward. We
had a market with a lot of players, many buyers, many sellers
that's evolved over time. We now have a fewer number of buyers
and sellers and they are larger entities.
This looks like oligopoly strategies being played out in
the market as opposed to the perfect competition of our college
courses.
Senator Risch. Very good. Thank you.
Senator Cantwell. Thank you. Thank you. I want to thank all
the witnesses for their testimony today and to share with my
colleagues that if they any follow up questions we can submit
them to the witnesses and if they could respond to us.
These legislative proposals are things we're going to be
considering as part of the mark up on energy legislation. So we
appreciate your response to that. This meeting is adjourned.
[Whereupon, at 3:15 p.m. the hearing was adjourned.]
APPENDIXES
----------
Appendix I
Responses to Additional Questions
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Responses of Anna Cochrane to Questions From Senator Bingaman
Question 1. Please describe the benefits that the Commission has
seen from the Open Access Same-time Information System (OASIS), with
emphasis on the number of alleged violations that OASIS has detected
that the Commission has then gone on to pursue.
How many of the violations that the Commission pursues are the
result of FERC discovery, and how many are the result of self-reports?
Answer. The Commission generally requires public utilities subject
to its jurisdiction to maintain Open Access Same-time Information
Systems (OASIS). OASIS systems are electronic databases that provide
information regarding available transmission capacity and prices as
well as an ability to request transmission service. This data is
regularly updated and provided simultaneously to all users of the
utility's OASIS system. The purpose of OASIS systems is to ensure that
existing and potential transmission customers have non-discriminatory
access to relevant transmission data from the transmission provider.
The primary benefit of OASIS postings is market transparency.
Market participants should have simultaneous access to data relevant to
making transmission purchasing decisions. Our OASIS regulations also
prohibit transmission providers from providing transmission data on a
preferential basis, including to an affiliate or business partner.
OASIS therefore plays a key role in our mission to ensure that our
regulated transmission markets are fair and transparent. Therefore,
OASIS is not designed so much to detect violations as it is to prevent
them, by making the transactions so transparent that would-be violators
are deterred. Though OASIS data sometimes evidences violations of
Commission requirements, the Commission's enforcement activities
relating to OASIS more often have to do with ensuring that market
participants timely and materially comply with the OASIS system
requirements.
Violations of our regulations related to OASIS systems are varied.
For example, through our normal auditing functions within the Office of
Enforcement, we have uncovered instances in which a transmission
provider has failed to provide all of the information required on
OASIS. In fiscal year 2008, we found 13 such instances of noncompliance
with our regulations through our auditing process. The data was
promptly corrected or supplied on the OASIS by the transmission
provider in response to the auditors' report.
Other types of potential violations are related to FERC's policies
prohibiting undue discrimination among transmission customers by the
transmission provider, touching upon OASIS postings. For example, FERC
imposed a $10 million civil penalty under a consent agreement with
PacifiCorp related to several self-reported violations of the company's
Open Access Transmission Tariff and OASIS postings. In re PacifiCorp,
118 FERC 61,026 (2007). Similarly, our investigations of SCANA
Corporation and Otter Tail Power Company revealed that the companies
had been erroneously utilizing network transmission service to make
off-system power sales. In re SCANA Corporation, 118 FERC 61,028
(2007) (consenting to imposition of civil penalty without admitting or
denying violation); Otter Tail Power Company, 123 FERC 1161,213 (2008)
(consenting to imposition of civil penalty without admitting or denying
violation). Commission audit staff uncovered non-compliance at
MidAmerican Energy Company involving preferential transmission service
to the company's wholesale merchant function. MidAmerican Energy
Company, 112 FERC 61,346 (2005). The Commission penalized Arizona
Public Service Company $4 million for OASIS posting violations and for
making off-system power sales without purchasing transmission service.
Arizona Public Service Company, 109 FERC 61,271 (2004).
Question 2. Are the Electric Quarterly Reports (EQRs) audited for
accuracy?
Answer. Yes. Commission staff reviews over 1,200 Electric Quarterly
Reports (EQR) filings each quarter for accuracy and completeness.
Commission staff determines whether sellers have timely complied with
the requirements set forth by the Commission through the use of
software tools designed to identify inconsistencies in the data. Once
identified, staff contacts EQR filers to determine whether the
information filed is correct and, if not, assists filers in revising
their EQRs to come into compliance with Commission requirements. During
FY2008, Commission staff contacted over 300 filers regarding issues
with their EQRs.
In addition, Commission staff has completed 18 audits of EQR data
during FY2004-09. The Commission will consider conducting audits of EQR
data in future audit planning cycles.
Question 3. In your written testimony, you stated that EQRs are
helpful in determining ``whether sellers are complying with Commission-
imposed price mitigation measures.'' Could you describe how the
Commission decides when to impose price mitigation?
Answer. In organized markets, each regional transmission
organization (RTO) and independent system operator (ISO) has
established market rules which govern when and how price mitigation is
imposed. These market rules are stated in the RTO's or ISO's tariff,
which is filed with the Commission and subject to public comment before
the market rules go into effect. Proposals on when to impose price
mitigation may come to the Commission from the RTO or ISO, from any
market participants (e.g., through complaints filed with the
Commission), from other interested participants in a proceeding (e.g.,
state regulatory commissions), or from the Commission itself. In many
cases, these market rules are the subject of stakeholder deliberations
before they are submitted to the Commission for approval. The decision
on when to approve price mitigation rules is a case-by-case
determination that is made after reviewing the record in a particular
case. The Commission may accept the rules in whole or in part, reject
them, or establish further proceedings.
Different RTOs/ISOs apply mitigation in their organized energy
markets using one of two methods. Under the first, bid caps are applied
when a structural market power screen is failed, such as when there are
few or no competing bids for service, and the seller's bid must be
accepted due to a transmission constraint. Under the second, bid caps
are applied when a seller's bid exceeds an estimate of its marginal
costs by an established threshold and as a result, the market price is
increased by another established threshold. The thresholds vary among
RTOs and ISOs.
Also, in either traditional or RTO/ISO markets, public utilities
that make wholesale sales of electric energy, capacity or ancillary
services under market-based rates authority granted by the Commission
are subject to Commission-imposed mitigation on a seller-specific basis
in instances where a market power problem has been identified. Such
mitigation includes, but is not limited to, various forms of price
mitigation which can be tailored to address the specific market
circumstances of the applicant. Section 35.38 of the Commission's
regulations also provides for default price mitigation in instances
where the seller fails to provide alternative mitigation that is
sufficient to address the identified market power problem.
Question 4. Please describe how cease-and-desist authority, such as
proposed in S. 672, could have altered any cases that have been
pursued, or are currently being pursued, by the Commission.
Answer. The cease-and-desist authority proposed in S. 672 would
permit the Commission to order any entity that may be committing a
violation or may have committed a violation to cease and desist from
the violation. Such authority would be utilized by the Commission to
temporarily prohibit practices that it preliminarily determines are
likely to result in significant harm to consumers or significant harm
to the public interest, until such time as the Commission has concluded
its investigation of the matter.
Once an investigation commences, subjects almost always promptly
and voluntarily stop the activities that gave rise to the investigation
so as to limit their potential exposure to penalties should FERC
determine that violations have occurred. For this reason, we have not
yet encountered many situations where cease and desist authority would
have been utilized. However, as our investigations, particularly
investigations into market manipulation, continue, the Commission could
face a situation where a subject continues the activity after we
commence an investigation, especially if such a violation is
particularly profitable. The ability to quickly and flexibly respond to
such an event is the primary benefit of the cease and desist authority
provided in S. 672. In addition, the Commission's current ability to
file in district court for an injunction is limited to ongoing
violations or suspected future violations, yet our investigations
necessarily focus on conduct that occurred in the past and there may be
circumstances where the nature and extent of past violations give rise
to a concern that violations may recur. This authority makes clear that
the Commission can order a subject to cease specific conduct based on
its past behavior.
I also want to distinguish between cease and desist authority and
the related authority under S. 672 to order an entity subject to
investigation for possible manipulation to preserve its assets. This
latter authority would be utilized when the subject is in the process
of dissolving its business or monies are being distributed to owners or
creditors. In these instances, the Commission could act to ensure that
monies will be available should there be an ultimate order requiring
disgorgement and/or penalties. The Amaranth matter is an example of a
situation where the prohibition of dissipation of assets authority
could have been used to good effect.
Responses of Anna Cochrane to Questions From Senator Murkowski
Question 1. Could you clarify the status of the Amarenth case,
since statements in the hearingeemed to indicate that Amarenth has
already been found liable?
Answer. The Amaranth proceeding is currently in litigation before
an administrative law judge at the Commission. On July 26, 2007, the
Commission issued an order that directed the Amaranth respondents to
show cause why they should not be found to have violated the Anti-
Manipulation Rule promulgated by the Commission under section 315 of
the Energy Policy Act of 2005, and why they should not be assessed
civil penalties and disgorge unjust profits associated with their
actions. Responses were submitted along with briefs on the merits by
the respondents and trial staff within the Commission's Office of
Enforcement.
On review of those responses and briefs, the Commission on July 17,
2008, issued an order ruling on certain preliminary legal issues raised
by the parties and setting for hearing issues involving disputes of
material fact. Specifically, the Commission directed an administrative
law judge to determine, based on the allegations contained in the Show
Cause Order and in the brief submitted by the Office of Enforcement,
whether any of the respondents violated the Anti-Manipulation rule and
whether they unjustly profited from their activities, and if so the
level of unjust profits. The Commission reserved for itself the issues
of whether civil penalties should be imposed for the respondents'
alleged violations and the method by which the respondents should
disgorge any unjust profits. The Commission stated that it would make
those determinations based on the record developed at the hearing.
The judge presiding over the hearing has established a procedural
schedule requiring the conclusion of discovery and the submission of
written testimony by July 23, 2009. The hearing is scheduled to begin
on August 4, 2009, followed by an initial decision by the judge on or
before December 1, 2009.
Question 2. Can you provide a breakdown of how many cases FERC is
pursuing that deal directly with market manipulation, in terms of both
number and percentage?
Answer. Currently, the Division of Investigations has open 23
investigations (some involving multiple subject companies) in which
market manipulation is a potential violation. These 23 investigations
constitute approximately 45% of all investigations currently open.
Question 3. What other enforcement proceedings is FERC currently
undertaking?
Answer. FERC engages in a number of enforcement activities beyond
matters involving opened investigations regarding market manipulation.
For example, the Commission is handling four manipulation proceedings
in which orders to show cause have been issued. These proceedings,
involving Amaranth (Docket No. IN07-26), Energy Transfer Partners
(Docket No. IN06-3), National Fuel Marketing Company (Docket No. IN09-
10), and Seminole Energy Services, Inc. (Docket No. IN09-9) are in
various procedural stages at the Commission.
Additionally, the Office of Enforcement's Division of
Investigations currently has 28 investigations (some with multiple
subject companies) pending which do not involve market manipulation.
These cases run the gamut of the Commission's regulatory authority,
including pipeline capacity release activities, the allocation of
network transmission service, potential undue discrimination, possible
standards of conduct violations, and pipeline and electric utility
tariff violations. Notably, investigations of potential violations of
new Electric Reliability Standards authorized by EPAct 2005 are an
emerging and increasingly significant proportion of the Commission's
investigative activity.
The Office of Enforcement also receives self-reports of potential
violations from the regulated community. Such reports are reviewed by
staff attorneys to determine whether an investigation is warranted. In
fiscal year 2008, the Commission received and reviewed 68 self-reports
and 36 were subsequently opened as investigations.
Further, the Division of Audits within the Office of Enforcement
conducts both financial and non-financial audits of the entities
subject to the Commission's regulations. For fiscal year 2008, this
division conducted 60 audits resulting in 156 recommendations for
corrective action. Our auditors address a wide range of enforcement
issues, including open access transmission tariff compliance,
interconnection rules, standards of conduct, and Commission filing
requirements.
Additionally, the Office of Enforcement operates a publicly-
accessible Enforcement Hotline. The Enforcement Hotline is staffed
during all business hours by attorneys within the Division of
Investigations. Where warranted, the Office utilizes information
obtained through the Hotline as a basis to begin an investigation.
Question 4. Considering the separate notion of modifying Section 5
of the NGA, have you assessed the degree to which retroactive refunds,
and the resulting insecurity of pipeline revenues, would have on the
ability of pipelines to access the capital markets?
Answer. We have not done a quantitative assessment. However, the
current proposals to modify section 5 of the NGA are similar to section
206 of the FPA. Among other limitations, these provisions set a refund
effective date no earlier than the date a complaint is filed or the
Commission issues a notice of its intent to initiate such a proceeding.
There is no evidence that refund liability under Section 206 of the FPA
has significantly impaired access by the electric utility industry to
the capital markets.
Question 5. Is the proposal for retroactive refunds limited to cost
of service or does it also apply to rate design and cost allocation? If
the latter, how can you justify making it retroactive?
Answer. The proposal to revise NGA section 5 to permit the
Commission to establish a retroactive refund effective date would apply
to all refunds, including refunds that result from a finding that the
pipeline's existing rate design or allocation of costs among its
customers is unjust and unreasonable. Currently, when the Commission
finds under NGA section 5 that a pipeline's rate design or existing
allocation of costs among its shippers is unjust and unreasonable, the
Commission allows the pipeline to implement any offsetting rate
increases at the same time as it implements the rate decreases. This
ensures that the Commission's action under NGA section 5 does not cause
the pipeline to under recover its cost of service. Similarly, if NGA
section 5 is amended to be consistent with section 206 of the FPA, the
Commission could nonetheless continue this practice of ensuring that
changes in rate design or cost allocation do not cause a shortfall for
the pipeline. It should also be noted that refunds are discretionary
under this provision and that, if they are ordered, they are limited to
15 months.
Question 6. Isn't it true that markets determine the ultimate price
for natural gas (i.e. it is not a compendium of segmented costs along
the way). Thus, retroactive refunds would have little or no impact on
the delivered price of gas. Rather, it's just a quest between market
participants, including producers, to capture the netback.
Answer. It is true that the price of natural gas is market-
determined. Some customers purchase their gas in locations close to the
market where it will be consumed, such as Chicago. However, other
customers purchase their gas at market hubs or producing areas, and pay
to transport that gas to the market where it will be resold or
consumed.
For any specific transaction, the party which acts as shipper on
the interstate natural gas pipeline could be a local distribution
company, a producer, a marketer, another interstate pipeline, or an
end-user. Retroactive refunds would go initially to whichever of the
numerous parties in a chain of commercial transactions was the actual
shipper, if that shipper was paying the maximum tariff rate. But a
number of shippers enter into negotiated rate transportation contracts
under which retroactive refunds may be reduced or relinquished, in
exchange for a mutually-agreeable rate; whether refunds apply is a
matter of the specific contract terms.
Many local distribution companies (LDCs), regulated by state public
service commissions, continue to hold sufficient long-term capacity to
ensure adequate deliveries to their markets, and the state public
service commissions most likely would require those LDCs to flow
through any retroactive refunds they receive to their customers,
including residential consumers. In the case of a producer which held
long-term firm pipeline capacity for the transportation of its gas to
market, the producer would receive the retroactive refund; this refund
would defer some of the producer's transportation costs, and may result
in an increase in its effective revenues from the transaction.
Regardless of whether the shipper is a producer, marketer,
pipeline, LDC, or end-user, the shipper's transportation payments
support the transmission infrastructure needed to allow a healthy
competitive natural gas market to function, and it is these shippers
and their customers who receive the benefit of any retroactive refunds
pipelines are ordered to make.
Question 7. Isn't adequate pipeline capacity key to keeping
delivered costs low? For example, during the New England cold snap of
2004 it was a lack of pipeline capacity--not a lack of natural gas--
which resulted in prices spiking over $50 per mmbtu. If retroactive
refunds impair the ability of pipes to access capital markets and
continue robust construction aren't we running the risk of repeating
that example?
Answer. Adequate pipeline capacity is certainly a key element in
keeping delivered natural gas costs low. Since the New England cold
snap of 2004, over 3,600 MMcf per day of pipeline delivery capacity and
800 MMcf of liquefied natural gas deliverability has been placed in
service in the Northeast with Commission approval. An additional 2,000
MMcf per day of pipeline capacity to the region is currently under
construction. The additional new capacity--along with generally milder
weather--is one reason why price spikes during the winter of 2008-09
were less frequent and less severe than those in the recent past.
The Commission diligently reviews the proposed rates associated
with new construction to assure that rates are just and reasonable. The
Commission would only order rate refunds in cases where those rates are
determined, after considerable review, not to be just and reasonable.
Additionally, in those cases the Commission is limited in its ability
regarding the refunds ordered.
Question 8. Most of the merchant generators who operate gas fired
generation facilities do not hold firm transportation capacity on the
natural gas on the pipelines that serve them. During the cold snap of
2004 this very nearly resulted in an inadequacy of electric power
generation. Have you evaluated the degree to which the failure to hold
firm capacity jeopardizes electric reliability on a larger scale?
Answer. A number of factors contributed to conditions in the New
England electricity market during the 2004 cold snap. Commission staff
began an assessment even while the cold snap continued and identified
many areas that contributed to market events. ISO-NE and state
agencies, at the urging of the Commission, took several steps to reduce
the risk of winter disruptions. Those steps included:
Altering bidding schedules during cold snaps so generators
know their power commitment before gas trading and pipeline
scheduling deadlines.
Improving operations to allow for increased power imports.
Restricting economic outages during cold snaps.
Including fuel and pipeline data in the unit commitment and
forecasting process.
Working with states to clarify emissions rules and make them
more flexible.
Reserving firm capacity directly from a pipeline on a year round
basis can be costly and may not always benefit the public. The
Commission has created conditions where those that value capacity the
most from day to day can acquire it at a market price through a
transparent posting system. This market price tells generators the
value of capacity during times of constraint; it tells the power system
operators that other resources may be more economic; and it tells
pipeline companies when sufficient demand exists to justify new
construction. During the winter of 2008-09, independent power providers
purchased 20% of the pipeline capacity released in the Northeast.
Question 9. When is the last time the Commission updated its policy
on incremental pricing of gas transmission capacity, as compared to
rolled in pricing? Don't we now have a system with wildly variant
prices for the same essential service? How do you justify that result?
Answer. The last generic policy review of the Commission's
incremental and rolled-in pricing policies was completed in 2000.
Certification of New Interstate Natural Gas Pipeline Facilities, 88
FERC 61,227 (1999), order on clarification, 90 FERC 61,128 (20000),
order on clarification, 92 FERC 61,094 (2000) (collectively we refer
to these orders as the ``Certificate Policy Statement''). Under this
policy, pipelines and shippers have significant flexibility to
negotiate rates which provide a fair balance between the pipeline and
individual shippers dealing with both price and risks, such as the risk
of future cost overruns, while ensuring that other shippers who do not
benefit from newly constructed capacity do not bear the costs. As a
result, shippers who enter into long-term contracts for pipeline
transportation service may pay different rates, depending on when they
entered into their contract, and other factors (such as how much must
be invested in new facilities to provide the requested service).
In addition, shippers also have the opportunity to seek released
capacity from other shippers or interruptible capacity from the
pipeline itself. This allows competition to take place between the
pipeline and releasing shippers. This competition creates short-term
market prices which reflect the relative surplus or scarcity of
capacity on individual pipelines and gives all interested shippers
opportunities to acquire short-term spot market gas supplies and the
pipeline capacity necessary to deliver their gas to market. On a
nation-wide basis these opportunities allow shippers to seek the most
cost-effective supplies of natural gas delivered to their markets.
Question 10. In testimony you stated that if FERC detects market
manipulation, it has no meanso order a stop to such manipulation until
the administrative proceeding results in a finding of liability. Isn't
it true that FERC does have that ability through the federal court
system?
If so, is this ability truly inadequate to deal with manipulation
or is it simply a bit less convenient for FERC to obtain judicial
injunctive relief?
Answer. To be clear, under Section 20 of the Federal Power Act
(FPA) and Section 314 of the Natural Gas Act (NGA), the Commission has
the authority to seek an injunction from the federal district courts to
stop actions that constitute or will constitute a violation of our
regulations, the acts, or our orders. Such an injunction will be issued
by the courts ``upon a proper showing.'' Proceedings under FPA Section
20 and NGA Section 314 are subject to the same scheduling, procedural
requirements, legal standards, and burden of proof as those faced by
private litigants seeking injunctions from the federal courts. And, as
noted above, the authority is limited to situations where the
Commission has a basis to find that ongoing or future conduct violates
or will violate the law.
The proposals contained in S. 672 would permit the Commission
itself to issue an order to companies subject to investigation to
temporarily cease and desist from potential violations based on past,
ongoing, or suspected future conduct. Notice and hearing would be
required prior to the issuance of such an order, except in the
circumstance where such procedures are impracticable or contrary to the
public interest. Upon issuance of such a temporary cease and desist
order, the subject of the order could request reconsiderationy the
Commission or proceed immediately to the Circuit Courts of Appeals to
obtain review of the order. Moreover, the related asset freeze
authority remedy may not clearly be available even in a district court
injunction proceeding under Rule 64 of the Federal Rules of Civil
Procedure, absent an express federal statutory authority. The procedure
provided for in S. 672 allows for much quicker action to stop
prohibited conduct or the dissipation of assets than going to federal
district court while also allowing for immediate access to appellate
court review.
Further, the existing authority to seek injunction from the courts
would not reach the situation posed by Amaranth. Section 20 of the FPA
only allows the Commission to seek an injunction of acts or practices
that ``constitute or will constitute a violation'' of the FPA or the
Commission's regulations or orders. Amaranth's conduct was completed by
the time the investigation commenced and its distribution of assets was
not, itself, an action that is a violation of the Act or the
Commission's regulations or orders.
The proposals would bring FERC's authority and practices more in
line with the authority and practices in place at CFTC and SEC. It
would also expand our ability to stop potential violations. Under
existing authority, the Commission would need to demonstrate the
subject is engaged or is about to engage in violations to obtain an
injunction. However, under S. 672, the Commission may, as a
precautionary measure, issue an order to prohibit any actions the
subject would take that would harm the public interest without proving
the likelihood that the violation would be repeated. Perhaps most
importantly, the proposals would allow the Commission to act rapidly
and flexibly to deal with potential violations, including market
manipulation, by ensuring that the public interest is protected while
investigations are pending. The proposals strike an appropriate balance
between the need to quickly respond to potential violations and
important due process rights.
______
Response of Howard Gruenspecht to Question From Senator Murkowski
Question 1. Do you think that there are certain duties and
functions that are fundamentally inconsistent with EIA's mission and
capacity that would be better left to the CFTC?
Answer. Yes, EIA's mission is to provide policy-neutral data,
forecasts, and analyses to promote sound policy making, efficient
markets, and public understanding regarding energy and its interaction
with the economy and the environment. The CFTC's mission is to protect
market users and the public from fraud, manipulation, and abusive
practices related to the sale of commodity and financial futures and
options, and to foster open, competitive, and financially-sound futures
and option markets. For both EIA and the CFTC, knowledge and
understanding of the market are very important. EIA's work focuses on
extracting information from the data available through its surveys and
third-party providers. CFTC's market oversight is directed to
supporting its policy-related activities, including development and
enforcement of regulations. The institution of processes for sharing
data, expertise and insights on a more timely basis--some of which has
already begun--will help both agencies. However, given the policy
neutrality of EIA's mission, it should not directly engage in the
policy-related functions of the CFTC that include regulation and
enforcement.
Appendix II
Additional Material Submitted for the Record
----------
Natural Gas Supply Association,
March 27, 2009.
Hon. Maria Cantwell,
Chair, Subcommittee on Energy, Committee on Energy and Natural
Resources, U.S. Senate, Washington, DC.
Dear Chair Cantwell: The Natural Gas Supply Association (``NGSA'')
requests inclusion of these comments in the record for the Subcommittee
on Energy's hearing on draft legislation to improve energy market
transparency and regulation held on March 25, 2009. In particular, NGSA
recently became aware of the proposed Amendment to the Natural Gas Act
(``NGA'') giving the Federal Energy Regulatory Commission (``FERC'')
cease-and-desist authority, and would like to submit brief initial
comments on the proposed language.
NGSA represents integrated and independent companies that produce
and market domestic natural gas. Established in 1965, NGSA encourages
the use of natural gas within a balanced national energy policy and
promotes the benefits of competitive markets to ensure reliable and
efficient transportation and delivery of natural gas and to increase
the supply of natural gas to U.S. consumers. NGSA strongly opposes
market manipulation and believes that FERC should have sufficient
enforcement tools to deter and stop such conduct. As NGSA stated as
part of an industry coalition in a white paper submitted to FERC in
Docket No. AD07-13, we believe that the vitality of the markets
regulated by FERC depends on the agency's vigorous, firm and fair use
of its enforcement authority.
However, it is also important that FERC's enforcement tools provide
the proper checks and balances, giving all parties due process rights.
FERC's authorities have already been significantly broadened in recent
years, and NGSA believes the tools already at the commission's disposal
are sufficient. To date, there has been only one reported instance in
which a company distributed its assets, ``frustrating the agency's
ability to collect civil penalties.'' (January 21, 2009 letter from
Chairman Kelliher to Senator Bingaman). If it is determined that FERC
requires additional enforcement authority beyond the existing court
injunction powers provided for in both Section 717s(a) of the NGA and
the Energy Policy Act of 2005, NGSA believes certain modifications are
needed to clarify and enhance the proposed language in order to ensure
that any additional enforcement authority is also coupled with a
balanced approach to due process. NGSA's suggestions with regard to
Senate Bill 672 titled ``Natural Gas and Electricity Review and
Enforcement Act'' include the following:
1. given the nature of any temporary cease-and-desist authority, it
should also include other enforcement limits
NGSA believes the language in Section 2(e)(1) of the proposed
amendment should be further tailored to limit the types of pre-emptive
enforcement actions that FERC will have authority to employ. NGSA is
concerned that the current language is overly broad and may give FERC
the authority to unnecessarily hinder, or even stop, companies from
operating their businesses (e.g. revocation of blanket certificate
authority). NGSA suggests modifying the proposed language in Section
2(e)(1) so that the remedy within any cease-and-desist order is
narrowly tailored to address the alleged violation. As stated below
regarding emergency orders, the amount of assets that can be frozen
should be commensurate with the level of penalty that ultimately may be
assessed. Failure to incorporate this limit could unreasonably result
in a company no longer being able to operate its business, potentially
impairing the supply of natural gas to the market.
2. require de novo court review
To ensure the fairness of due process, the judicial review of a
FERC cease-and-desist order should provide all parties, including FERC,
with equal deference. Specifically, the proposed language should be
modified to grant explicitly de novo jurisdiction to the reviewing
district courts, thus allowing the court to make an independent
determination of all of the facts and all of the issues surrounding the
agency's actions. As courts have previously recognized in cases
involving other agencies, such de novo review is appropriate in
analogous circumstances where the agency has the ability to serve as
the prosecutor, judge and jury in the proceeding. (See NRC v. Radiation
Tech, Inc., 519 F. Supp. 1266, 1286 (D. N.J. 1981); FCC v. Summa Corp.,
447 F. Supp. 923, 925 (D. Nev. 1978). In situations where an emergency
cease-and-desist order is issued without a prior hearing, it is
critical that on judicial review, the district court is able to
independently review the facts and circumstances in order to determine
whether the order was appropriate.
3. employ the cftc model for any immediate emergency actions
The proposed language for the cease-and-desist authority appears to
be modeled after Section 21(c) of the Securities Exchange Act of 1934
(``SEA''). Instead, NGSA believes that the U.S. Commodity Futures
Trading Commission's (``CFTC'') model provides the most effective due
process procedures for addressing undesirable behavior. In particular,
for emergency situations, NGSA supports adopting language modeled after
Section 6c of the Commodities Exchange Act (``CEA''), which states
that,
Whenever it shall appear to the Commission that any
registered entity or other person has engaged, is engaging, or
is about to engage in any act or practice constituting a
violation of any provision of this chapter or any rule,
regulation, or order thereunder, or is restraining trading in
any commodity for future delivery, the Commission may bring an
action in the proper district court of the United States or the
proper United States court of any territory or other place
subject to the jurisdiction of the United States, to enjoin
such act or practice, or to enforce compliance with this
chapter, or any rule, regulation or order thereunder, and said
courts shall have jurisdiction to entertain such actions.
(emphasis added)
One of the primary functions of the CFTC is to enforce laws which
ensure that market participants do not engage in actions that
manipulate the marketplace. Conversely, the SEC is primarily
responsible for supervising fiduciary responsibility between market
participants, which ensures that all market participants are treated
fairly and without discrimination. Given that the enforcement
activities of the FERC and the CFTC are similar, it follows that to the
extent FERC's enforcement powers should be broadened, the laws
governing the CFTC enforcement activities could serve as an appropriate
model rather than the laws which govern the responsibilities of the
SEC.
Moreover, FERC has the authority under Section 717s(a) of the NGA
to seek an injunction through the district courts. Modifying the
proposed language to mirror the CFTC approach in those instances where
FERC has not yet held a hearing reinforces Section 717s(a) and will
help safeguard against any tendency by the agency to serve as
prosecutor, judge and jury prior to full fact-finding. This will
guarantee parties an independent adjudication of findings that protect
the public interest.
NGSA further favors the CFTC model in those situations in which a
prior hearing is not practical because certain cease-and-desist
provisions in the current language fail to provide parties with
sufficient due process protection, give the Commission unlimited
discretion, or provide a low threshold for action. The proposed
legislation, unlike the CFTC model, would allow the agency to issue a
cease-and-desist order without notice and hearing. Specifically, the
areas of concern with the proposed approach are as follows:
No Limits on the Power to Freeze Assets. In Section 2(f),
the proposed language gives FERC the ability to prevent the
dissipation or conversion of assets. If FERC is granted this
ability, the assets subject to being frozen should not be
unlimited. Instead, the amount of assets that can be frozen
should be commensurate with the level of penalty that
ultimately may be assessed. The failure to limit this amount
could unreasonably result in an unjustified inequity or a
company that is no longer able to operate its business.
The Standard Is Too Low for Issuing an Emergency Order
without Hearing. In Section 2(f)(2), the proposed language
gives FERC authority to bypass a hearing prior to issuing a
cease-and-desist order in instances where FERC determines that
a prior hearing would be ``impracticable or contrary to the
public interest.'' In contrast, courts have a higher standard
for issuing a restraining order to preserve the status quo. For
example, in district court a restraining order will only be
granted, without a prior hearing, in situations where the
moving party can plead and prove: (1) reasonable probability of
success on the merits; (2) irreparable injury; and (3) a
balance of equities in favor of the moving party. A similarly
high standard should apply when considering whether use of
cease-and-desist authority by FERC is appropriate.
No Deadline is Specified for FERC Action Once an Emergency
Cease-and-Desist Order Issues. Section 2(g)(2)(B) states that
an applicant can request a hearing within 10 days of an
emergency order and FERC shall hold a hearing and render a
decision ``at the earliest practicable time.'' Given that a
cease-and-desist order can have significant consequences for a
company, FERC action on a hearing and decision in an instance
where a cease-and-desist order has already been issued should
be expedited and not left unspecified. A hearing should take
place within 10 days of the order and a decision should be
issued within 30 days of the order.
To the extent any further FERC enforcement authority is warranted,
NGSA strongly endorses the CFTC model for cease-and-desist authority,
and asks that the Committee consider modifying Section 2(f) to require
a court injunction in instances where an immediate cease-and-desist
order must be issued.
Thank you for the opportunity to provide these comments. In
closing, we appreciate the Committee's efforts to consider whether FERC
has sufficient enforcement authority in order to prevent market
manipulation, and believe the tools already at the commission's
disposal are sufficient. To date, there has been only one reported
instance in which a company reportedly distributed its assets in order
to avoid pending penalties. In the event Congress decides to move
forward with this legislation, NGSA hopes you will give our suggestions
serious consideration so that balanced due process benefits are
provided to all potentially affected parties.
Sincerely,
R. Skip Horvath.
______
American Public Gas Association,
March 25, 2009.
Hon. Maria Cantwell,
U.S. Senate, 511 Senate Dirksen Building Washington, DC.
Dear Senator Cantwell: On behalf of the American Public Gas
Association (APGA), I want express our strong support for S. 672--The
Natural Gas and Electricity Review and Enforcement Act which you
recently introduced. I commend you for your efforts on behalf of
natural gas consumers.
APGA is the national association for publicly-owned natural gas
distribution systems. Of the some 1,200 local distribution systems in
the United States, approximately 1,000 are public gas systems located
in 36 states; over 700 of these systems are APGA members. Publicly-
owned gas systems are not-for-profit, retail distribution entities
owned by, and accountable to, the citizens they serve. They include
municipal gas distribution systems, public utility districts, county
districts, and other public agencies that have natural gas distribution
facilities.
Your legislation will bring parity to the manner in which electric
customers versus gas customers are treated when it comes to the ability
of the Federal Energy Regulatory Commission (FERC) to review and timely
set just and reasonable rates. Correcting this inequity in Section 5 of
the Natural Gas Act to allow the FERC to set a refund-effective date
commensurate with the date on which a consumer complaint is filed and
will allow FERC to treat regulated pipelines just as it currently
treats regulated electricity transmission providers. This is a critical
consumer protection tool that the current and past FERC Chairmen and
sitting Commissioners have themselves recognized that FERC is lacking.
Your legislation will also provide the FERC with cease and desist
authority. Currently, if FERC wants an entity to refrain from certain
offensive activities, such as market manipulation, it must go to court
to obtain an order, which can be a time-consuming exercise. By
contrast, Congress has provided other federal agencies, such as the
Commodity Futures Trading Commission and the Securities Exchange
Commission, with cease and desist authority, which gives the agency the
authority to order a bad actor to cease its offensive behavior
immediately. This authority would significantly enhance the FERC's
ability to protect consumers by providing it with the ability to stop
market manipulation and other market abuses in a timely fashion.
I thank you for your efforts on behalf of natural gas consumers and
look forward to working with you and others towards passage of these
critical consumer protection provisions.
Sincerely,
Bert Kalisch,
President and CEO.
______
American Public Gas Association,
March 25, 2009.
Hon. Jeff Bingaman,
Chairman, Committee on Energy and Natural Resources, U.S. Senate,
Washington, DC.
Dear Chairman Bingaman: On behalf of the American Public Gas
Association (APGA), I request your support to eliminate the wide
disparity that currently exists in the manner that electric customers
are treated versus natural gas customers. Under the Federal Power Act
(FPA), the Federal Energy Regulatory Commission (FERC) has the ability
to review and timely set just and reasonable rates because the
complaint section of the FPA provides for refunds. There is no
corresponding protection for consumers under the Natural Gas Act (NGA).
Yesterday, Senator Cantwell introduced legislation, S. 672, that
would correct this inequity (by putting gas customers on the same
footing as electric power customers), and I urge your support of this
legislation that provides FERC with this critical consumer protection
tool--a tool that the FERC Chairman and all sitting Commissioners have
outspokenly supported.
APGA is the national, non-profit association of publicly-owned
natural gas distribution systems. Nationwide there are approximately
1,000 public gas systems in 36 states. Public gas systems range in size
from Philadelphia Gas Works, the largest and longest-operating public
gas utility in the U.S., to Wagon Mound Municipal Gas Department in New
Mexico that serves approximately 80 customers.
Under the FPA, if a complaint is filed and FERC rules that the rate
the customers have paid was unjust and unreasonable, FERC has the
authority to order refunds from and after the date the complaint case
was filed. By contrast, FERC does not have the same authority under the
NGA to provide for the reimbursement to a gas customer that is
determined to have been paying an unjust and unreasonable rate after a
complaint has been filed. Under NGA Section 5, FERC can only rule that
a rate reduction take effect prospectively after FERC's order is
issued, which more often than not occurs years after a complaint is
filed. Given the time and expense of a complaint proceeding and the
pipeline's obvious and strong incentive to delay the proceeding (since
no refunds can be ordered under NGA Section 5), the absence of a
refund-effective date provision in NGA Section 5 completely undermines
its effectiveness, as the FERC Commissioners themselves have expressly
recognized.
Last week the Natural Gas Supply Association (NGSA) released a
study (copy attached) that analyzed the cost recovery of 32 major
pipelines based on financial data that they are required to file
annually with the FERC. The study shows, among other things, that
``over a 5-year period [from 2003-2007], pipelines earned roughly $3.7
billion more than they would have collected on an average 12% allowed
return on equity. While pipelines have clearly performed effectively
for their shareholders, it is just as clear that returns are at a point
where FERC oversight is necessary.'' The study also shows that seven of
the 32 pipelines earned on average equity returns in excess of 20%. In
fact in the case of one pipeline, Natural Gas Pipeline Company of
America, its 5-year average return on equity was 34.4% (ranging from a
low of 29% to a high of 40%).
One of the arguments raised in the past by the pipeline lobby
against providing FERC with this consumer protection tool is that it
would have a negative impact upon a pipeline's ability to attract new
capital, and this in turn would have an adverse impact on
infrastructure investment. This argument is a red-herring with no basis
in fact. The FERC in establishing just and reasonable rates provides
for the recovery of all costs, including debt costs and a fair return
on equity. And a fair return on equity must, as the Supreme Court long
ago mandated, permit the regulated utility to go to the marketplace to
raise capital at reasonable rates. In addition, many infrastructure
projects are undertaken by pipelines, as identified in the NGSA study,
that are not in the egregious overcollection category.
Ironically, the pipelines never argue that they are not over-
recovering their costs--only that if caught they should not have to
refund the overcharges. The FERC Commissioners, all of whom support
infrastructure improvement and the amendment of NGA Section 5 to
provide for the establishment of a refund-effective date, understand
that this is not an ``either-or'' proposition.
As the Committee considers developing an energy package, I hope you
will support much-needed legislation that provides natural gas
consumers with the same level of protection from overcharges that
currently exists for electric consumers. The current economic climate,
not to mention the NGA's requirement that rates be just and reasonable,
demands nothing less.
Sincerely,
Bert Kalisch,
President & CEO.