[Senate Prints 109-65]
[From the U.S. Government Publishing Office]


109th Congress                                                  S. Prt.
                                 SENATE                         
 2nd Session                                                    109-65
_______________________________________________________________________

                                     



THE ROLE OF MARKET SPECULATION IN RISING OIL AND GAS PRICES: A NEED TO 
                      PUT THE COP BACK ON THE BEAT

                               __________

                              STAFF REPORT

                            prepared by the

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                                 of the

                              COMMITTEE ON

               HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS

                          UNITED STATES SENATE



[GRAPHIC] [TIFF OMITTED] TONGRESS.#13


                             JUNE 27, 2006


                    U.S. GOVERNMENT PRINTING OFFICE
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        COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS

                   SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska                  JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
NORM COLEMAN, Minnesota              DANIEL K. AKAKA, Hawaii
TOM COBURN, Oklahoma                 THOMAS R. CARPER, Delaware
LINCOLN D. CHAFEE, Rhode Island      MARK DAYTON, Minnesota
ROBERT F. BENNETT, Utah              FRANK LAUTENBERG, New Jersey
PETE V. DOMENICI, New Mexico         MARK PRYOR, Arkansas
JOHN W. WARNER, Virginia

           Michael D. Bopp, Staff Director and Chief Counsel
   Joyce A. Rechtschaffen, Minority Staff Director and Chief Counsel
                  Trina Driessnack Tyrer, Chief Clerk


                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                   NORM COLEMAN, Minnesota, Chairman
TED STEVENS, Alaska                  CARL LEVIN, Michigan
TOM COBURN, Oklahoma                 DANIEL K. AKAKA, Hawaii
LINCOLN D. CHAFEE, Rhode Island      THOMAS R. CARPER, Delaware
ROBERT F. BENNETT, Utah              MARK DAYTON, Minnesota
PETE V. DOMENICI, New Mexico         FRANK LAUTENBERG, New Jersey
JOHN W. WARNER, Virginia             MARK PRYOR, Arkansas

       Raymond V. Shepherd, III, Staff Director and Chief Counsel
                      Leland B. Erickson, Counsel
        Elise J. Bean, Minority Staff Director and Chief Counsel
                   Dan M. Berkovitz, Minority Counsel
                     Mary D. Robertson, Chief Clerk


                            C O N T E N T S

                                 ------                                
                                                                   Page

I. EXECUTIVE SUMMARY.............................................     1

II. FINDINGS AND RECOMMENDATIONS.................................     6

    A. Findings..................................................     6
      1.  GRise in Speculation...................................     6
      2.  GSpeculation Has Increased Prices......................     6
      3.  GPrice-Inventory Relationship Altered..................     7
      4.  GLarge Trader Reports Essential........................     7
      5.  GICE Impact on Energy Prices...........................     7

    B. Recommendations...........................................     7
      1.  GEliminate Enron Loophole..............................     7
      2.  GRequire Large Trader Reports..........................     7
      3.  GMonitor U.S. Energy Trades on Foreign Exchanges.......     7
      4.  GIncrease U.S.-U.K. Cooperation........................     7
      5.  GMake ICE Determination................................     7

III. RECENT TRENDS IN ENERGY MARKETS.............................     8

    A. Increasing Prices.........................................     8

    B. Increasing Amounts of Crude Oil in Storage................    12

    C. Increased Speculation in Energy Commodities...............    16
      1.  GIncreased Investments in Energy Commodities...........    16
      2.  GThe Effect of Speculation on Prices...................    17
      3.  GLarge Profits from Speculation in Energy Commodities..    23

IV. NO COP ON THE BEAT FOR OVER-THE-COUNTER ENERGY MARKETS.......    28

    A. Development of OTC Electronic Markets.....................    29

    B. No Oversight of OTC Electronic Markets....................    32

    C. No Large Trader Reporting in OTC Electronic Markets.......    35

    D. No Public Dissemination of Trading Data by OTC Electronic 
      Markets....................................................    37

V. THE COP'S BLIND EYE: U.S. ENERGY TRADES ON FOREIGN EXCHANGES..    40

    A. U.S. Energy Commodities Traded on Foreign Exchanges.......    40

    B. ICE Futures Trading of U.S. Energy Commodities............    41

    C. Implications for Oversight of U.S. Commodity Markets......    42

APPENDIX: MEASURING THE INCREASE IN SPECULATIVE TRADING..........    44

    A. CFTC Commitment of Traders Report.........................    44

    B. Increased Speculative Trading on the NYMEX................    45

    C. Increased Speculative Trading on ICE......................    48

 
THE ROLE OF MARKET SPECULATION IN RISING OIL AND GAS PRICES: A NEED TO 
                      PUT THE COP BACK ON THE BEAT

                              ----------                              


I. EXECUTIVE SUMMARY

    For the past 5 years, the U.S. Senate Permanent 
Subcommittee on Investigations has conducted a number of 
investigations into the pricing of energy commodities, 
including gasoline, crude oil, and natural gas.1 
These investigations reflect a continuing concern over the 
sustained increases in the price and price volatility of these 
essential commodities, and, in light of these increases, the 
adequacy of governmental oversight of the markets that set 
these prices.
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    \1\ See, e.g., Minority Staff, U.S. Senate Permanent Subcommittee 
on Investigations, U.S. Strategic Petroleum Reserve: Recent Policy Has 
Increased Costs to Consumers But Not Overall U.S. Energy Security, S. 
Prt. 108-18 (March 5, 2003); Majority Staff, U.S. Senate Permanent 
Subcommittee on Investigations, Gas Prices: How Are They Really Set?, 
reprinted in Gas Prices: How Are They Really Set, Hearings before the 
U.S. Senate Permanent Subcommittee on Investigations (S. Hrg. 107-509) 
(April 30 and May 2, 2002), at p. 322; U.S. General Accounting Office, 
Effects of Mergers and Market Concentration in the U.S. Petroleum 
Industry, Report to the Ranking Minority Member, U.S. Senate Permanent 
Subcommittee on Investigations, GAO-04-96 (May 2004); Volatility in the 
Natural Gas Market: The Impact of High Natural Gas Prices on American 
Consumers, Hearing before the U.S. Senate Permanent Subcommittee on 
Investigations (S. Hrg. 109-398) (February 13, 2006).
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    Over the past 6 years, crude oil, gasoline, and natural gas 
prices have risen significantly. Crude oil has risen from a 
range of $25-$30 per barrel in 2000, to a range of $60-$75 per 
barrel in 2006. High crude oil prices are a major reason for 
the record or near-record highs of the prices of a variety of 
petroleum products, including gasoline, heating oil, diesel 
fuel, and jet fuel. The average price for a gallon of regular 
unleaded gasoline has jumped from $1.46 per gallon in 2000 to 
$2.36 per gallon over the past 12 months, with peaks at $3.14 
per gallon in September 2005, and $2.93 per gallon in May 2006. 
Rising crude oil prices have helped push up natural gas prices 
as well: the price of natural gas has risen from $2-$3 per 
million BTU (British Thermal Unit) in 2000 to a typical range 
of $6-$8 per million BTU during the past year.
    The traditional forces of supply and demand cannot fully 
account for these increases. While global demand for oil has 
been increasing--led by the rapid industrialization of China, 
growth in India, and a continued increase in appetite for 
refined petroleum products, particularly gasoline, in the 
United States--global oil supplies have increased by an even 
greater amount. As a result, global inventories have increased 
as well. Today, U.S. oil inventories are at an 8-year high, and 
OECD oil inventories are at a 20-year high. Accordingly, 
factors other than basic supply and demand must be examined. 
For example, political instability and hostility to the United 
States in key producer countries, such as Nigeria, Venezuela, 
Iraq, and Iran, threaten the security and reliability of these 
supplies. Furthermore, in each of the past 2 years hurricanes 
have disrupted U.S. oil and gas production in the Gulf of 
Mexico. As Saudi Arabia has increased its rate of production to 
meet increasing demand, its ability to pump additional oil in 
the event of a shortfall has declined, thereby providing less 
of a cushion in the event of a supply disruption. It is often 
asserted that these fears over the adequacy of supply have 
built a ``risk premium'' into crude oil prices.2
---------------------------------------------------------------------------
    \2\ See, e.g., Statement of Daniel Yergin, World Crude Oil Pricing, 
Hearing before the U.S. House of Representatives Committee on Energy 
and Commerce, May 4, 2006.
---------------------------------------------------------------------------
    In addition, over the past few years, large financial 
institutions, hedge funds, pension funds, and other investment 
funds have been pouring billions of dollars into the energy 
commodities markets--perhaps as much as $60 billion in the 
regulated U.S. oil futures market alone--to try to take 
advantage of price changes or to hedge against them. Because 
much of this additional investment has come from financial 
institutions and investment funds that do not use the commodity 
as part of their business, it is defined as ``speculation'' by 
the Commodity Futures Trading Commission (CFTC). According to 
the CFTC, a speculator ``does not produce or use the commodity, 
but risks his or her own capital trading futures in that 
commodity in hopes of making a profit on price changes.'' 
Reports indicate that, in the past couple of years, some 
speculators have made tens and perhaps hundreds of millions of 
dollars in profits trading in energy commodities. This 
speculative trading has occurred both on the regulated New York 
Mercantile Exchange (NYMEX) and on the over-the-counter (OTC) 
markets.
    The large purchases of crude oil futures contracts by 
speculators have, in effect, created an additional demand for 
oil, driving up the price of oil to be delivered in the future 
in the same manner that additional demand for the immediate 
delivery of a physical barrel of oil drives up the price on the 
spot market. As far as the market is concerned, the demand for 
a barrel of oil that results from the purchase of a futures 
contract by a speculator is just as real as the demand for a 
barrel that results from the purchase of a futures contract by 
a refiner or other user of petroleum.
    Although it is difficult to quantify the effect of 
speculation on prices, there is substantial evidence that the 
large amount of speculation in the current market has 
significantly increased prices. Several analysts have estimated 
that speculative purchases of oil futures have added as much as 
$20-$25 per barrel to the current price of crude oil, thereby 
pushing up the price of oil from $50 to approximately $70 per 
barrel. Additionally, by purchasing large numbers of futures 
contracts, and thereby pushing up futures prices to even higher 
levels than current prices, speculators have provided a 
financial incentive for oil companies to buy even more oil and 
place it in storage. A refiner will purchase extra oil today, 
even if it costs $70 per barrel, if the futures price is even 
higher.
    As a result, over the past 2 years, crude oil inventories 
have been steadily growing, resulting in U.S. crude oil 
inventories that are now higher than at any time in the 
previous 8 years. The last time crude oil inventories were this 
high, in May 1998--at about 347 million barrels--the price of 
crude oil was about $15 per barrel. By contrast, the price of 
crude oil is now about $70 per barrel. The large influx of 
speculative investment into oil futures has led to a situation 
where we have high crude oil prices despite high levels of oil 
in inventory.
    As former Federal Reserve Chairman Alan Greenspan recently 
explained in testimony before the Congress, over the past few 
years ``there has been a major upsurge in over-the-counter 
trading of oil futures and other commodity derivatives.'' 
3 Hedge funds and other institutional investors have 
accumulated ``substantial net long positions in crude oil 
futures, largely in the over-the-counter market.'' 4 
According to Mr. Greenspan, these futures positions have 
created an additional demand for oil for future delivery, and 
``with the demand from the investment community, oil prices 
have moved up sooner than they would have otherwise.'' Mr. 
Greenspan states these price increases have stimulated 
additional oil production, a large increase in oil inventories, 
and a partial scale-back of consumption.5
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    \3\ Statement of Alan Greenspan, Oil Depends on Economic Risks, 
Hearing before the Committee on Foreign Relations, U.S. Senate, June 7, 
2006.
    \4\ Id.
    \5\ Id.
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    In general, speculative trading brings greater liquidity to 
the futures market, so that companies seeking to hedge their 
exposure to commodity prices can find counterparties willing to 
take on those price risks. Speculative purchases of futures 
contracts can also, in effect, finance the production and 
storage of the underlying commodity to meet future demand. On 
the other hand, large speculative buying or selling of futures 
contracts can distort the market signals regarding supply and 
demand in the physical market or lead to excessive price 
volatility, either of which can cause a cascade of consequences 
detrimental to the overall economy.
    A key responsibility of the CFTC is to ensure that prices 
on the futures market reflect the laws of supply and demand 
rather than manipulative practices 6 or excessive 
speculation.7 The Commodity Exchange Act (CEA) 
states, ``Excessive speculation in any commodity under 
contracts of sale of such commodity for future delivery . . . 
causing sudden or unreasonable fluctuations or unwarranted 
changes in the price of such commodity, is an undue and 
unnecessary burden on interstate commerce in such commodity.'' 
8 The CEA directs the CFTC to establish such trading 
limits ``as the Commission finds are necessary to diminish, 
eliminate, or prevent such burden.'' 9
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    \6\ 7 U.S.C. Sec. 5(b),
    \7\ 7 U.S.C. Sec. 6a(a).
    \8\ Id.
    \9\ Id.
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    At the same time that there has been a huge influx of 
speculative dollars in energy commodities, the CFTC's ability 
to monitor the nature, extent, and effect of this speculation 
has been diminishing. Most significantly, there has been an 
explosion of trading of U.S. energy commodities on exchanges 
that are not regulated by the CFTC. Available data on the 
nature and extent of this speculation is limited, so it is not 
possible for anyone, including the CFTC, to make a final 
determination about the current level of speculation.
    In Irrational Exuberance, which forecasted the collapse of 
stock market prices in 2000-2001, Professor Robert Shiller 
wrote of the importance of understanding the role of 
speculation in setting market prices. ``We need to know 
confidently whether the increase that brought us here is indeed 
a speculative bubble--an unsustainable increase in prices 
brought on by investors'' buying behavior rather than by 
genuine, fundamental information about value. In short, we need 
to know if the value investors have imputed to the market is 
not really there, so that we can readjust our planning and 
thinking.'' 10
---------------------------------------------------------------------------
    \10\ Robert J. Shiller, Irrational Exuberance (Princeton University 
Press, 2000), at p. 5.
---------------------------------------------------------------------------
    To a certain extent, whether any level of speculation is 
``excessive'' lies within the eye of the beholder. In the 
absence of data, however, it is impossible to begin the 
analysis or engage in an informed debate over whether our 
energy markets are functioning properly or are in the midst of 
a speculative bubble. Again, Professor Shiller has warned, ``It 
is a serious mistake for public figures to acquiesce in the 
stock market valuations we have seen recently, to remain silent 
about the implications of such high valuations, and to leave 
all commentary to the market analysts. . . . The valuation of 
the stock market is an important national--indeed international 
issue.'' 11 This advice would appear to be as 
relevant to the energy markets as to the stock market.
---------------------------------------------------------------------------
    \11\ Id., at pp. 203-204.
---------------------------------------------------------------------------
    Until recently, U.S. energy futures were traded exclusively 
on regulated exchanges within the United States, like the 
NYMEX, which are subject to extensive oversight by the CFTC, 
including ongoing monitoring to detect and prevent price 
manipulation or fraud. In recent years, however, there has been 
a tremendous growth in the trading of contracts that look and 
are structured just like futures contracts, but which are 
traded on unregulated OTC electronic markets. Because of their 
similarity to futures contracts they are often called ``futures 
look-alikes.'' The only practical difference between futures 
look-alike contracts and futures contracts is that the look-
alikes are traded in unregulated markets whereas futures are 
traded on regulated exchanges. The trading of energy 
commodities by large firms on OTC electronic exchanges was 
exempted from CFTC oversight by a provision inserted at the 
behest of Enron and other large energy traders into the 
Commodity Futures Modernization Act of 2000 in the waning hours 
of the 106th Congress.
    The impact on market oversight has been substantial. NYMEX 
traders, for example, are required to keep records of all 
trades and report large trades to the CFTC. These Large Trader 
Reports (LTR), together with daily trading data providing price 
and volume information, are the CFTC's primary tools to gauge 
the extent of speculation in the markets and to detect, 
prevent, and prosecute price manipulation. CFTC Chairman Reuben 
Jeffery recently stated: ``The Commission's Large Trader 
information system is one of the cornerstones of our 
surveillance program and enables detection of concentrated and 
coordinated positions that might be used by one or more traders 
to attempt manipulation.'' 12
---------------------------------------------------------------------------
    \12\ Letter from Reuben Jeffery III, Chairman, Commodity Futures 
Trading Commission, to Michigan Governor Jennifer Granholm, August 22, 
2005.
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    In contrast to trades conducted on the NYMEX, traders on 
unregulated OTC electronic exchanges are not required to keep 
records or file Large Trader Reports with the CFTC, and these 
trades are exempt from routine CFTC oversight. In contrast to 
trades conducted on regulated futures exchanges, there is no 
limit on the number of contracts a speculator may hold on an 
unregulated OTC electronic exchange, no monitoring of trading 
by the exchange itself, and no reporting of the amount of 
outstanding contracts (``open interest'') at the end of each 
day.
    The CFTC's ability to monitor the U.S. energy commodity 
markets was further eroded when, in January of this year, the 
CFTC permitted the Intercontinental Exchange (ICE), the leading 
operator of electronic energy exchanges, to use its trading 
terminals in the United States for the trading of U.S. crude 
oil futures on the ICE futures exchange in London--called ``ICE 
Futures.'' Previously, the ICE Futures exchange in London had 
traded only in European energy commodities--Brent crude oil and 
United Kingdom natural gas. As a United Kingdom futures market, 
the ICE Futures exchange is regulated solely by the United 
Kingdom Financial Services Authority. In 1999, the London 
exchange obtained the CFTC's permission to install computer 
terminals in the United States to permit traders here to trade 
European energy commodities through that exchange.
    Then, in January of this year, ICE Futures in London began 
trading a futures contract for West Texas Intermediate (WTI) 
crude oil, a type of crude oil that is produced and delivered 
in the United States. ICE Futures also notified the CFTC that 
it would be permitting traders in the United States to use ICE 
terminals in the United States to trade its new WTI contract on 
the ICE Futures London exchange. Beginning in April, ICE 
Futures similarly allowed traders in the United States to trade 
U.S. gasoline and heating oil futures on the ICE Futures 
exchange in London.
    Despite the use by U.S. traders of trading terminals within 
the United States to trade U.S. oil, gasoline, and heating oil 
futures contracts, the CFTC has not asserted any jurisdiction 
over the trading of these contracts. Persons within the United 
States seeking to trade key U.S. energy commodities--U.S. crude 
oil, gasoline, and heating oil futures--now can avoid all U.S. 
market oversight or reporting requirements by routing their 
trades through the ICE Futures exchange in London instead of 
the NYMEX in New York.
    As an increasing number of U.S. energy trades occurs on 
unregulated, OTC electronic exchanges or through foreign 
exchanges, the CFTC's large trading reporting system becomes 
less and less accurate, the trading data becomes less and less 
useful, and its market oversight program becomes less 
comprehensive. The absence of large trader information from the 
electronic exchanges makes it more difficult for the CFTC to 
monitor speculative activity and to detect and prevent price 
manipulation.13 The absence of this information not 
only obscures the CFTC's view of that portion of the energy 
commodity markets, but it also degrades the quality of 
information that is reported. A trader may take a position on 
an unregulated electronic exchange or on a foreign exchange 
that is either in addition to or opposite from the positions 
the trader has taken on the NYMEX, and thereby avoid and 
distort the large trader reporting system. Not only can the 
CFTC be misled by these trading practices, but these trading 
practices could render the CFTC weekly publication of energy 
market trading data, intended to be used by the public, as 
incomplete and misleading.
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    \13\ Enron's manipulation of prices on its unregulated electronic 
trading platform demonstrates the widespread economic harm that may 
result from abuses in unregulated markets. In 2002, for example, the 
Federal Energy Regulatory Commission (FERC) found that 174 trades 
between Enron and one other party in the last hour of trading in 
Enron's electronic market on January 31, 2001, resulted in a steep 
increase in the price of natural gas on that date. The report 
tentatively concluded that Enron OnLine price data was susceptible to 
price manipulation and may have affected not only Enron trades, but 
also increased natural gas prices industrywide. See, e.g., August 2002 
report prepared by the FERC staff, Docket No. PA-02-000.
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    It is critical for U.S. policymakers, analysts, regulators, 
investors and the public to understand the true reasons for 
skyrocketing energy prices. If price increases are due to 
supply and demand imbalances, economic policies can be 
developed to encourage investments in new energy sources and 
conservation of existing supplies. If price increases are due 
to geopolitical factors in producer countries, foreign policies 
can be developed to mitigate those factors. If price increases 
are due to hurricane damage, investments to protect producing 
and refining facilities from natural disasters may become a 
priority. To the extent that energy prices are the result of 
market manipulation or excessive speculation, only a cop on the 
beat with both oversight and enforcement authority will be 
effective.
    Extending the CFTC's Large Trader Reporting system to 
require all U.S. traders of energy futures or futures-like 
contracts to keep records and report large trades to the CFTC, 
regardless of where the trade takes place--on the NYMEX, on an 
unregulated OTC electronic exchange, or on a foreign exchange--
will eliminate the gaps in large trader reporting requirements. 
This action is necessary to preserve the CFTC's ability to 
oversee energy futures markets in order to detect and prevent 
price manipulation and excessive speculation.

II. FINDINGS AND RECOMMENDATIONS

    Based upon its investigation into the role of market 
speculation in rising oil and gas prices, the Subcommittee 
staff makes the following findings and recommendations.

A. Findings

    1. Rise in Speculation. Over the past few years speculators 
have expended tens of billions of dollars in U.S. energy 
commodity markets.

    2. Speculation Has Increased Prices. Speculation has 
contributed to rising U.S. energy prices, but gaps in available 
market data currently impede analysis of the specific amount of 
speculation, the commodity trades involved, the markets 
affected, and the extent of price impacts.

    3. Price-Inventory Relationship Altered. With respect to 
crude oil, the influx of speculative dollars appears to have 
altered the historical relationship between price and 
inventory, leading the current oil market to be characterized 
by both large inventories and high prices.

    4. Large Trader Reports Essential. CFTC access to daily 
reports of large trades of energy commodities is essential to 
its ability to detect and deter price manipulation. The CFTC's 
ability to detect and deter energy price manipulation is 
suffering from critical information gaps, because traders on 
OTC electronic exchanges and the London ICE Futures are 
currently exempt from CFTC reporting requirements. Large trader 
reporting is also essential to analyze the effect of 
speculation on energy prices.

    5. ICE Impact on Energy Prices. ICE's filings with the 
Securities and Exchange Commission and other evidence indicate 
that its over-the-counter electronic exchange performs a price 
discovery function--and thereby affects U.S. energy prices--in 
the cash market for the energy commodities traded on that 
exchange.

B. Recommendations

    1. Eliminate Enron Loophole. Congress should eliminate the 
Enron loophole that currently limits CFTC oversight of key U.S. 
energy commodity markets and put the CFTC back on the beat 
policing these markets.

    2. Require Large Trader Reports. Congress should enact 
legislation to provide that persons trading energy futures 
``look-alike'' contracts on over-the-counter electronic 
exchanges are subject to the CFTC's large trader reporting 
requirements.

    3. Monitor U.S. Energy Trades on Foreign Exchanges. 
Congress should enact legislation to ensure that U.S. persons 
trading U.S. energy commodities on foreign exchanges are 
subject to the CFTC's large trader reporting requirements.

    4. Increase U.S.-U.K. Cooperation. The CFTC should work 
with the United Kingdom Financial Services Authority to ensure 
it has information about all large trades in U.S. energy 
commodities on the ICE Futures exchange in London.

    5. Make ICE Determination. The CFTC should immediately 
conduct the hearing required by its regulations to examine the 
price discovery function of the ICE OTC electronic exchange and 
the need for ICE to publish daily trading data as required by 
the Commodity Exchange Act.

III. RECENT TRENDS IN ENERGY MARKETS

    ``There has been no shortage and inventories of crude oil 
and products have continued to rise. The increase in prices has 
not been driven by supply and demand.''
        --Lord Browne, Group Chief Executive of BP 
        14
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    \14\ Melanie Feisst, ``Joseph was a speculator too,'' Hedge funds 
draw on the Bible to defend themselves against accusations that they 
have destablised the markets, The Daily Telegraph, U.K., May 6, 2006.

    ``Senator, the facts are--and I've said this publicly for a 
long time--the oil prices have been moving steadily up for the 
last 2 years. And I think I have been very clear in saying that 
I don't think that the fundamentals of supply and demand--at 
least as we have traditionally looked at it--have supported the 
price structure that's there.''
        --Lee Raymond, Chairman and CEO, ExxonMobil 
        15
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    \15\ Engergy Pricing and Profits, Joint Hearing before the Senate 
Committee on Commerce, Science and Transportation and the Senate 
Committee and Energy and Natural Resources, November 9, 2005.
---------------------------------------------------------------------------

A. Increasing Prices

    In what has become an all-too-familiar refrain over the 
past several years, energy prices have recently reached record 
highs. Oil prices in the spring of 2006 surpassed the record 
highs reached last summer in the days after Hurricane Katrina 
rampaged through the Gulf of Mexico and shut down over a 
million barrels per day of U.S. oil production. Figure 1 shows 
the steep climb and recent record highs in crude oil prices. 
[GRAPHIC] [TIFF OMITTED] T8640.001

   Figure 1. Since January 2002, crude oil prices have steadily risen; 
oil prices reached record high levels in spring of 2006. Prices reflect 
spot month NYMEX futures contract prices. Data source: U.S. Department 
of Energy, Energy Information Administration (EIA), NYMEX data.

    Because gasoline and other petroleum-based energy 
commodities are produced by refining crude oil, the rising 
price of crude oil has been a major cause of rising gasoline 
and petroleum product prices. Figure 2 illustrates how U.S. 
gasoline prices have increased in recent years. 
[GRAPHIC] [TIFF OMITTED] T8640.002

   Figure 2. The average price of gasoline in the United States has 
risen from an average of $1.10 cents per gallon in the late 1990s to an 
average of over $2.20 per gallon over the past 12 months, and nearly $3 
per gallon in the spring of 2006. Prices reflect the weekly average 
retail price for all grades of gasoline. Data source: EIA.

    Natural gas prices also have jumped higher over the past 
several years. Because several industries, such as electric 
power generation, can use natural gas as a substitute for crude 
oil, and vice versa, natural gas prices are significantly 
affected by crude oil prices. Natural gas prices also are 
highly correlated with the prices of several petroleum 
products, such as diesel fuel and heating oil. Figure 3 
illustrates the recent rise in natural gas prices. 

[GRAPHIC] [TIFF OMITTED] T8640.003

   Figure 3. Natural gas prices have risen from an average of $2 per 
million BTU in the late 1990s to a current range of $6-$8 per million 
BTU in the spring of 2006. At times, price spikes have doubled the 
price of natural gas. Prices reflect spot month NYMEX futures contract 
prices. Data source: EIA, NYMEX data.

    A number of factors are often cited as contributing to 
these increasing prices.16 Generally, the rising 
prices are attributed to an increasingly precarious balance 
between supply and demand. Global demand for oil has been 
increasing, led by the rapid industrialization of China, growth 
in India, and a continued increase in appetite for refined 
products, particularly gasoline, in the United 
States.17 Although supplies have been increasing to 
keep pace with this increased demand, 18 these 
supplies are perceived to be increasingly vulnerable to 
disruption. Political instability and hostility to U.S. 
interests in the key producer countries of Iran, Iraq, 
Venezuela, 19 and Nigeria 20 are among 
the most frequently cited threats to supplies. Additionally, in 
each of the past 2 years hurricanes have disrupted U.S. oil and 
gas production in the Gulf of Mexico.21 As Saudi 
Arabia has increased its rate of production to meet increasing 
demand, its ability to pump additional oil in the event of a 
shortfall elsewhere has declined, thereby providing less of a 
cushion in the event of such a supply disruption.22 
It is often asserted that these and other fears over the 
adequacy of supply have built a ``risk premium'' into crude oil 
prices.23
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    \16\ See, e.g., U.S. Department of Energy, Energy Information 
Administration (EIA), Short-Term Energy Outlook and Summer Fuels 
Outlook, April 2006 (2006 Summer Fuels Outlook), at pp. 2-3; Jeffrey H. 
Birnbaum and Steven Mufson, Cost of Gas Puts Pressure on GOP, The 
Washington Post, April 25, 2006; BBC News, What is driving oil prices 
so high?, http://news.bbc.co.uk/go/pr/fr/-/1/hi/business/4922172.stm 
(April 20, 2006); Peg Mackey and Janet McBride, Reuters, Oil's top 
brass talk prices at summit, Saturday, April 22, 2006, 9:33 a.m.; 
Steven Mufson, The Battle Over the Blame for Gas Prices, The Washington 
Post, Friday, April 21, 2006, at p. A01.
    \17\ See, e.g., Philip K. Verleger, Jr., A Primer on Oil Prices: I, 
The Petroleum Economics Monthly, December 2005; International Energy 
Agency (IEA), Oil Market Report, May 12, 2006, at p. 3.
    \18\ For example, from 2002 through 2005 global demand increased 
from 77.8 to 83.6 million barrels per day (bpd), while global supply 
increased from 76.9 to 84 million bpd. This represents an increase in 
demand of 5.8 million bpd, and an increase in supply of 7.1 million 
bpd. As a result, OECD inventories grew by 300,000 bpd in 2003 and 
200,000 bpd in 2004 and 2005. Id., at p. 43.
    \19\ Monte Reel, Chavez Stokes Confrontation Over U.S. Role in 
Venezuela, The Washington Post, July 19, 2005.
    \20\ See, e.g., Matt Piotrowski, Nigerian Shut-Ins Fail to 
Stimulate Oversupplied US Cash Crude Market, Oil Daily, March 6, 2006. 
This spring, however, despite several well-publicized disruptions to 
Nigerian supplies, no shortfalls resulted. `` `Physical traders have 
taken the Nigerian outage totally in stride,' [one trader] said. 
`Without the Nigerian troubles, there would be even more oversupply.' 
'' Id.
    \21\ Between August 26, 2005 and April 19, 2006, the cumulative 
loss of production in the Gulf of Mexico due to Hurricane Katrina was 
approximately 149 million barrels, or approximately 1 million barrels 
per day (bpd). U.S. Department of Interior Materials and Management 
Service (MMS), Hurricane Katrina/Hurricane Rita, Evacuation and 
Production Shut-in Statistics Report, Wednesday, April 19, 2006, at 
http://www.mms.gov/ooc/press0419.htm. Nearly 90 percent of total Gulf 
of Mexico oil production, which normally is about 1.5 million bpd, was 
shut down in the first few days after landfall on August 29; nearly 56 
percent, or about 840,000 bpd, was still shut-in (i.e., unable to be 
produced) on September 15, 2 weeks after landfall. U.S. Department of 
Energy, Office of Electricity Delivery and Energy Reliability, Energy 
Assurance Daily, September 15, 2005, at pp. 2-3.
      In the 6-month period between September 11, 2004 and February 14, 
2005, Hurricane Ivan caused a cumulative loss of nearly 44 million 
barrels of crude oil production in the Gulf of Mexico, which was 
equivalent to about 7.2 percent of the annual production of oil in the 
Gulf. MMS, Hurricane Ivan Evacuation and Production Shut-in Statistics 
as of Monday, February 14, 2005, Final Report, at http://www.mms.gov/
ooc/press/2005/press0214.htm.
      The International Energy Agency (IEA) states that ``random 
events,'' such as accidents, labor unrest, ``guerilla activity,'' 
unplanned maintenance, and weather-related events, including hurricanes 
in North America, ``may cause supply losses of between 300 kb/d 
[thousand barrels per day] and 400 kb/d for non-OPEC supply each 
year.'' IEA, Oil Market Report, May 12, 2006, at p. 14.
    \22\ 2006 Summer Fuels Outlook, at p. 3. On the other hand, 
government-controlled strategic stocks, including the U.S. Strategic 
Petroleum Reserve, are at historically high levels. 2006 Summer Fuels 
Outlook, Summer Fuel Charts, at p.3 and at Summer Fuel Charts, p. 9; 
IEA, Oil Market Report, March 14, 2006, at p. 59. In the event of a 
disruption in supply, these strategic stocks can be just as effective 
as using spare production capacity to make up for production 
shortfalls. For example, in 2005, the United States released 30 million 
barrels of oil from the U.S. Strategic Petroleum Reserve, and other IEA 
members released another 30 million barrels to compensate for the loss 
of production caused by Hurricanes Katrina and Rita. H. Josef Hebert, 
Nations to Release 60M Barrels of Oil, Gas, Associated Press Financial 
Wire, September 2, 2005, 10:51 p.m. GMT. In 2003, Saudi Arabia and 
other OPEC members increased their production to compensate for the 
temporary loss of about 1.7 million barrels per day of Iraq oil due to 
the American invasion. David Ivanovich, OPEC strives to prevent world 
oil-supply shortage, Houston Chronicle, March 10, 2003; Producers 
Expect Minimal War Diruption, Oil Daily, March 19, 2003.
    \23\ See, e.g., Daniel Yergin, Testimony Before the U.S. House of 
Representatives Committee on Energy and Commerce, May 4, 2006, at 
www.cera.com/news (last visited May 22, 2006).
---------------------------------------------------------------------------
    These factors, however, do not tell the whole story. 
Concurrent with the most recent sustained run-up in energy 
prices, large financial institutions, hedge funds, pension 
funds, and other investors have been pouring billions of 
dollars into the energy commodities markets to try to take 
advantage of price changes or hedge against them. Most of this 
additional investment has not come from producers or consumers 
of these commodities, but from speculators seeking to take 
advantage of these price changes. The CFTC defines a speculator 
as a person who ``does not produce or use the commodity, but 
risks his or her own capital trading futures in that commodity 
in hopes of making a profit on price changes.'' 24 
Reports indicate that in the past year a few speculators have 
made tens and perhaps hundreds of millions of dollars trading 
in oil and gas.25
---------------------------------------------------------------------------
    \24\ CFTC, The Economic Purpose of Futures Markets, at http://
www.cftc.gov/opa/brochures/opaeconpurp. htm.
    \25\ See Section III.C.3 in this report, below.
---------------------------------------------------------------------------
    The large purchases of crude oil futures contracts by 
speculators have, in effect, created an additional demand for 
oil, driving up the price of oil for future delivery in the 
same manner that additional demand for contracts for the 
delivery of a physical barrel today drives up the price for oil 
on the spot market. As far as the market is concerned, the 
demand for a barrel of oil that results from the purchase of a 
futures contract by a speculator is just as real as the demand 
for a barrel that results from the purchase of a futures 
contract by a refiner or other user of petroleum.
    Although it is difficult to quantify the effect of 
speculation on prices, there is substantial evidence supporting 
the conclusion that the large amount of speculation in the 
current market has significantly increased prices; several 
analysts have estimated that speculative purchases of oil 
futures have added as much as $20-$25 per barrel to the current 
price of crude oil. Additionally, by purchasing large numbers 
of futures contracts, and thereby pushing up futures prices to 
even higher levels than current prices, speculators have 
provided a financial incentive for oil companies to buy even 
more oil and place it in storage. A refiner will purchase extra 
oil today, even if it costs $70 per barrel, if the futures 
price is even higher.
    As a result, over the past 2 years, crude oil inventories 
have been steadily growing, resulting in U.S. crude oil 
inventories that are now higher than at any time in the 
previous 8 years. The last time crude oil inventories were this 
high, in May 1998--at about 347 million barrels--the price of 
crude oil was about $15 per barrel. By contrast, the price of 
crude oil today is about $70 per barrel. The large influx of 
speculative investment into oil futures has led to a situation 
where we have both high supplies of crude oil and high crude 
oil prices.
    High crude oil prices are a major reason for the record or 
near-record highs of the prices of a variety of petroleum 
products, including gasoline, heating oil, diesel fuel, and jet 
fuel.26 There also is evidence that the skyrocketing 
prices of metal commodities can partially be attributed to 
these skyrocketing oil prices.27
---------------------------------------------------------------------------
    \26\ As explained in two previous reports issued by the 
Subcommittee staff, U.S. gasoline prices are also influenced by the 
overall gasoline supply and demand balance within the U.S. gasoline 
market, which in turn depends on a variety of other factors, including 
the profitability of refinery operations, domestic refinery capacity 
and availability, the level of imports, competition within the industry 
at the national and local level, and fuel specifications resulting from 
environmental requirements that affect the fungibility of gasoline 
supplies. This year, uncertainty within the market regarding whether 
there would be an adequate supply of gasoline blended with ethanol to 
replace the supply of gasoline blended with MTBE also contributed to 
some of the increases in gasoline prices.
    \27\ See, e.g., Falling oil prices would help stem rise in copper 
prices: trader, Platts Metals Week, May 19, 2006, at http://
www.platts.com/Metals/highlights/2006/mp--mw--051906.xml (last visited 
May 26, 2006).
---------------------------------------------------------------------------

B. Increasing Amounts of Crude Oil in Storage

    ``What's been happening since 2004 is very high prices 
without record-low stocks. The relationship between U.S. [oil] 
inventory levels and prices has been shredded, has become 
irrelevant.''
        --Jan Stuart, Global Oil Economist, UBS Securities 
        28
---------------------------------------------------------------------------
    \28\ Bhusan Bahree and Ann Davis, Oil Settles Above $70 a Barrel, 
Despite Inventories at 8-Year High, The Wall Street Journal, April 18, 
2006.

    Compelling evidence that the oft-cited geopolitical, 
economic, and natural factors do not fully explain the recent 
rise in energy prices can be seen in the actual data on crude 
oil supply and demand. Although demand has significantly 
increased over the past few years, so have supplies. As Figure 
4 indicates, over the past couple of years global crude oil 
production has increased along with the increases in demand; in 
fact, during this period global supplies have exceeded 
demand.29
---------------------------------------------------------------------------
    \29\ 2006 Summer Fuels Outlook, at p. 3. 
    [GRAPHIC] [TIFF OMITTED] T8640.004
    
   Figure 4. In 2004 and 2005 the supply of crude oil exceeded demand. 
---------------------------------------------------------------------------
Data source: EIA, International Petroleum Monthly, March 2006.

    Projections for the future indicate that, for the near 
term, supply will continue to keep pace with demand. In its 
monthly report for March 2006, the International Energy Agency 
(IEA), stated, ``Additions to OPEC and non-OPEC capacity are 
forecast to keep global supply trends broadly in line with 
global demand in 2007 and 2008.'' 30 The U.S. 
Department of Energy's Energy Information Administration (EIA) 
recently forecast that in the next few years global surplus 
production capacity will continue to grow to between 3 and 5 
million barrels per day by 2010, thereby ``substantially 
thickening the surplus capacity cushion.'' 31
---------------------------------------------------------------------------
    \30\ IEA, Oil Market Report, March 14, 2006, at p. 3. See also, 
2006 Summer Fuels Outlook, at p. 3.
    \31\ EIA, Energy Assurance Daily, May 4, 2006. The EIA reported the 
current spare capacity to be between 1 and 1.5 million barrels per day 
(bpd). Id. The International Energy Agency reports the spare capacity 
at 1.7 million bpd. IEA, Oil Market Report, May 12, 2006, at p. 14.
---------------------------------------------------------------------------
    Because supplies have been rising along with demand, 
commercial crude oil inventories have been rising as well. As 
can be seen in Figure 5, the amount of crude oil in U.S. 
commercial inventories is higher today than at any other time 
in the current decade. The EIA forecasts that U.S. inventories 
will increase again in 2006.32
---------------------------------------------------------------------------
    \32\ 2006 Summer Fuels Outlook, at Table 3. In Europe, crude oil in 
inventories also were higher in 2005 than in either 2003 or 2004. IEA, 
Oil Market Report, March 14, 2006, at p. 29. Not only are the absolute 
levels of U.S. and European inventories above average, inventories are 
also higher when measured by days-of-supply those inventories could 
provide at current consumption levels. Id. In June, the IEA reported 
that OECD crude stocks had risen to their highest level in 20 years. 
IEA, Oil Market Report Highlights, June 13, 2006. 

[GRAPHIC] [TIFF OMITTED] T8640.005

   Figure 5. The amount of crude oil in storage in commercial 
inventories has risen to higher-than-average levels over the past year. 
---------------------------------------------------------------------------
Data source: EIA.

    The amount of natural gas in storage also has been 
increasing over the past couple of years. From mid-2004 to the 
present, except for the period shortly following the landfall 
of Hurricane Katrina, the amount of natural gas in storage has 
exceeded the previous 5-year average.33 Yet during 
this entire period natural gas prices were higher than the 
previous 5-year average. These trends are expected to continue. 
Despite a projected increase in the amount of natural gas 
available in storage for next winter, the EIA states that 
``concerns about potential future supply tightness and 
continuing pressure from high oil markets are keeping expected 
spot natural gas prices for the next heating season at high 
levels.'' 34
---------------------------------------------------------------------------
    \33\ EIA, Short-Term Energy Outlook and Summer Fuels Outlook, April 
2006, Summer Fuel Charts, at p.11.
    \34\ 2006 Summer Fuels Outlook, at Table 3. In mid-May of this 
year, however, natural gas spot month futures fell below $6 per million 
BTU.
---------------------------------------------------------------------------
    Figure 6 shows the relationship between U.S. crude oil 
inventories and prices over the past 8 years, and how the 
relationship between physical supply and price has 
fundamentally changed since 2004. For the period from 1998 
through 2003, the chart shows that the price-inventory 
relationship generally centered around a line sloping from the 
middle-left of the chart down to the lower right, meaning that 
low inventories were accompanied by high prices, and high 
inventories were accompanied by low prices. For 2004, 2005, and 
through May 2006, which is the most recently available data, 
the inventory-price relationships fall nowhere near this 
downward sloping line; if anything, the points seem to go in 
the opposite direction, such that higher inventories seem to be 
correlated with higher prices. Figure 6 clearly indicates that 
there has been a fundamental change in the oil industry, such 
that the previous relationship between price and inventory no 
longer applies.

[GRAPHIC] [TIFF OMITTED] T8640.006

   Figure 6. Since 2004, crude oil prices have risen as inventories 
have risen. Data source: EIA.

    As will be discussed in the next section, one reason 
underlying this change is the influx of billions of dollars of 
speculative investment in the crude oil and natural gas futures 
markets. As energy prices have not only increased but become 
more volatile, energy commodities have become an attractive 
investment for financial institutions, hedge funds, pension 
funds, commodity pools, and other large investors. One oil 
economist has calculated that over the past few years more than 
$60 billion has been spent on oil futures in the NYMEX market 
alone.35 As explained below, this frenzy of 
speculative buying has created additional demand for oil 
futures, thereby pushing up the price of those futures. The 
increases in the price of oil futures have provided financial 
incentives for companies to buy even more oil and put it into 
storage for future use, resulting in high prices despite ample 
inventories.36
---------------------------------------------------------------------------
    \35\ Philip Verleger, Commodity Investors: A Stabilizing Force?, 
The Petroleum Economics Monthly, March 2006.
    \36\ Some traders contend that the high inventories have lowered 
spot prices. ``The physical market is pretty relaxed,'' one trader said 
this spring, as prices rose over $60 per barrel. ``There's been 
downward pressure on WTI [West Texas Intermediate] because of 
inventories.'' Matt Piotrowski, Nigerian Shut-Ins Fail to Stimulate 
Oversupplied US Cash Crude Market, Oil Daily, March 6, 2006. ``What the 
high stock levels are doing, along with unsold spot cargoes and storage 
capacity constraints, is driving down the spot and front month prices 
relative to the outer months. In effect, a chunk of the fear premium is 
being taken out of the market.'' Receding Fear Premium, Petroleum 
Intelligence Weekly, March 13, 2006.
    On the other hand, by creating a financial incentive to purchase 
oil for storage, the steep rise in futures prices may also have 
stimulated current demand, thereby pushing up current prices. Although 
some of this increased demand for oil--for present consumption plus for 
future consumption--has been met by increase in supply, any increase in 
production necessary to meet this additional demand has come at a time 
of low excess global excess production capacity. The recent decline in 
global excess production capacity has been one of the major factors 
supporting current price levels. See, e.g., Verleger, A Primer on Oil 
Prices: I, at p. 22. (``This process of inventory building [due to 
speculative purchases of futures contracts] reduces the supply of 
certain crudes and products available to the current spot market when 
current supply cannot be increased, as has been the case in 2005. This 
promotion of inventory holding raises current spot prices.'').
    Using the IEA estimate of 1.7 million bpd for OPEC's surplus 
production capacity, an amount of oil equivalent to between 10 and 15 
percent of OPEC's surplus capacity has been placed into commercial 
inventories. It is not apparent why these increases in commercial 
inventories, together with the high level of strategic reserves in OECD 
countries, including the U.S. Strategic Petroleum Reserve, have not had 
a greater effect in alleviating the ``fear premium'' regarding 
potential supply disruptions.
---------------------------------------------------------------------------

C. Increased Speculation in Energy Commodities

    ``Ironically, hedge funds trading oil are not doing 
anything very different than the large investment banks such as 
Goldman Sachs, Bank of America, or Morgan Stanley already do. 
The proprietary trading desks of these and other large 
investment banks are actually ``hedge funds in drag,'' just as 
Enron was.''
        --Peter C. Fusaro and Gary M. Vasey, Hedge Funds Change 
        Energy Trading 37
---------------------------------------------------------------------------
    \37\ International Research Center for Energy and Economic 
Development, 2005.
---------------------------------------------------------------------------

  1. Increased Investments in Energy Commodities

    At the same time energy commodity prices have been 
increasing, there has been a large increase in the amount of 
money expended on energy commodities futures and other 
derivative instruments. ``Volatile energy markets and record-
high commodity prices are prompting renewed interest from 
investors eager to play in the sector,'' The New York Times 
reported earlier this year. ``That has pushed banks and a 
growing number of hedge funds to hire more energy traders and 
brainy quantitative minds to back their bets on energy 
prices.'' 38 Recent academic research indicating 
that commodity futures have performed as well as stocks and 
better than bonds, with less risk, also has boosted 
expenditures on energy commodity futures.39
---------------------------------------------------------------------------
    \38\ Alexei Barrionuevo and Simon Romero, Energy Trading, Without a 
Certain ``E'', The New York Times, January 15, 2006.
    \39\ Michael R. Sesit, Commodities Enter Investment Mainstream, 
Pension Funds, Universities Jump Into the Asset Class; High Returns, 
Low Risk, Wall Street Journal, September 9, 2004; Philip Verleger, 
Commodity Investors: A Stabilizing Force?, The Petroleum Economics 
Monthly, March 2006. The most frequently cited research papers are 
Thomas Schneeweis, Georgi Georgiev, The Benefits of Managed Futures, 
June 10, 2002; and Gary Gorton and K. Geert Rouwenhorst, Facts and 
Fantasies about Commodity Futures, Yale International Center for 
Finance, Working Paper No. 04-20, June 14, 2004.
---------------------------------------------------------------------------
    Because the over-the-counter energy markets are 
unregulated, there are no precise or reliable figures as to the 
total dollar value of recent spending on investments in energy 
commodities, but the estimates are consistently in the range of 
tens of billions of dollars. Last fall, the International 
Monetary Fund reported, ``Industry estimates suggest that 
approximately $100-$120 billion of new investment in the past 3 
years has been in active and passive energy investment 
vehicles.'' 40 The New York Times cited an estimate 
that there were ``at least 450 hedge funds with an estimated 
$60 billion in assets focused on energy and the environment, 
including 200 devoted exclusively to various energy 
strategies.'' 41
---------------------------------------------------------------------------
    \40\ Pelin Berkma, Sam Ouliaris, and Hossein Samiei, The Structure 
of the Oil Market and Causes of High Prices, International Monetary 
Fund, September 21, 2005.
    \41\ Alexei Barrionuevo, Energy Trading, Without a Certain ``E'', 
The New York Times, January 15, 2006 (citing Mr. Peter Fusaro of the 
Energy Hedge Fund Center).
---------------------------------------------------------------------------
    The increased speculative interest in commodities is also 
seen in the increasing popularity of commodity index funds, 
which are funds whose price is tied to the price of a basket of 
various commodity futures. Goldman Sachs estimates that pension 
funds and mutual funds have invested a total of approximately 
$85 billion in commodity index funds, and that investments in 
its own index, the Goldman Sachs Commodity Index (GSCI), has 
tripled over the past few years to $55 billion.42 In 
March of this year, petroleum economist Philip Verleger 
calculated that the amount of money invested in commodity index 
funds ``jumped from $15 billion in 2003 to $56 billion in 2004 
and on to $80 billion today.'' 43
---------------------------------------------------------------------------
    \42\ Jad Mouawad and Heather Timmons, Trading Frenzy Adding to Rise 
in Price of Oil, The New York Times, April 29, 2006.
    \43\ Philip Verleger, Commodity Investors: A Stabilizing Force?, 
The Petroleum Economics Monthly, March 2006.
---------------------------------------------------------------------------
    With respect to crude oil in particular, Verleger estimates 
that, during 2005, $25 billion was ``injected'' into the West 
Texas Intermediate (WTI) crude oil futures contract traded on 
the NYMEX, mostly coming from pension funds and other managed 
money. Verleger states ``another $20 billion or so'' was 
invested in NYMEX WTI contracts in the first few months of this 
year.44 Overall, Verleger estimates that between 
July 2004 and mid-March 2006, a total of approximately $60 
billion has been invested in the NYMEX WTI 
contract.45
---------------------------------------------------------------------------
    \44\ Philip Verleger, A Primer on Oil Prices II: The Role of 
Inventories, The Petroleum Economics Monthly, February 2006, at p. 20.
    \45\ Verleger, March 2006.
---------------------------------------------------------------------------
    The increase in speculative trading is directly observable 
in the CFTC weekly reports on trading activity in the CFTC-
regulated futures markets. Over the past 2 years, the CFTC data 
shows more than a doubling in the ``open interest'' in both 
crude oil and natural gas contracts--essentially the number of 
outstanding futures contracts at the end of a trading 
day.46 The CFTC data indicates that much of the 
increase is due to ``non-commercial'' trading--namely, trading 
by speculators.47
---------------------------------------------------------------------------
    \46\ See the Appendix to this Report for a more detailed discussion 
of open interest.
    \47\ See the Appendix to this Report for a more detailed discussion 
of this CFTC data.
---------------------------------------------------------------------------

  2. The Effect of Speculation on Prices

    ``There is little doubt that Katrina only exacerbated a 
troubling trend in energy prices that already seemed to ignore 
basic fundamental drivers to thrive instead on hype.''
        --A futures trader, September 2005.48
---------------------------------------------------------------------------
    \48\ Behind Runaway Prices: Supply Issues are Real, But Hype Sets 
Bar, Natural Gas Week, September 5, 2005.
---------------------------------------------------------------------------
    One of the benefits of speculative trading is that it 
brings needed liquidity to the futures market so that companies 
seeking to hedge their exposure to commodity prices can find 
counterparties willing to take on those price risks. Also, as 
previously discussed, speculation can help finance the build-up 
of inventories when prices are expected to increase. On the 
other hand, large speculative buying or selling of futures 
contracts can distort the price signals influencing supply and 
demand in the physical market or lead to excessive price 
volatility, either of which can cause a cascade of consequences 
detrimental to the supply and price of the commodity and the 
overall economy.
    A key responsibility of the CFTC is to ensure that prices 
on the futures market reflect the laws of supply and demand 
rather than manipulative practices 49 or excessive 
speculation.50 The Commodity Exchange Act (CEA) 
states, ``Excessive speculation in any commodity under 
contracts of sale of such commodity for future delivery . . . 
causing sudden or unreasonable fluctuations or unwarranted 
changes in the price of such commodity, is an undue and 
unnecessary burden on interstate commerce in such commodity.'' 
51 The CEA directs the CFTC to establish such 
trading limits ``as the Commission finds are necessary to 
diminish, eliminate, or prevent such burden.'' 52
---------------------------------------------------------------------------
    \49\ 7 U.S.C. Sec. 5(b),
    \50\ 7 U.S.C. Sec. 6a(a).
    \51\ Id.
    \52\ Id.
---------------------------------------------------------------------------
    A number of energy industry participants and analysts have 
noted the divergence between the ample supplies of crude oil 
and natural gas, and record-high prices for those commodities, 
and have attributed some of this disconnect to the presence of 
speculators in the market. ``Gold prices don't go up just 
because jewelers need more gold, they go up because gold is an 
investment,'' one consultant said. ``The same has happened to 
oil.'' 53
---------------------------------------------------------------------------
    \53\ Jad Mouawad and Heather Timmons, Trading Frenzy Adding to Rise 
in Price of Oil, The New York Times, April 29, 2006 (quoting Roger 
Diwan, partner, PFC Energy).
---------------------------------------------------------------------------
    ``The answer to the puzzle posed by rising prices and 
inventories, industry analysts say, lies not only in supply 
constraints such as the war in Iraq and civil unrest in Nigeria 
and the broad upswing in demand caused by industrialization of 
China and India. Increasingly, they say, prices also are being 
guided by a continuing rush of investor funds in commodities 
investments.'' 54 Another gas trader said: ``It's 
all about futures speculators shooting for irrational price 
objectives, as well as trying to out-think other players--sort 
of like a twisted game of chess.'' ``[T]he basic facts are 
clear,'' he added, ``this market is purely and simply being 
controlled by over-speculation.'' 55 Tim Evans, 
senior analyst at IFR Energy Services, stated, ``What you have 
on the financial side is a bunch of money being thrown at the 
energy futures market. It's just pulling in more and more cash. 
That's the side of the market where we have runaway demand, not 
on the physical side.'' 56
---------------------------------------------------------------------------
    \54\ Bhusan Bahree and Ann Davis, Oil Settles Above $70 a Barrel, 
Despite Inventories at 8-Year High, The Wall Street Journal, April 18, 
2006.
    \55\ Behind Runaway Prices: Supply Issues are Real, But Hype Sets 
Bar, Natural Gas Week, September 5, 2005.
    \56\ Oil: A Bubble, not a Spike? BusinessWeek online, April 27, 
2005.
---------------------------------------------------------------------------
    Some traders charge that certain hedge fund managers have 
purposefully contributed to a misperception that there is a 
shortage of supply. ``There's a few hedge fund managers out 
there who are masters at knowing how to exploit the peak 
theories [that the world is running out of oil] and hot buttons 
of supply and demand, (and) by making bold predictions of 
shocking price advancements to come (they) only add more fuel 
to the bullish fire in a sort of self-fulfilling prophecy.'' 
57
---------------------------------------------------------------------------
    \57\ Natural Gas Week, September 5, 2005.
---------------------------------------------------------------------------
    Several analysts have estimated that the influx of 
speculative money has tacked on anywhere from about $7 to about 
$30 per barrel to the price of crude oil.58 Even 
OPEC officials are concerned that a shift in the market from 
high futures prices relative to current prices, to lower 
futures prices relative to current prices (i.e. from contango 
to backwardation) could precipitate a ``quick drop of $20 a 
barrel or more.'' 59 Noting that ``fundamentals are 
in balance and stock levels are comfortable,'' the president of 
the OPEC cartel, Edmund Daukoru, recently attributed the 
current price levels to ``refinery tightness, geopolitical 
developments and speculative activity.'' 60 Other 
traders have pointed out the possibility of a sharp drop in 
price. ``At some point, this oversupplied market has to begin 
to break down this house of cards which is dominated by 
speculative entities,'' one futures trader noted, ``and when 
those entities decide to start liquidating their futures 
positions in crude and gas, look out below.'' 61
---------------------------------------------------------------------------
    \58\ See, e.g., Jad Mouawad and Heather Timmons, Trading Frenzy 
Adding to Rise in Price of Oil, The New York Times, April 29, 2006 
(``by some estimates 10 percent to 20 percent'' of current prices); 
Goldman Sachs, Natural Gas Weekly, December 10, 2004 ($7 per barrel in 
spring, 2004); John M. Berry, Speculation plays a role in high oil 
prices, Alexander's Gas & Oil Connections, August 17, 2005 (`` `Current 
US oil inventory levels suggest WTI crude prices should be around $25 a 
barrel,' [oil analyst Mike Rothman of International Strategy and 
Investment] calculated. `Given underlying issues and concerns about 
OPEC capacity and demand growth, we certainly are not prepared to argue 
that the price spread between the $25 model value and near $60 actual 
is all speculation, but we do feel that a portion is.' ''); Oil 
Pricing: Don't Underestimate the Fear Factor, BusinessWeek online, 
March 13, 2006 (Sarah Emerson, director of petroleum market analysis 
and research at Energy Security Analysis estimates an additional $15 
per barrel is due to ``fear;'' Tim Evans, senior energy analyst for IFR 
Markets, estimates $25-$30 per barrel.).
    \59\ Bhusan Bahree and Ann Davis, Oil Settles Above $70 a Barrel, 
Despite Inventories at 8-Year High, The Wall Street Journal, April 18, 
2006.
    \60\ Platts, OPEC has no option but to maintain output at current 
prices: Libya, June 15, 2006. Similarly, Saudi Arabian Oil Minister Ali 
Naimi has stated, ``World oil supply is currently exceeding demand, and 
there is no lack of spare capacity.'' Kate Dourian, Naimi says 
producers can't be assured robust demand will continue, Platts Oilgram 
News, May 16, 2006. U.S. Energy Secretary Samuel Bodman agreed with 
Minister Naimi's assessment: ``[Secretary] Bodman, meeting with 
reporters after a speech at an electricity forum, suggested that there 
seems to be plenty of oil available.'' H. Josef Hebert, Energy 
secretary says U.S. can weather Iranian oil disruption, Associated 
Press Worldstream, June 6, 2006.
    \61\ Bears Predict Bullish Crude, Gas Bubble to Burst Sooner Than 
Later, Natural Gas Week, June 27, 2005.
---------------------------------------------------------------------------
    Generally, economists struggle to quantify the effect of 
speculators on market prices. Part of the difficulty is due to 
the absence of specific data about the strategies of particular 
traders or classes of traders. The CFTC's weekly Commitment of 
Trader Reports are not specific or precise enough to provide 
the basis for rigorous quantitative analysis, 62 and 
commodity traders are, as a rule, reluctant to distribute their 
data for such purposes. Another difficulty is separating cause 
from effect: are high prices caused by an increase in 
speculation, or do more speculators enter the market when 
prices become more volatile because that is when the profit 
opportunities arise?
---------------------------------------------------------------------------
    \62\ See the Appendix for an explanation of these reports.
---------------------------------------------------------------------------
    Several recent analyses have concluded that speculation has 
significantly increased energy prices; others have concluded 
otherwise.

    Former Federal Reserve Chairman Alan Greenspan. In 
testimony before the Senate Committee on Foreign Relations, 
former Chairman Greenspan stated that, in the last couple of 
years, ``increasing numbers of hedge funds and other 
institutional investors began bidding for oil [and] accumulated 
it in substantial net long positions in crude oil futures, 
largely in the over-the-counter market. These net long futures 
contracts, in effect, constituted a bet that oil prices would 
rise.'' 63 The former Chairman observed that these 
purchases of oil futures have had a cascade of effects on 
prices, production, inventories, and consumption:
---------------------------------------------------------------------------
    \63\ Statement of Alan Greenspan Oil Depends on Economic Risks, 
Hearing before the Senate Committee on Foreign Relations, June 7, 2006.

          With the demand from the investment community, oil 
        prices have moved up sooner than they would have 
        otherwise. In addition, there has been a large increase 
        in oil inventories. In response to higher prices, 
        producers have increased production dramatically and 
        some consumption has been scaled back. Even though 
        crude oil productive capacity is still inadequate, it, 
        too, has risen significantly over the past 2 years in 
        response to price.64
---------------------------------------------------------------------------
    \64\ Id.

    Citgroup. In a May 5, 2006 report on prices of U.S. 
commodities, Citigroup reported that the monthly average value 
of speculative positions held in all U.S. commodity markets 
rose to over $120 billion, just under the record of $128 
billion set the previous October. Of the 36 agricultural, 
energy, and metal commodities analyzed, Citigroup found the 
largest speculative positions were in natural gas ($30.3 
billion) and crude oil ($30.1 billion), followed by gold ($13.3 
billion). The report stated, ``We believe the hike in 
speculative positions has been a key driver for the latest 
---------------------------------------------------------------------------
surge in commodity prices.''

    Goldman Sachs. In a report on the natural gas markets 
issued in late 2004, Goldman Sachs determined that the rising 
natural gas prices--which were then near $7 per million BTU--
were ``rooted in tightening fundamentals.'' 65 
Goldman Sachs also stated, ``Our analysis indicates that 
speculative money does have some impact on natural gas prices 
and the shape of the forward curve.'' Goldman Sachs reported 
that the net-speculative positions had depressed the next-month 
natural gas futures contract price by $0.28 per million BTU in 
early December 2004, but the previous spring it had increased 
the ``prompt'' NYMEX natural gas futures contract (i.e., the 
futures contract that is next to expire) by $0.60 per million 
BTU--an increase of slightly greater than 10 percent.
---------------------------------------------------------------------------
    \65\ Goldman Sachs, Natural Gas Weekly, December 10, 2004.
---------------------------------------------------------------------------
    The Goldman Sachs report also noted that natural gas prices 
were directly affected by crude oil prices, and ``we believe 
that speculators also impact the price of crude oil and 
petroleum products, with the impact of speculators peaking at 
roughly $7 [per barrel] in the spring of 2004.'' At that time, 
crude oil prices ranged from $35-$40 per barrel; hence, 
according to the Goldman Sachs analysis, speculators at that 
time were boosting the price of oil by about 20 percent. 
``Unlike natural gas,'' Goldman Sachs wrote, ``we estimate that 
the impact of speculators on oil prices is roughly equivalent 
in magnitude to the impact of shifts in supply and demand 
fundamentals (as reflected in stocks).'' In other words, shifts 
in speculative positions could affect crude oil to the same 
degree as actual changes in the supply of or demand for crude 
oil.

    Philip Verleger: A New Era for Energy. In a series of 
analyses in his publication, The Petroleum Economics Monthly, 
Philip Verleger contends that the recent increase in 
speculative activity has altered the nature of the crude oil 
markets and boosted futures prices. Verleger believes that the 
recent infusion of tens of billions of dollars from pension 
funds, speculators, and other investors into crude oil and 
natural gas futures markets has ushered in a ``new era'' for 
energy producers and refiners. ``The current new era is marked 
by the entry of long-term investors, who have pushed forward 
crude prices to record levels,'' Verleger writes. ``Consumers, 
no doubt, will have another term for it.'' 66 During 
this era ``prices will likely be quite high for several 
years,'' but ``will be followed by a period of very low 
prices.'' 67
---------------------------------------------------------------------------
    \66\ Philip K. Verleger, Jr., The Petroleum Economics Monthly, July 
2005, at p. 1.
    \67\ Id., at p. 2.
---------------------------------------------------------------------------
    A key indicator of this new era, according to Verleger, is 
the emergence of a `` `disconnect' between the cash price 
behavior and the fundamentals, as measured by supply-and-demand 
balances or stocks.'' 68 The reason for this 
divergence, in Verleger's analysis, is that purchases of long-
term crude oil futures contracts have pushed up the longer-term 
futures prices by so much that it is more profitable for oil 
companies to store the oil and then sell it at a later date 
than sell it today, even at record-high spot prices. Even if 
oil is at $70 per barrel today, suppliers will hold their 
inventories if they can sell it for $75 for delivery a year 
from now.
---------------------------------------------------------------------------
    \68\ Id., at p. 10.
---------------------------------------------------------------------------
    Since 2001 there has been a dramatic growth in the open 
interest in very long-term futures contracts (30 months or 
longer). At the end of July 2001, there was an open interest of 
19,624 in very long-term contracts, representing about 4.5 
percent of all open interest; at the end of July 2005, there 
was an open interest of 125,546 in very long-term contracts, 
representing about 15 percent of all open interest. According 
to Verleger, nearly all of the buying of these very long-term 
crude oil futures contracts reflects speculative buying, since 
commercial firms typically don't enter into contracts for 
delivery so far into the future, and therefore have no need to 
use such long-term futures contracts for hedging 
purposes.69
---------------------------------------------------------------------------
    \69\  Id., at p. 12.
---------------------------------------------------------------------------
    ``In summary,'' Verleger writes, ``increased purchases of 
long-dated crude lift the forward price curve. The rise in 
prices is reflected back to contracts maturing in a few 
months.'' 70 Quantitatively, ``the impact of 
increasing stocks has been overwhelmed by the strong demand for 
forward crude, which has added as much as $24 per barrel to 
prices.'' 71
---------------------------------------------------------------------------
    \70\ Id., at p. 15.

    \71\ Id., at p. 19.
---------------------------------------------------------------------------
    CFTC staff study. In contrast to the studies that have 
found a relationship between speculative activity and price, a 
CFTC staff study released in April 2005 found, in general, ``no 
evidence of a link between price changes and MMT [managed money 
trader] positions'' in the natural gas markets and ``a 
significantly negative relationship between MMT positions and 
price changes (conditional on other participants trading) in 
the crude oil market.'' 72 The CFTC staff found, 
generally, that these managed money funds tended to follow what 
the commercial participants in the market were doing, and 
tended to trade less frequently than commercial traders.
---------------------------------------------------------------------------
    \72\ Michael S. Haigh, Jana Hranaiova and James A. Overdahl, Office 
of the Chief Economist, U.S. Commodity Futures Trading Commission, 
Price Dynamics, Price Discovery and Large Futures Trader Interactions 
in the Energy Complex, Working Paper, First Draft: April 28, 2005.

    NYMEX study. A second study that found no relationship 
between hedge fund activity and volatility was conducted by the 
NYMEX. Overall, the NYMEX found that during 2004, ``hedge fund 
trading activity comprised a modest share of trading volume in 
both crude oil and natural gas futures markets,'' and comprised 
``a relatively modest share of open interest.'' It also found 
that hedge fund participation during this period tended to 
decrease volatility. ``In short,'' the NYMEX stated, ``it 
appears that Hedge Funds have been unfairly maligned by certain 
quarters who are seeking simple answers to the problem of 
substantial price volatility in energy markets, simple answers 
that are not supported by the available evidence.'' 
73
---------------------------------------------------------------------------
    \73\ New York Mercantile Exchange, A Review of Recent Hedge Fund 
Participation in NYMEX Natural Gas and Crude Oil Futures Markets, March 
1, 2005.
---------------------------------------------------------------------------
    A number of industry participants have expressed skepticism 
about the accuracy of the NYMEX and CFTC analyses. Neither the 
NYMEX study nor the CFTC study addressed the effects of hedge 
fund and other speculative investments on the price of longer-
term futures contracts. Rather, both the CFTC study and the 
NYMEX focused on the near-term effects of trading by hedge 
funds, particularly with respect to volatility. ``[D]espite 
those [NYMEX and CFTC] reports,'' one trade publication 
reported, ``a majority of industry professionals still contend 
that there are too many large speculative entities actively 
engaged in the market--with fund accounts taking on massive 
equity positions in the commodities.'' 74 Another 
article reported that many traders have ``scoffed'' at these 
two studies, ``saying that they focused only on certain months, 
missing price run-ups.'' 75
---------------------------------------------------------------------------
    \74\ Bears Predict Bullish Crude, Gas Bubble to Burst Sooner Than 
Later, Natural Gas Week, June 27, 2005. See, e.g., Oil Market Control 
Passes From OPEC to Speculators, Jet Fuel Intelligence, August 29, 2005 
(`` `The amount of paper barrels being traded is extraordinary and this 
has had an extraordinary effect on prices,' said one industry 
veteran.''); Commodity Strategists: Oil to Fall, Toronto Bank Says, 
Bloomberg.com, April 25, 2005 (the speculative rally has `` 
`decoupled'' prices from the reality of supply and demand.'') .
    \75\ Alexei Barrionuevo, Energy Trading, Without a Certain ``E'', 
The New York Times, January 15, 2006.
---------------------------------------------------------------------------
    In sum, while industry and regulatory economists and 
analysts do not agree on the extent to which market speculation 
has affected energy prices, it is beyond dispute that 
speculation has increased. CFTC data as well as numerous 
industry reports indicate that speculators have injected tens 
of billions of dollars into the energy commodities markets. 
Although the absence of data makes it impossible to precisely 
quantify the effect of these speculative investments on prices, 
it appears from the CFTC data, market data, and the comments of 
a number of well-respected analysts that this increased 
speculation has fundamentally altered the relationship between 
crude oil inventories and prices. The purchase of long-term 
futures by speculators has provided a financial incentive for 
oil purchasers to build inventories and store oil for future 
use; this has resulted in a market characterized both by large 
amounts of oil in inventory and high prices.
    Whether the current level of speculation has provided 
needed liquidity, encouraged the building of inventories, or 
created a speculative bubble in energy prices is impossible to 
determine without additional data. It is clear that better 
tools are needed to understand how much is being spent, by 
whom, in which markets and instruments, and the effect of 
increasing speculation on the price and affordability of energy 
in the United States.
    The importance of understanding the effect of speculation 
on market prices cannot be understated. Professor Robert 
Shiller, in his prescient book Irrational Exuberance, which 
warned that the U.S. stock market was in the midst of a 
speculative bubble just prior to the price collapse of 2000-
2001, wrote as follows:

          The extraordinary recent levels of U.S. stock prices, 
        and associated expectations that these levels will be 
        sustained or surpassed in the near future, present some 
        important questions. We need to know whether the 
        current period of high stock market pricing is like the 
        other historical periods of high pricing, that is, 
        whether it will be followed by poor or negative 
        performance in coming years. We need to know 
        confidently whether the increase that brought us here 
        is indeed a speculative bubble--an unsustainable 
        increase in prices brought on by investors' buying 
        behavior rather than by genuine, fundamental 
        information about value. In short, we need to know if 
        the value investors have imputed to the market is not 
        really there, so that we can readjust our planning and 
        thinking.76
---------------------------------------------------------------------------
    \76\ Robert J. Shiller, Irrational Exuberance (Princeton University 
Press, 2000), at p. 5.

    In light of the vital importance of energy to our national 
economy and security, the need to better understand the role of 
speculation in price formation is just as important for the 
energy market as for the stock market.

  3. Large Profits from Speculation in Energy Commodities

    Accurate information about the profits and losses of market 
participants is difficult to obtain. Nonetheless, reports 
indicate that a number of firms, funds, and traders have reaped 
enormous profits from the recent increases in energy prices, 
energy price volatility, and trading volume. These large 
profits provide an indication of one of the incentives for 
speculation in today's energy commodity markets.
    For example, it has been reported that in 2004, Goldman 
Sachs and Morgan Stanley, the two leading energy trading firms 
in the United States, earned a total of about $2.6 billion in 
net revenues from commodities trading, mostly from energy 
commodities.77 For 2005, Goldman Sachs and Morgan 
Stanley each reportedly earned about $1.5 billion in net 
revenue from energy transactions.78
---------------------------------------------------------------------------
    \77\ Alexei Barrionuevo, Energy Trading, Without a Certain ``E'', 
The New York Times, January 15, 2006.
    \78\ Wall Street firms reshape power trading, add liquidity in 
physical and paper markets, Platts Power Markets Week, January 16, 
2006; See also, Ann Davis, Morgan Stanley trades energy in barrels, 
Pittsburgh post-gazette.com, March 3, 2005.
---------------------------------------------------------------------------
    A recent article in Trader Monthly magazine included short 
profiles of the ``100 Highest Earning Traders'' for 2005, as 
ranked by the magazine. Overall, Trader Monthly reported, ``On 
Wall Street, some of the scores were gargantuan, as bulge-
bracket banks enjoyed one of the most profitable years in the 
history of the markets, from asset-backed to credit and crude 
to crack spreads.'' 79 Although the rankings are 
based on estimates and anecdotal information, and the article 
does not explain how the profiled traders generated their 
income, it nonetheless provides some information regarding the 
magnitude of some of the earnings of leading energy commodity 
traders in 2005.80 The Trader Monthly rankings group 
these traders into several categories: hedge fund managers, 
Wall Street Traders, and ``the rest,'' which includes traders 
working for brokerage firms that own seats on the NYMEX.
---------------------------------------------------------------------------
    \79\ Rich Blake and Andrew Barber with Robert LaFranco, The Trader 
Monthly 100; Earn, Baby, Earn, Trader Monthly, April/May 2006 
(hereinafter cited as ``The Trader Monthly 100''), at p. 69.
    \80\ The Subcommittee staff has not verified the information 
contained in the Trader Monthly article.
---------------------------------------------------------------------------
    At the top of the Trader Monthly list, T. Boone Pickens was 
reported to have earned between $1 and $1.5 billion in energy 
trading in 2005. The magazine reports that Mr. Pickens' main 
commodities fund earned a return of approximately 700 percent 
in 2005, which it ``believes is the largest one-year sum ever 
earned.'' 81 Another hedge fund magazine, Alpha, 
estimated that Mr. Pickens' trading strategies earned $1.4 
billion in 2005, largely due to his bets on crude 
oil.82
---------------------------------------------------------------------------
    \81\ The Trader Monthly 100,, at p. 71.
    \82\ Stephen Taub, Really Big Bucks, Alpha, May 2006, at p. 19. Mr. 
Pickens ranked second on the Alpha list. Mr. James Simons, who Trader 
Monthly ranked third with an estimated $900 million-$1 billion in 
earnings, was ranked first by Alpha, with an estimated $1.5 billion in 
earnings. The two rankings identify many of the same individuals as the 
top hedge fund traders, although the estimates of earnings vary by 
significant amounts--hundreds of millions of dollars in some instances. 
The Alpha rankings only list the top 25 traders; with the exception of 
Mr. Pickens, the energy traders identified in the Trader Monthly 
rankings did not earn enough to qualify for this list. See also 
Alistair Barr, Hedge-fund giants Simon, Pickens made more than $1 bln 
in 2005, MarketWatch, May 26, 2006, at http://www.marketwatch.com (last 
visited May 26, 2006).
---------------------------------------------------------------------------
    Following an interview with Mr. Pickens, the Associated 
Press reported, ``Oil tycoon Boone Pickens' bet that energy 
prices would rise made him more money in the past 5 years than 
he earned in the preceding half century hunting for riches in 
petroleum deposits and companies.'' 83 During this 
interview, which occurred in mid-2005, when the price of oil 
was approaching a then-record $60 per barrel, Mr. Pickens 
stated, ``I can't tell for sure where [prices are] going, other 
than up.'' 84 Mr. Pickens' success in predicting 
price increases may have even created its own momentum for 
further price increases--according to Natural Gas Week, ``[Mr. 
Pickens] regularly talks up crude oil and natural gas prices on 
financial market cable TV. Traders and futures brokers report 
that each time this happens, more speculative interest is drawn 
to energy futures markets.'' 85
---------------------------------------------------------------------------
    \83\ Brad Foss, AP Interview; Riding high on oil prices, Boone 
Pickens sees prices going even higher, Associated Press, June 22, 2005.
    \84\ Id. It was long before this 2005 interview, however, that Mr. 
Pickens began betting that the price of oil would rise, based on a 
belief that the rapid increase in demand had used up all of the global 
spare production capacity. In May 2004, for example, when oil was 
trading at about $40 per barrel, and most analysts were predicting 
prices would fall, Mr. Pickens publicly predicted prices would keep 
increasing: ``I think you'll see $50 before you see $30 again.'' 
Darrell Preston, Bloomberg News, T. Boone is Back; The Corporate Raider 
Who Brought Down Gulf Oil is Cashing in on Oil Price Spike, Pittsburgh 
Post-Gazette, October 10, 2004. Opinions vary as to the reason Mr. 
Pickens has been so successful recently. ``He understands the industry 
and business like no one else,'' commented billionaire Harold Simmons, 
one of the original investors in Mr. Pickens' hedge funds. Id. On the 
other hand, Peter Fusaro, chairman of Global Change Associates, a 
consulting firm, commented, ``He just got lucky.'' Id.
    \85\ Behind Runaway Prices: Supply Issues are Real, But Hype Sets 
Bar, Natural Gas Week, September 5, 2005.
---------------------------------------------------------------------------
    Also at the top of the list of energy traders is John 
Arnold, a former Enron trader who left Enron in 2002 to start 
his own hedge fund, Centaurus Energy, with three employees and 
$8 million of his own money.86 As of January of this 
year, Centaurus employed 36 people and had about $1.5 billion 
in assets.87 At a recent energy conference, Mr. 
Arnold said he ``looks to place bets on a market that he 
determines is `biased,' '' meaning that the market is not 
reflecting the fair value for a product.88 ``We ask 
ourselves can we identify what is forcing a market to price a 
product at an unfair value, and then, what will push it back to 
fair value.'' 89 Mr. Arnold also stated how a 
significant amount of speculative trading was taking place on 
the unregulated over-the-counter Intercontinental Exchange 
(ICE). `` `Trading never went away,' Arnold said, `What has 
changed is the non-commercial type of interest.' 
Intercontinental Exchange, he said, has provided huge new 
opportunities, as has NYMEX's Clearport trading. `Because of 
this, there has never been as much investor interest . . . as 
there is today.' '' 90
---------------------------------------------------------------------------
    \86\ See Barrionuevo, Energy Trading, Without a Certain ``E'', The 
New York Times, January 15 2006.
    \87\ Id.; See also, Peter Elkind, Bethany McLean, The Luckiest 
People in Houston, Fortune, April 17, 2006. Among those now working for 
Mr. Arnold is Greg Whalley, who, as head of wholesale trading at Enron, 
once was Mr. Arnold's boss. In August 2001, following the resignation 
of Jeffrey Skilling, Mr. Whalley was appointed Enron's president. Id.
    \88\ Two former Enron trading experts share dais and ideas on 
energy market evolution, Platts Power Markets Week, February 13, 2006.
    \89\ Id.
    \90\ Id.
---------------------------------------------------------------------------
    Table 1 lists the traders who Trader Monthly reported to 
have obtained a significant portion of their profits from 
trading energy commodities. Inclusion on this list is not meant 
to imply that any of the traders derived their profits from any 
improper trading activity.

                                 Table 1
                   Selected Top Energy Traders in 2005
------------------------------------------------------------------------
                 Firm Type of  2005 Estimated
    Trader          Trader        Earnings      Trader Monthly Comments
------------------------------------------------------------------------
T. Boone        BP Capital     $1.5 billion +  `` `Long Crude' doesn't
 Pickens         (hedge fund)                   even begin to describe
                                                T. Boone Pickens'
                                                position. With $5
                                                billion and growing in
                                                assets under management,
                                                his fund company, BP
                                                Capital, is throwing off
                                                a small national economy
                                                via an unshakable bet
                                                that the world's oil
                                                supply can't keep up
                                                with demand. . . .
                                                Returns on Pickens' main
                                                commodities pool were
                                                over 700 percent in
                                                2005. . . . [This]
                                                translates into what
                                                Trader Monthly believes
                                                is the largest one-year
                                                sum ever earned. . . .''
------------------------------------------------------------------------
Brian Hunter    Amaranth       $75-$100        ``In 2005, Hunter was
                 Advisors       million         certainly among the top
                 (hedge fund)                   natural gas traders in
                                                the world. . . . Rumor
                                                is that Hunter made
                                                Amaranth an estimated
                                                $800 million off his
                                                book, mainly [natural]
                                                gas derivatives
                                                positions but also some
                                                other energy
                                                dabblings.''
------------------------------------------------------------------------
John Arnold     Centaurus      $75-$100        ``Starting 4 years ago
                 Energy         million         with $8 million of his
                 (hedge fund)                   own dough, John D.
                                                Arnold, former star
                                                Enron energy trader, has
                                                since amassed more than
                                                $1 billion in assets.
                                                Most of the 16 other
                                                traders at his Centaurus
                                                Energy fund operation
                                                came from Enron.''
------------------------------------------------------------------------
Jim Pulaski     Tudor          $50-$75         ``[T]his Tudor energy
                 Investment     million         trader is commander in
                 (hedge fund)                   chief when it comes to
                                                natural gas.''
------------------------------------------------------------------------
Steven Berkson  Trader         $25-$30         ``Readers of Trader
                (NYMEX)         million         Monthly will remember
                                                the legend of natural-
                                                gas-futures stalwart
                                                Steve Berkson and
                                                Hurricane Katrina. One
                                                of the tallest versions
                                                of the tale has Berkson
                                                making $40 million off
                                                the opening bell the day
                                                Katrina made landfall
                                                (we heard he ended up
                                                tallying around $20
                                                million for the week).
                                                Lesser known is how much
                                                of that score Berky
                                                ultimately slid to
                                                relief efforts
                                                (reportedly a sizable
                                                portion).''
------------------------------------------------------------------------
Mark Fisher     MBF Clearing   $25-$30         ``Few people have more at
                 operator       million         stake in the future of
                 (NYMEX)                        the NYMEX than Fisher,
                                                who runs MBF Clearing,
                                                the primary market-
                                                making operation for the
                                                exchange's top-grossing
                                                crude-oil futures
                                                contract.''
------------------------------------------------------------------------
Simon           Morgan         $20-$25         ``Morgan Stanley's head
 Greenshields    Stanley        million         of gas and power,
                                                Greenshields is part of
                                                the bank's elite energy
                                                crew. His specialties
                                                are natural gas and
                                                electricity. . . .''
------------------------------------------------------------------------
Olav Refvik     Morgan         $20-$25         ``Refvik is a key part of
                 Stanley        million         one of the most
                                                profitable energy-
                                                trading operations in
                                                the world. He has helped
                                                the bank dominate the
                                                heating oil market by
                                                locking up New Jersey
                                                storage-tank farms
                                                adjacent to New York
                                                Harbor. . . .''
------------------------------------------------------------------------
John Shapiro    Morgan         $20-$25         ``Shapiro has been a
                 Stanley        million         vital part of Morgan's
                                                energy effort, working
                                                [to help] oversee the
                                                200-plus-person profit
                                                center.''
------------------------------------------------------------------------
John Bertuzzi   Goldman Sachs  $15-$20         ``A star trader on one of
                                million         the most powerful energy
                                                desks on earth. . . .''
------------------------------------------------------------------------
George          J.P. Morgan    $15-$20         ``[Taylor] . . . switched
 ``Beau''                       million         over to J.P. Morgan,
 Taylor                                         where he now helps
                                                oversee the firm's 80-
                                                person energy-trading
                                                unit.''
------------------------------------------------------------------------
Jeffrey         Trader         $15-$20         ``Crude oil traders don't
 Wolfson         (NYMEX)        million         come much bigger than
                                                the man whose badge
                                                reads GEOF. A one-man
                                                volume-generation
                                                machine. . . .''
------------------------------------------------------------------------
Vincent         Citigroup      $10-$15         ``Kaminski is a revered
 Kaminski                       million         energy trader considered
                                                among the foremost
                                                authorities on measuring
                                                and analyzing market
                                                risk. . . .''
------------------------------------------------------------------------
Todd Applebaum  Trader         $10-$15         ``Applebaum is another
                 (NYMEX)        million         natural gas guy who lit
                                                it up in 2005. `Great
                                                trader, huge volume,'
                                                says one NYMEX
                                                insider.''
------------------------------------------------------------------------
Eric Bolling    Trader         $10-$15         ``Among the most famous
                 (NYMEX)        million         natural gas traders on
                                                the floor today . . .
                                                [Bolling] is said to
                                                account for as much as 5
                                                percent of total volume
                                                in [natural gas]. . .
                                                .''
------------------------------------------------------------------------
Sandy Goldfarb  Trader         $10-$15         ``. . . [Goldfarb]
                 (NYMEX)        million         knocked his [natural
                                                gas] book out of the
                                                ozone layer last year
                                                amid one hurricane after
                                                another and some of the
                                                most treacherous
                                                volatility ever recorded
                                                in the decade and a half
                                                since natural gas
                                                futures were created. .
                                                . .''
------------------------------------------------------------------------
Robert Halper   Trader         $10-$15         ``When it comes to
                 (NYMEX)        million         [arbitraging] crude oil
                                                against gasoline, Bob
                                                Halper wrote the book.
                                                According to some, he
                                                will go down as one of
                                                the biggest crack-spread
                                                traders the NYMEX has
                                                ever seen.''
------------------------------------------------------------------------
Daniel          Trader         $10-$15         ``A natural gas
 Lirtzman        (NYMEX)        million         `natural.'. . .''
------------------------------------------------------------------------
Kevin           Trader         $10-$15         ``Chalk up yet another
 McDonnell       (NYMEX)        million         blowout year. . . .''
------------------------------------------------------------------------
Simon Posen     Trader         $10-$15         ``Last year's natural gas
                 (NYMEX)        million         swings produced a
                                                significant surge in
                                                Posen's trading
                                                profits.''
------------------------------------------------------------------------
Mitchell Stern  Trader         $10-$15         ``Stern had a huge year,
                 (NYMEX)        million         sources say.''
------------------------------------------------------------------------

   Table 1. Large trader profits are an indicator of increased 
speculation in energy commodity markets. Data source: Trader Monthly, 
April/May 2006.

    Not only are the top traders for investment banks and funds 
earning record incomes, but in-house corporate traders are 
earning record amounts as well. According to a recent article 
in Bloomberg news, at Sempra Energy, the owner of the biggest 
U.S. natural gas utility, ``as many as 30 commodity traders 
[make] more than the $2 million earned last year by Chief 
Executive Officer Don Felsinger. `That's what it costs to be in 
this business,' Felsinger [said] in a May 17 interview.'' 
91 Bloomberg also reported that division managers 
for commodities trading were also the most highly paid 
employees at Constellation Energy, earning approximately $5 
million in bonuses, compared to a total compensation package of 
about $4 million for the chief executive officer.92
---------------------------------------------------------------------------
    \91\ What's a Top Commodity Trader Worth? Quintuple 2000 Salaries, 
Bloomberg.com, June 1, 2006.
    \92\ Id.
---------------------------------------------------------------------------

IV. NO COP ON THE BEAT FOR OVER-THE-COUNTER ENERGY MARKETS

    Until recently, the trading of U.S. energy futures was 
conducted exclusively on regulated exchanges within the United 
States, like the NYMEX, and subject to extensive oversight by 
the CFTC and the exchanges themselves in order to detect and 
prevent price manipulation. Under the Commodity Exchange Act, 
the purpose of CFTC regulation is to deter and prevent price 
manipulation, ensure the ``financial integrity'' of 
transactions, maintain market integrity, prevent fraud, and 
promote fair competition.93 This regulation and the 
resulting transparency has bolstered investor confidence in the 
integrity of the regulated U.S. commodity markets and helped 
propel U.S. exchanges into the leading marketplace for many 
commodities.
---------------------------------------------------------------------------
    \93\ 7 U.S.C. Sec. 5.
---------------------------------------------------------------------------
    Pursuant to its statutory mandate to detect and prevent 
price manipulation, the CFTC has imposed a variety of reporting 
requirements and regulations on the trading of commodity 
futures and options. NYMEX traders, for example, are required 
to keep records of all trades and report large trades to the 
CFTC. The CFTC uses these Large Trader Reports, together with 
daily trading data providing price and volume information, to 
monitor exchange activity and detect unusual price movements or 
trading.
    None of this oversight to prevent price manipulation, 
however, applies to any of the energy trading conducted on OTC 
electronic exchanges. As a result of a provision inserted by 
House and Senate negotiators during the waning hours of the 
106th Congress into legislation that became the Commodity 
Futures Modernization Act of 2000 (CFMA), 94 the 
Commodity Exchange Act exempts from CFTC oversight all trading 
of energy commodities by large firms on OTC electronic 
exchanges.95
---------------------------------------------------------------------------
    \94\ The provisions of the CFMA that provide exclusions and 
exemptions for energy and metal commodities were included in the 
version of the legislation that passed the House on October 19, 2000 
(H.R. 4541, 106th Cong., 2nd Sess.), but were omitted from the version 
placed on the Senate calendar after passage by the Senate Committee on 
Agriculture in late August (S. Rept. 106-390). Following negotiations 
between members of the House and Senate Agriculture committees, the 
legislation that became the Commodity Futures Modernization Act--with 
the exclusions for energy and metal commodities--was introduced in the 
House on December 14 and in the Senate on December 15, 2000. The CFMA 
was passed by both the House and Senate on December 15, the last day of 
the 106th Congress, as part of an omnibus legislative package involving 
13 appropriations bills and several authorization bills. There was no 
opportunity for debate on any of the specific provisions in the CFMA; 
the Senate passed this entire omnibus package by unanimous consent. A 
history of the regulation of the trading of energy commodities is 
presented in Appendix 2 of the Report prepared by the Minority Staff of 
the Permanent Subcommittee on Investigations, U.S. Strategic Petroleum 
Reserve: Recent Policy Has Increased Costs to Consumers But Not Overall 
U.S. Energy Security, S. Prt. 108-18, 108th Cong., 1st Sess. (March 5, 
2003).
    \95\ 7 U.S.C. Sec. 2(h)(3).
---------------------------------------------------------------------------
    In recent years, there has been a tremendous growth in the 
trading of energy commodity contracts that are virtually 
identical to futures contracts, but which are traded on OTC 
electronic exchanges rather than the regulated futures 
exchanges. These contracts are so similar to futures contracts 
that they are often called ``futures look-alike contracts.'' 
Although the trading of futures contracts on futures markets is 
subject to extensive oversight, as a result of the CFMA 
exemptions the trading of futures look-alikes on an OTC 
electronic exchange is not subject to any CFTC oversight. The 
growth of these OTC electronic markets, therefore, has been 
creating an increasing ``blind spot'' in the CFTC's oversight 
of the trading of energy commodity futures. This increasing 
blind spot significantly impairs the CFTC's ability to carry 
out its statutory mandate to detect and prevent price 
manipulation.

A. Development of OTC Electronic Markets

    ``Enron did two things for us. It validated our model, and 
in 2000, 13 big market makers agreed to support the ICE's 
efforts.''
        --Jeffrey Sprecher, Chairman and CEO, Intercontinental 
        Exchange 96
---------------------------------------------------------------------------
    \96\ Gerelyn Terzo, A Battle Royal; A sleek upstart and an 
entrenched giant are waging all-out war for the soul of the energy 
trading market, Investment Dealers Digest, May 1, 2006.

    Initially, the OTC market was not an actual place or 
facility where trading occurred, but rather a general term that 
referred to instances in which two parties would come together 
to reach agreement on a contract between them to protect 
against or assume price risks that could not be adequately 
addressed by the trading of standardized futures contracts on 
the regulated futures exchanges. Until the advent of electronic 
trading in the late 1990s, the terms of most OTC contracts were 
customized through negotiations between the two parties, either 
face-to-face or through brokers over the telephone. Because the 
terms of these customized, bilateral deals were unique, and the 
contracts generally could not be traded or assigned to third 
parties, these OTC contracts were considered simply as 
bilateral contracts, outside the CFTC's jurisdiction.
    In the 1990s, as energy deregulation gained momentum, and 
energy was increasingly being considered as another commodity 
priced on an open market, energy producers and suppliers 
desired additional protections against market price risks. OTC 
contracts became more popular, and the increasing number of 
energy providers, merchants and traders holding these contracts 
desired to trade these OTC instruments to third parties to help 
reduce, diversify or spread the risks they had assumed. In 
response, the OTC market began to develop standardized OTC 
contracts that could be traded to multiple parties. Following 
rapid developments in computer and internet technology in the 
1990s, a number of companies and groups developed electronic 
exchanges to facilitate these OTC trades.97
---------------------------------------------------------------------------
    \97\ Initially, the most prominent of these electronic exchanges 
was operated by Enron. On Enron's electronic trading platform, called 
``Enron OnLine,'' Enron became the counterparty to all of the trades. 
Enron's position as a party to all trades provided Enron with superior 
market information and created a non-level playing field. Following 
Enron's collapse and the subsequent revelations of how Enron abused its 
superior knowledge and market position, see, e.g., note 117, the Enron 
``one to many'' trading model was discredited. Today, all of the 
electronic exchanges are ``many to many'' exchanges, meaning that the 
parties trade with each other rather than the operator of the exchange.
---------------------------------------------------------------------------
    In 2000, a half dozen investment banks and oil companies 
formed the Intercontinental Exchange (ICE) for OTC electronic 
trading in energy and metals commodities.98 The 
Atlanta-based ICE is an electronic exchange open only to large 
commercial traders that meet the definition of an ``eligible 
commercial entity'' under the Commodity Exchange 
Act.99 According to ICE, its market participants 
``must satisfy certain asset-holding and other criteria and 
include[] entities that, in connection with their business, 
incur risks relating to a particular commodity or have a 
demonstrable ability to make or take delivery of that 
commodity, as well as financial institutions that provide risk-
management or hedging services to those entities.'' 
100
---------------------------------------------------------------------------
    \98\ The founding partners of ICE are BP Amoco, Deutsche Bank AG, 
Goldman Sachs, Dean Witter, Royal Dutch/Shell Group, SG Investment 
Bank, and Totalfina Elf Group. In November 2005, ICE became a publicly 
traded corporation. Many of these original founders are major 
shareholders: Morgan Stanley owns nearly 15 percent of ICE shares, 
Goldman Sachs owns about 14 percent, Total owns about 9.5 percent, and 
BP owns about 9 percent. Market Forces: Big Oil increases market reach, 
Energy Compass, March 24, 2006.
    \99\ Participation is restricted to parties that quality as an 
``eligible commercial entity'' under Section 1a(11) of the CEA. 
Generally, these entities are large financial institutions, insurance 
companies, investment companies, corporations and individuals with 
significant assets, employee benefit plans, government agencies, and 
registered securities brokers and futures commission merchants.
    \100\ Intercontinental Exchange Inc, Form 10-K, filed March 10, 
2006 (``ICE 10-K''), at p. 14. There does not appear to be any 
mechanism to ensure that only eligible commercial entities actually 
trade on ICE. The CFTC does not monitor or oversee participation; ICE 
declined to answer the Subcommittee staff's questions as to whether or 
how it monitors trader qualifications.
---------------------------------------------------------------------------
    Today, ICE operates the leading OTC electronic exchange for 
energy commodities. ICE describes its participants as ``some of 
the world's largest energy companies, financial institutions 
and other active contributors to trading volume in global 
commodity markets. They include oil and gas producers and 
refiners, power stations and utilities, chemical companies, 
transportation companies, banks, hedge funds and other energy 
industry participants.'' 101 According to ICE, its 
electronic markets now constitute ``a significant global 
presence with over 9,300 active screens at over 1,000 OTC 
participant firms and over 440 futures participant firms as of 
December 31, 2005.'' 102
---------------------------------------------------------------------------
    \101\ ICE 10-K, at p. 14.
    \102\ ICE 10-K, at p. 6. As explained in Section V, in 2001, ICE 
purchased the International Petroleum Exchange, a London-based futures 
exchange that traded North Sea Brent crude oil and natural gas 
delivered in Europe. In 2005, ICE renamed the London exchange as ``ICE 
Futures'' and converted its open-outcry pit trading system into an all-
electronic exchange. Hence, ICE now operates two major electronic 
markets: ICE Futures and ICE OTC. ICE Futures is a futures market in 
London, regulated by the U.K. Financial Services Authority, and ICE OTC 
operates as an ``exempt commercial market'' under Section 2(h)(3) of 
the U.S. Commodity Exchange Act. Both markets operate outside of the 
CFTC's oversight.
---------------------------------------------------------------------------
    Unlike NYMEX, ICE does not require its participants to 
become formal members of its exchange or to join a 
clearinghouse.103 Any large commercial company 
qualifying as an eligible commercial entity can trade through 
ICE's OTC electronic exchange without having to employ a broker 
or pay a fee to a member of the Exchange.
---------------------------------------------------------------------------
    \103\ In contrast, on NYMEX and other regulated futures exchanges, 
the exchange clearinghouse acts as the buyer for all sellers and the 
seller for all buyers. Persons that are not members of the exchange 
must trade through a clearing member. Clearing members accept all 
financial responsibility for the trades they conduct on behalf of the 
customer initiating the trade.
---------------------------------------------------------------------------
    Although ICE's OTC exchange does not operate its own 
clearinghouse, ICE has contracted with a third party, the 
LCH.Clearnet, to offer clearing services for traders who desire 
to trade only with other cleared traders. By trading only with 
other cleared traders, a party trading on ICE can eliminate the 
risk of default by the other party just as if he or she were 
trading on a futures exchange, thereby avoiding one of the 
traditional disadvantages of OTC trading.104 ICE 
describes the advantages of OTC trading through a 
clearinghouse:
---------------------------------------------------------------------------
    \104\ NYMEX also offers an electronic trading platform for the 
trading of standardized OTC instruments, and provides clearinghouse 
services, called ``NYMEX ClearPort,'' for traders using the NYMEX OTC 
electronic trading platform. NYMEX states that its OTC clearing service 
``lets market participants take advantage of the financial depth and 
security of the Exchange clearinghouse along with round-the-clock 
access to more than 60 energy futures contracts including natural gas 
location differentials; electricity, crude oil spreads and outright 
transactions; refined product crack and location spreads and outright 
transactions; and coal.'' NYMEX, NYMEX ClearPort Services, on NYMEX 
website, at http://www.nymex.com/cp--overview.aspx (last visited May 
19, 2006).

          The use of OTC clearing serves to reduce the credit 
        risk associated with bilateral OTC trading by 
        interposing an independent clearinghouse as a 
        counterparty to trades in these contracts. The use of a 
        central clearinghouse rather than the reliance on 
        bilateral trading agreements [has] resulted in more 
        participants becoming active in the OTC markets. In 
        addition, clearing through a central clearinghouse 
        typically offers market participants the ability to 
        reduce the amount of capital required to trade as well 
        as the ability to cross-margin positions in various 
        commodities.105
---------------------------------------------------------------------------
    \105\ Intercontinental Exchange Inc., Form 10-Q, filed May 2, 2006 
(``ICE 10-Q''), at p. 16. In 2005, ICE also contracted with North 
American Energy Credit and Clearing, LLC, to provide clearing for 
trades in physically-settled OTC natural gas and power contracts. Id.

    ICE claims that its OTC markets ``offer trading in hundreds 
of natural gas, power and refined oil products on a bilateral 
basis. At the end of first quarter 2006, we also offered over 
50 cleared OTC contracts, which account for the majority of our 
commission revenue. In March 2006, we began the introduction of 
more than 50 planned additional cleared OTC contracts, with the 
first 34 cleared contracts launched through the end of April 
this year.'' 106 According to ICE, its natural gas 
contracts are its most heavily traded contracts. ICE states it 
traded nearly 43 million cleared OTC Henry Hub natural gas 
contracts in 2005, ``compared to 10.4 million cleared OTC Henry 
Hub natural gas contracts traded by our nearest competitor 
during the same period.'' 107
---------------------------------------------------------------------------
    \106\ ICE 10-Q, at p. 17.
    \107\ ICE 10-K, at p. 5.
---------------------------------------------------------------------------
    ICE claims that its ``introduction of cleared OTC products 
has enabled us to attract significant liquidity in the OTC 
markets we operate.'' 108 Others agree. ``[C]learing 
is paving the way for greater growth of the energy market as a 
whole,'' one futures industry publication reported. ``Clearing 
not only helped restore liquidity post-Enron, it opened the 
door to an influx of hedge funds and other professional 
traders, many of whom come from the financial world.'' 
Moreover, OTC clearing has ``created a new linkage'' between 
the futures markets and the OTC markets. ``On one level this is 
simple arbitrage between two sets of similar contracts. On 
another level it is a cross-fertilization of people and ideas, 
as each side seeks out better opportunities in newly accessible 
markets.'' 109 ``If you want to participate in all 
the information of the market,'' said Bo Collins, former 
President of NYMEX, and now the operator of his own hedge fund, 
``you have to participate electronically and OTC.'' 
110
---------------------------------------------------------------------------
    \108\ ICE 10-K, at p. 5. ICE states, ``both physically-delivered 
and cash-settled gas products can be traded at a fixed price or 
differential to recognized published indices.'' ICE website, at https:/
/www.theice.com/naturalgas.jhtml. See also, e.g., ICE, OTC Natural Gas 
Clearing and Credit, Product Specifications, March 24, 2006; ICE, OTC 
Natural Gas and Financial Power Clearing and Credit, Product 
Specifications for products to be launched on April 7, 2006. ICE 
further amplifies: ``A substantial portion of the trading volume in our 
OTC markets relates to approximately 15-20 highly liquid contracts in 
natural gas, power, and oil. For these contracts, the highest degree of 
market liquidity resides in the prompt, or front month, whereas that 
liquidity is reduced for contracts with settlement dates further out, 
or in the back months.'' ICE 10-K, at p. 9.
    \109\ Will Acworth, The Tipping Point: OTC Energy Clearing Takes 
Off, Futures Industry Magazine, January/February 2005.
    \110\ Id. Although NYMEX's ClearPort offers a similar OTC trading 
opportunities, ICE currently has approximately 80 percent of the market 
for cleared OTC Henry Hub natural gas contracts and 85 percent of the 
cleared OTC PJM financial power contracts. ICE 10-Q, at p. 28.
---------------------------------------------------------------------------
    Today, there are few, if any, practical differences between 
the energy commodities traded on the regulated futures markets 
and the standardized, cleared contracts traded on the 
unregulated OTC electronic exchanges. From an economic 
perspective, there is no distinction between trading a 
standardized, cleared OTC contract for future delivery on ICE 
and trading a standardized, cleared futures contract on 
NYMEX.111 Both types of contracts allow buyers and 
sellers to hedge against price risks and to speculate on price 
changes. In each market counterparty risk is eliminated by use 
of a clearinghouse. In each market, contracts are put on the 
market and bought and sold many times.
---------------------------------------------------------------------------
    \111\ Generally, futures contracts for key energy commodities can 
be settled through physical delivery of the commodity, whereas OTC 
futures look-alikes are financially settled. Since only a small 
percentage of futures contracts actually result in physical delivery of 
the commodity, this distinction does not make a practical difference in 
the economic function or utility of the two types of contracts. 
Moreover, many of the financially-settled OTC contracts reference the 
NYMEX price for settlement; in this respect the two markets are 
intertwined.
---------------------------------------------------------------------------
    From a practical perspective, the only real difference 
between the two markets is the degree of regulation. ICE 
distinguishes its OTC market from the regulated futures 
exchanges primarily by the absence of regulation.112 
Trading on the futures market is subject to CFTC oversight, 
while trading on the unregulated OTC exchanges is not.
---------------------------------------------------------------------------
    \112\ ICE 10-K, at p. 25.
---------------------------------------------------------------------------

B. No Oversight of OTC Electronic Markets

    Section 2(h)(3) of the Commodity Exchange Act, which became 
law as part of the CFMA, exempts from CFTC oversight all 
agreements, contracts, and transactions in energy and metals 
(``exempt commodities'') that are traded on electronic trading 
facilities between ``eligible commercial entities.'' 
113 Generally, an eligible commercial entity must be 
either a large financial institution, insurance company, 
investment company, corporation or individuals with significant 
assets, employee benefit plan, government agency, registered 
securities broker, or futures commission merchant. Markets 
operating under Section 2(h)(3) are referred to as ``exempt 
commercial markets.'' 114
---------------------------------------------------------------------------
    \113\ 7 U.S.C. Sec. 2(h)(3).
    \114\ 7 U.S.C. Sec. 1a(11).
---------------------------------------------------------------------------
    An exempt commercial market (ECM) is subject to the CEA's 
statutory prohibitions on fraud and price manipulation and, if 
the CFTC determines that the market performs a significant 
price discovery function, the ECM must provide pricing 
information to the public, but otherwise it is fully exempt 
from the CFTC's regulatory oversight. The CFTC describes its 
authority over these ECMs as follows:

          In contrast to its authority over designated contract 
        markets and registered derivatives transaction 
        facilities, the CFTC does not have general oversight 
        authority over exempt commercial markets. Exempt 
        commercial markets are not registered with, or 
        designated, recognized, licensed or approved by the 
        CFTC.115
---------------------------------------------------------------------------
    \115\ Cite to Section 2(h)(3). CFTC, Exempt Commercial Markets That 
Have File Notice with the CFTC, at CFTC website at http://www.cftc.gov/
dea/dea--ecm--table.htm (last visited May 19, 2006).

    Today, the CFTC does not apply to exempt commercial markets 
like ICE any of the oversight and surveillance measures it 
currently uses to oversee regulated futures markets like the 
NYMEX. Table 2 provides a comparison of the oversight 
mechanisms used to police trading on the two markets and 
prevent price manipulation and fraud.

                                                     Table 2
                                     Futures and Exempt Commercial Markets:
                             Differences in Oversight to Prevent Price Manipulation
----------------------------------------------------------------------------------------------------------------
                                                                        Does the Measure Apply to the:
            Measure to Prevent Price Manipulation            ---------------------------------------------------
                                                                   Futures Market       Exempt Commercial Market
----------------------------------------------------------------------------------------------------------------
CFTC Market Surveillance Program
----------------------------------------------------------------------------------------------------------------
 CFTC staff monitoring of daily trading reports                           Yes                        No
----------------------------------------------------------------------------------------------------------------
 Weekly reports and reviews for expiring contracts                        Yes                        No
----------------------------------------------------------------------------------------------------------------
 Option of special data call by CFTC                                      Yes                       Yes
----------------------------------------------------------------------------------------------------------------
Large Trader Reporting
----------------------------------------------------------------------------------------------------------------
 Large trader reporting by clearing members                               Yes                        No
----------------------------------------------------------------------------------------------------------------
 Large trader reporting by exchanges                                      Yes                        No
----------------------------------------------------------------------------------------------------------------
 Filing of information about trading accounts by                          Yes                        No
 traders
----------------------------------------------------------------------------------------------------------------
Core Principles for Exchange Operations
----------------------------------------------------------------------------------------------------------------
 Exchange is responsible for monitoring compliance                        Yes                        No
 with market rules
----------------------------------------------------------------------------------------------------------------
 Exchange can only list contracts for trading that                        Yes                        No
 are not readily susceptible to manipulation
----------------------------------------------------------------------------------------------------------------
 Exchange must monitor trading to prevent                                 Yes                        No
 manipulation, price distortion, and disruption of the
 delivery or cash-settlement process
----------------------------------------------------------------------------------------------------------------
 Position limits for speculators to reduce the                            Yes                        No
 potential threat of manipulation or congestion
----------------------------------------------------------------------------------------------------------------
 Emergency authority, in consultation with the CFTC,                      Yes                        No
 to liquidate positions, suspend trading, or impose special
 margin requirements
----------------------------------------------------------------------------------------------------------------
 Daily submission of trading information to CFTC                          Yes                   Limited
----------------------------------------------------------------------------------------------------------------
 Daily publication of trading information                                 Yes                         *
----------------------------------------------------------------------------------------------------------------
 Exchange must keep records of trading                                    Yes                      Yes
----------------------------------------------------------------------------------------------------------------
* Section 2(h)(4) of the Commodity Exchange Act requires daily publication of trading information if the market
  performs a price discovery function. The CFTC has not made any determination as to whether any of the exempt
  commercial markets performs a price discovery function. See Section IV.D. in this report.

    These differences are substantial. For example, unlike the 
regulated exchanges, on OTC electronic exchanges, neither the 
CFTC nor the OTC trading facility itself monitors trading 
activity to detect and deter fraud and price manipulation. Key 
trading information is not disclosed to the CFTC or the public. 
Although ICE discloses to the CFTC and subscribers of its data 
services certain information about posted bids, offers, and 
completed trades, other critical data routinely reported by the 
regulated exchanges to the CFTC and the public, such as open 
interest, is not reported by ICE. Large trader reports do not 
have to be filed with the CFTC. Unlike trading on the NYMEX, 
there are no position limits or price change limits.
    The most frequently asserted justification for this 
disparity in regulatory coverage is that only large 
institutions that are sophisticated traders with less need for 
governmental protection are permitted to trade on these 
electronic trading facilities. But federal regulation of 
commodity markets is not designed solely to protect commodity 
traders; it is also intended to protect commodity purchasers 
and the public at large, including consumers who ultimately 
bear the costs of energy products such as gasoline, heating 
oil, diesel fuel, and natural gas.
    The Commodity Exchange Act articulates the national 
interest in preventing price manipulation and excessive 
speculation:

          The transactions and prices of commodities on such 
        boards of trades are susceptible to excessive 
        speculation and can be manipulated, controlled, 
        cornered or squeezed to the detriment of the producer 
        or the consumer and the persons handling commodities 
        and the products and byproducts thereof in interstate 
        commerce, rendering regulation imperative for the 
        protection of such commerce and the national public 
        interest therein.116
---------------------------------------------------------------------------
    \116\ 7 U.S.C. Sec. 5. This statement of purpose in the CEA was 
revised to read in its current form as part of the CFMA of 2000.

    The history of commodity markets demonstrates it is 
unrealistic to rely on the self-interest of a few large traders 
as a substitute for dedicated, independent oversight to protect 
the public interest. Commodity traders have no responsibility 
or obligation to look out for public rather than private 
interests. In some cases, it could be a breach of fiduciary 
duty for officers of a private corporation to look out for 
interests other than those of the corporation's shareholders. 
Most recently, the Enron scandal, which involved misconduct by 
a number of traders at large energy and trading companies 
active in OTC trading, is clear evidence of how a few 
sophisticated, unscrupulous traders can harm not only other 
market participants, but also the public at large by 
artificially increasing prices.117 Consumers paying 
artificially high energy prices suffer the same harm regardless 
of whether the price was manipulated on an OTC electronic 
exchange or on a regulated futures market.
---------------------------------------------------------------------------
    \117\ See, e.g., August 2002 report prepared by the Federal Energy 
Regulatory Commission (FERC) staff, Docket No. PA-02-000, which found 
significant evidence of price manipulation and deceptive practices by 
Enron in connection with its OTC electronic trading platform, known as 
Enron OnLine. The report includes a detailed analysis of natural gas 
trades made on Enron OnLine for next-day delivery into California over 
the course of a single day, January 31, 2001. The report found that of 
a total of 227 trades on that day, 174 involved Enron and a single 
unnamed party; these 174 trades took place primarily during the last 
hour of trading, and by using ``higher prices,'' these trades resulted 
in a steep price increase over the last hour of trading. The report 
also noted that price information displayed electronically on Enron 
OnLine was a ``significant, even dominant'' source of price information 
used by reporting firms publishing natural gas pricing data. The report 
tentatively concluded that Enron OnLine price data was susceptible to 
price manipulation and may have affected not only Enron trades, but 
also increased natural gas prices industrywide.
---------------------------------------------------------------------------

C. No Large Trader Reporting in OTC Electronic Markets

    As indicated in Table 2, Large Trader Reports are not 
required in OTC electronic markets. The absence of information 
about large trades increases the vulnerability of these markets 
to price manipulation and excessive speculation.
    CFTC Chairman Reuben Jeffery III, recently stated, ``One of 
the core themes of the Commodity Exchange Act . . . is that the 
commodity markets operate free of manipulation and the 
Commission's most basic responsibility is to detect and deter 
such behavior so that markets operate in an open and 
competitive manner, free of price distortions.'' 118 
To fulfill this responsibility, the Commission has established 
a market surveillance program, whose primary mission is ``to 
identify situations that could pose a threat of manipulation 
and to initiate appropriate preventive actions.'' 
119 ``[T]he Commission attempts to proactively 
combat potential manipulation,'' Chairman Jeffery explains, 
``rather than simply waiting until someone has attempted to 
manipulate prices.'' 120 The CFTC staff monitors the 
daily trading on the regulated exchanges, with particular focus 
on ``the daily activities of large traders, key price 
relationships, and relevant supply and demand factors.'' 
121
---------------------------------------------------------------------------
    \118\ Letter from Reuben Jeffery III, Chairman, Commodity Futures 
Trading Commission, to Governor Jennifer Granholm, August 22, 2005.
    \119\ CFTC Backgrounder, The CFTC Market Surveillance Program, June 
2001, at CFTC website, at http://www.cftc.gov/opa/backgrounder/
opasurveill.htm?from=home&page=mktsurveil-content.
    \120\ Letter from Reuben Jeffery III, Chairman, Commodity Futures 
Trading Commission, to Governor Jennifer Granholm, August 22, 2005.
    \121\ CFTC, The CFTC Market Surveillance Program.
---------------------------------------------------------------------------
    The ``cornerstone'' of the surveillance program is the 
Commission's Large Trader Reporting (LTR) system.122 
Chairman Jeffery states the LTR system ``enables detection of 
concentrated and coordinated positions that might be used by 
one or more traders to attempt manipulation. This transparency 
is also well known to market participants, providing yet 
another element of deterrence.'' 123 The CFTC's 
Chief Economist, Dr. James Overdahl, recently told Congress 
that the LTR system ``is a powerful tool for detecting the 
types of concentrated and coordinated positions required by a 
trader or group of traders attempting to manipulate the 
market.'' 124
---------------------------------------------------------------------------
    \122\ Letter from Reuben Jeffery III, Chairman, Commodity Futures 
Trading Commission, to Governor Jennifer Granholm, August 22, 2005.
    \123\ Id.
    \124\ Statement of Dr. James Overdahl, Global Oil Demand/Gasoline 
Prices, Hearing before the Senate Committee on Energy and Natural 
Resources, September 6, 2005.
---------------------------------------------------------------------------
    Under the LTR system, clearing members of futures exchanges 
(the entities that actually do the trading on behalf of 
customers) must file daily reports with the CFTC identifying 
the futures and options positions held by its customers above 
specific threshholds established by the Commission. To enable 
the CFTC to aggregate trader positions that may have been 
established through more than one clearing member, traders 
themselves are required to inform the CFTC of each account that 
acquires a reportable position. ``Only by properly identifying 
and aggregating accounts can the surveillance staff make a 
thorough assessment of a trader's potential market impact and a 
trader's compliance with speculative position limits.'' 
125 The exchanges themselves are required to report 
similar data to the CFTC. According to the CFTC, ``The 
aggregate of all large-traders'' positions reported to the 
Commission usually represents 70 to 90 percent of the total 
open interest in any given market.'' 126
---------------------------------------------------------------------------
    \125\ CFTC Backgrounder, The CFTC's Large-Trader Reporting System, 
at CFTC website, at http://www.cftc.gov/opa/backgrounder/opa-ltrs.htm.
    \126\ Id.
---------------------------------------------------------------------------
    The Commission describes how it uses this data to take 
appropriate action to detect and deter price manipulation:

          Surveillance economists prepare weekly summary 
        reports for futures and options contracts that are 
        approaching their critical expiration periods. Regional 
        surveillance supervisors immediately review these 
        reports. Surveillance staff advise the Commission and 
        senior staff of potential problems and significant 
        market developments at weekly surveillance meetings so 
        that they will be prepared to take prompt action when 
        necessary.127
---------------------------------------------------------------------------
    \127\ CFTC, The CFTC Market Surveillance Program.

    The LTR system also provides critical information for the 
weekly Commitment of Traders Reports that the CFTC provides to 
the public. The CFTC's Chief Economist stated, ``Data from the 
CFTC's Large Trader Reporting System can help answer questions 
about the role of non-commercial traders in U.S. energy futures 
markets.'' This data can be used to help determine the relative 
participation of commercial participants (firms that buy or 
sell the traded commodity as part of their business and use the 
futures markets for hedging) and of speculators (who are not 
using the market for hedging physical commodities). Without a 
Large Trader Reporting system, it is impossible to determine 
the composition of the futures markets and analyze the 
influence of speculation on market prices.128
---------------------------------------------------------------------------
    \128\ There are anecdotal reports that some traders prefer trading 
on the OTC energy markets in the United States because of the lack of 
regulation. Natural Gas Week recently quoted one trader:
      When volumes all of a sudden begin to increase in one market and 
begin to erode in another, you have to ask yourself where the real 
market is? Since there's not the same sort of mandatory reporting 
requirements in the OTC world, it's very likely the funds have had 
their fill of being scrutinized and spot-lighted as the culprits, so 
they are moving into another market area that is not so easily tracked 
and doesn't have as much attention drawn to it.
    Funds Increasing OTC Volumes, Sidestepping Nymex Oversight, Natural 
Gas Week, April 25, 2005. Natural Gas Week also reported that hedge 
funds ``benefit from the OTC traded futures market because they are not 
as transparent as NYMEX traded futures, and the non-commercial 
reporting requirements such as the CFTC mandated Commitment of Traders 
Report is not as stringent.'' Id. The article explained how speculators 
can influence the futures markets through their activity in the OTC 
market, or vice versa, and capture a profit through the difference in 
price between the two markets that may result from trading in one of 
the markets.
      ``Last week, there was a lot of arbitrage going on between the 
OTC gas futures markets and the NYMEX futures markets, because at times 
the OTC markets were as much as 5 cents in back of the futures 
screen,'' another gas futures trader said. ``The OTC futures markets 
usually trade nearly in tandem with the NYMEX futures screen, but it's 
not uncommon to be able to capture a spread between the two markets. 
Still, it's amazing that the speculative entities in the OTC market can 
move the NYMEX down by 5 cents or more in about 30 seconds. But they 
could just as easily position themselves in the OTC market to influence 
the NYMEX futures market to the upside as well,'' the trader added.
    Id. The article also noted that funds can take large positions in 
the OTC market without having to report those positions to any 
regulatory agency, thereby circumventing any position limits that apply 
to their trading on the futures market.
---------------------------------------------------------------------------

D. No Public Dissemination of Trading Data by OTC Electronic Markets

    Under the Commodity Exchange Act, regulated markets are 
required to publish daily information about settlement prices, 
volume, open interest, and opening and closing price ranges for 
all actively traded contracts.129 Under the 
Commodity Futures Modernization Act, OTC electronic markets 
must publish similar information if the CFTC determines that 
the market ``performs a significant price discovery function'' 
for the underlying cash market.130 Although there is 
substantial evidence that the ICE OTC electronic exchange 
performs such a price discovery function, the CFTC has not 
undertaken any effort to make this determination. The failure 
to even attempt to make this determination ignores the 
Congressional mandate expressed in the law that the OTC 
electronic exchanges that perform a price discovery function be 
as transparent to the public as the regulated futures 
exchanges.
---------------------------------------------------------------------------
    \129\ 7 U.S.C. Sec. 7(d).
    \130\ Under the CEA, electronic trading facilities that trade 
energy commodities are subject to ``such rules and regulations as the 
Commission may prescribe if necessary to ensure timely dissemination by 
the electronic trading facility of price, trading, volume, and other 
trading data to the extent appropriate, if the Commission determines 
that the electronic trading facility performs a significant price 
discovery function for transactions in the cash market for the 
commodity underlying any agreement, contract, or transaction executed 
or traded on the electronic trading facility.'' 7 U.S.C. Sec. 
2(h)(4)(D).
---------------------------------------------------------------------------
    In 2004, the CFTC issued a rule setting forth the process 
and criteria it would use to determine whether an electronic 
exchange performed a price discovery function.131 
However, the CFTC has not taken any action in the 2 years since 
that rule was issued to actually determine whether ICE or any 
other OTC electronic market meets these criteria. Under the 
2004 rule, an ECM performs a price discovery function when it 
meets one of two specified criteria:
---------------------------------------------------------------------------
    \131\ 69 Fed. Reg. 43285 (July 20, 2004).

        (A) LCash market bids, offers or transactions are 
        directly based on, or quoted at a differential to, the 
        prices generated on the market on a more than 
        occasional basis; or
        (B) LThe market's prices are routinely disseminated in 
        a widely distributed industry publication and are 
        routinely consulted by industry participants in pricing 
        cash market transactions.132
---------------------------------------------------------------------------
    \132\ 17 C.F.R. Sec. 36.3(c)(2).

    An ECM operating under the Section 2(h)(3) exemption must 
notify the CFTC when ``it has reason to believe'' either of 
these criteria are met, or if the ``market holds itself out to 
the public as performing a price discovery function for the 
cash market for the commodity.'' 133
---------------------------------------------------------------------------
    \133\ 17 C.F.R. Sec. 36.3(c)(2)(C).
---------------------------------------------------------------------------
    If an ECM notifies the CFTC that it has reason to believe 
that it meets any of these criteria for performing a price 
discovery function, or the CFTC itself determines that an ECM 
appears to meet one of these criterion, then the CFTC must 
provide the ECM ``with an opportunity for a hearing through the 
submission of written data, views and arguments.'' 
134 After conducting such a hearing, and 
``consideration of all relevant matters,'' the Commission 
``shall issue an order containing its determination whether the 
electronic trading facility performs a significant price 
discovery function'' under this section.135
---------------------------------------------------------------------------
    \134\ 17 C.F.R. Sec. 36.3(c)(2)(C)(iii).
    \135\ Id.
---------------------------------------------------------------------------
    If the CFTC determines that an electronic trading facility 
performs a significant price discovery function, then the 
regulations require the facility to disseminate to the public, 
on a daily basis, the following information:

        (1) Contract terms and conditions, or a product 
        description, and trading conventions, mechanisms and 
        practices;
        (2) Trading volume by commodity and, if available, 
        open interest; [and]
        (3) The opening and closing prices or price ranges, 
        the daily high and low prices, a volume-weighted price 
        . . . or such other daily price information as proposed 
        by the facility and approved by the 
        Commission.136
---------------------------------------------------------------------------
    \136\ 17 C.F.R. Sec. 36.3(c)(2)(C)(iv)(A). The information must be 
publicly disseminated no later than the business day following the day 
to which the information applies. Id. at Section 36.3(c)(2)(C)(iv)(B).
      The 2004 rule also requires an exempt commercial market to inform 
the CFTC of those commodity contracts it is trading in reliance on the 
exemption set forth in Section 2(h)(3). Id. at Sec. 36.3(b)(1)(ii). The 
ECM must provide the CFTC with a description of the contract and weekly 
reports on the price, quantity, and other information the CFTC 
determines is appropriate for each trade in that commodity contract 
during the previous week. The facility may either provide this 
information in weekly reports or provide the CFTC with electronic 
access to the same information. Id. at Section 36.3(b)(1)(ii)(A) and 
(B). Additionally, the ECM must maintain records of complaints or 
allegations of fraud or manipulation, and forward any such complaints 
to the CFTC. Id. at Section 36.3(b)(1)(iii) and (iv). There is no 
requirement that the CFTC or an ECM provide this data to the public.
      In comments filed on the proposed rule, ICE contended that the 
CFMA did not give the CFTC authority to conduct regulatory oversight of 
trading on electronic trading facilities or to require electronic 
trading facilities to submit reports. The CFTC rejected this argument, 
noting that Congress expressly stated ECMs were still subject to the 
anti-fraud and anti-manipulation provisions of the CEA. ``If the 
Commission is to have the ability to enforce those provisions, it must 
have access to meaningful information concerning transactions on 
ECMs.'' 69 Fed. Reg. 43287. The CFTC also dismissed the contention that 
allowing the CFTC staff to monitor trading through the installation of 
a view-only trading screen at the CFTC was sufficient to enable the 
CFTC to monitor those markets for fraud and manipulation. ``The 
Commission has found that the information provided under the current 
electronic access option is neither as relevant, nor as useful, as 
anticipated.'' Id. 69 Fed. Reg. 43286. It stated that the view-only 
access to computer screens provided to the CFTC by ICE ``is not, in 
fact, equivalent to the large trader information received with respect 
to designated contract markets.'' Id. The CFTC, however, has not used 
this section to require information on open interest or large trades. 
Hence, the information that is provided to the CFTC under this section 
does not serve to provide the CFTC with the type of large trader 
information necessary to detect and prevent manipulation.

    Despite the 2004 regulations, to date, neither ICE--nor any 
other ECM--has informed the CFTC that it has reason to believe 
that its electronic exchange performs a price discovery 
function. Yet at the same time, ICE appears to have made that 
very claim to the Securities and Exchange Commission (SEC). In 
the Form 10-K that ICE filed with the SEC on March 10, 2006, 
ICE identified price discovery as a core function of its over-
the-counter markets: ``Our participants, representing many of 
the world's largest energy companies, leading financial 
institutions and proprietary trading firms, as well as natural 
gas distribution companies and utilities, rely on our platform 
for price discovery, hedging and risk management.'' 
137
---------------------------------------------------------------------------
    \137\ ICE 10-K, at p. 4.
---------------------------------------------------------------------------
    ICE's 10-K filing also describes its sale of a daily report 
containing price data about OTC transactions as a core business 
activity. ICE described its ``OTC End of Day Report'' as 
follows:

          The OTC ICE Data end of day report is a comprehensive 
        electronic summary of trading activity in our OTC 
        markets. The report is published daily at 3:00 p.m. 
        Eastern time and features indicative price statistics, 
        such as last price, high price, low price, total 
        volume-weighted average price, best bid, best offer, 
        closing bid and closing offer, for all natural gas and 
        power contracts that are traded or quoted on our 
        platform. The end of day report also provides a summary 
        of every transaction, which includes the price [and] 
        the time stamp. . . .138
---------------------------------------------------------------------------
    \138\ ICE 10-K, at p. 13.

    It is not apparent why traders and energy firms would pay 
for ICE Data's End of Day Trader Reports if those reports did 
not provide valuable information about the data that is most 
useful to market participants--prices. Such price reports would 
appear to be useless or not worth the cost if the ICE trades 
did not perform a price discovery function. By generating 
valuable daily price data to industry participants, trading on 
ICE now performs a price discovery function.
    It is difficult to reconcile ICE's daily trading reports 
and its statements to the SEC with its failure to notify the 
CFTC that its natural gas and electricity markets perform a 
price discovery function. As ICE states, most of the natural 
gas and power contracts traded in its OTC markets relate to 
``the prompt, or front month,''--meaning the futures contract 
that is closest to the spot or cash market. Hence, the prices 
of these contracts as traded on ICE have a direct influence on 
the prices of these commodities in the cash market.
    Although the CFTC's 2004 rulemaking requires an ECM that 
has reason to believe it is performing a price discovery 
function to notify the CFTC, the CFTC has retained authority to 
initiate a hearing to determine whether an ECM meets the 
criteria for performing a price discovery function. Despite 
numerous unqualified statements by ICE on its website, 
139 in press releases, 140 and in filings 
with the SEC that its OTC electronic trading facility performs 
a price discovery function, the CFTC has failed to initiate any 
type of inquiry to evaluate this issue. In light of the 
substantial evidence that the ICE electronic exchange is 
performing a price discovery function, the CFTC appears to have 
failed to carry out its statutory mandate to require ICE to 
publicly disseminate trading data.
---------------------------------------------------------------------------
    \139\ See, e.g., ICE. The Energy Marketplace, at https://
www.theice.com/profile.jhtml (last visited June 9, 2006) 
(``IntercontinentalExchange is the world's leading electronic 
marketplace for energy trading and price discovery. . . . ICE's 
electronic trading platform offers direct, centralized access to trade 
execution and real-time price discovery through over 7,000 active 
screens at more than 1000 OTC and futures participant firms.''); A 
Global Community of Energy Market Participants, at https://
www.theice.com/customers.jhtml (last visited June 9, 2006) (``Through 
ICE's markets, participants have direct access to trade execution, 
real-time price information, market activity and unparallelled 
transparency in both futures and OTC energy markets. From the world's 
leading oil majors, to funds, utilities and financial institutions, 
energy market participants rely on ICE.''); Clearing, at https://
www.theice.com/futures--clearing.jhtml (last visited June 9, 2006) 
(``As the world's leading electronic energy exchange, ICE provides an 
unsurpassed forum for price discovery and risk management.''); ICE 
Platform, https://www.theice.com/ice--platform.jhtml (last visited June 
9, 2006) (ICE's electronic platform is the gateway to an open 
marketplace--one in which each participant has access to real-time 
price discovery and trading functionality.'').
    \140\ See, e.g., Statement of Jeffrey Sprecher, ICE Chairman and 
Chief Executive Officer, Intercontinental Announces 2003 Results, March 
4, 2004, (``ICE's investment in the development of cleared OTC products 
was beneficial to a growing number of market participants who relied on 
clearing to ease credit constraints while managing risk. As a result, 
Intercontinental is well positioned to participate in the stabilizing 
OTC energy markets, and to facilitate the migration to electronic price 
discovery.''), at https://www.theice.com/showpr.jhtml?id=558; Statement 
of Jeffrey Sprecher, Trading Technologies to Connect to ICE Energy 
Markets, March 17, 2004 (``We look forward to together delivering 
alternatives to the markeplace for electronic price discovery and 
expanded market access to a diverse group of participants.''), at 
https://www.theice.com/showpr.jhtml?id=557.
---------------------------------------------------------------------------

V. THE COP'S BLIND EYE: U.S. ENERGY TRADES ON FOREIGN EXCHANGES

    ``Growth in our industry is certainly exceeding the ability 
of the regulators to get their heads around it.''
        --Jeffrey Sprecher, ICE Chairman and CEO 141
---------------------------------------------------------------------------
    \141\ Comments at a conference, May 9, 2006. An audio replay of Mr. 
Sprecher's presentation can be downloaded from the ICE website, at 
https://www.theice.com/showpr.jhtml?id=2321 (last visited June 9, 
2006).

    ICE now operates two types of electronic energy exchanges. 
One is the ICE OTC exchange, which is registered in the United 
States. The other is ICE Futures, which is a futures exchange 
registered in London and regulated by the United Kingdom 
Financial Services Authority (FSA). Until January of this year, 
ICE Futures traded solely in European-based energy commodities. 
Within the past few months, however, the CFTC has permitted ICE 
Futures in London to use its trading terminals within the 
United States for the trading of U.S. energy commodities, 
including U.S. crude oil, U.S. gasoline, and U.S. home heating 
oil. The result is that persons located in the United States 
seeking to trade key U.S. energy commodities now can avoid all 
U.S. market oversight and reporting requirements simply by 
routing their trades through the ICE Futures exchange in London 
instead of the NYMEX in New York.

A. U.S. Energy Commodities Traded on Foreign Exchanges

    In May 1999, the London International Petroleum Exchange 
(IPE) petitioned the CFTC to permit the IPE to make its 
electronic trading system available to IPE members in the 
United States. Specifically, the IPE desired that its members 
who were registered with the CFTC be able to electronically 
place orders from within the United States, or to 
electronically submit the orders of customers within the United 
States, to the IPE in London, without requiring the IPE to be 
fully regulated as a U.S. futures market under the CEA. The 
IPE's petition contained general information about the IPE's 
operations, the contracts traded on the IPE, its floor and 
trading procedures, a description of the United Kingdom 
regulatory structure applicable to the IPE, the IPE's 
procedures for compliance with the U.K. regulations, and 
procedures for sharing information with the CFTC.142
---------------------------------------------------------------------------
    \142\  Letter from IPE to CFTC, May 14, 1999.
---------------------------------------------------------------------------
    In November 1999, the CFTC granted the IPE's request by 
releasing a ``no-action'' determination, permitting the IPE to 
allow its members to electronically trade from within the 
United States without having to designate the IPE as a U.S. 
futures exchange under the CEA. The CFTC wrote that its 
position was ``restricted to providing relief from the 
requirement that IPE obtain contract market designation 
pursuant to [the CEA] and regulatory requirements that flow 
specifically from the contract market designation requirement 
in the event that the above-reference contracts are made 
available in the United States.'' The CFTC stated its ``no-
action position does not affect the Commission's ability to 
bring appropriate action for fraud or manipulation.'' It also 
stated that it retained the authority to ``condition further, 
modify, suspend, terminate, or otherwise restrict the terms of 
the no-action relief provided herein, in its discretion.'' The 
initial no-action letter permitted the trading of IPE's natural 
gas, fuel oil, gas oil, and Brent crude oil contracts through 
IPE terminals in the United States. Subsequently, in 2002 and 
2003, following the purchase of the IPE by ICE, the IPE 
received permission from the CFTC, through several amendments 
to the initial no-action letter, to trade U.K. natural gas, gas 
oil, and Brent crude oil contracts through the ICE electronic 
trading platform.

B. ICE Futures Trading of U.S. Energy Commodities

    In mid-January 2006, ICE notified the CFTC that on February 
3, 2006, it would begin trading a U.S. energy commodity--West 
Texas Intermediate crude oil, a crude oil that is produced in 
the United States--on its ICE Futures exchange in London, and 
that it would offer this contract for trading on its electronic 
trading devices that were operating in the United States under 
the no-action letters the CFTC had previously issued. Under 
CFTC policy in effect at the time, ICE Futures did not need an 
additional no-action letter to make this new contract available 
for trading in the United States; rather, ICE Futures needed 
only to provide prior notice to the CFTC.143 This 
marked the first time that futures contracts for crude oil 
produced in the United States was traded on an exchange outside 
of the United States.
---------------------------------------------------------------------------
    \143\ Notice of Statement of Commission Policy Regarding the 
Listing of New Futures and Options Contracts by Foreign Boards of Trade 
that Have Received Staff No-Action Relief to Place Electronic Trading 
Devices in the United States, 65 Fed. Reg. 41641 (July 6, 2000). On 
April 14, 2006, the CFTC revised its policy to require a foreign board 
of trade to provide the CFTC with at least ten days' notice prior to 
the commencement of trading from within the United States of any 
product on such board of trade. 71 Fed. Reg. 19877 (April 18, 2006).
---------------------------------------------------------------------------
    Since ICE began trading WTI crude oil futures on its London 
exchange, it has steadily increased its share of the WTI crude 
oil furtures market.144 According to CFTC data, as 
of the end of April 2006, nearly 30 percent of WTI crude oil 
futures were traded on ICE Futures.145 According to 
one energy trade publication, several of the large ICE 
stakeholders--BP, Total, and Morgan Stanley--were ``doing their 
best to support the ICE WTI contract, with Goldman Sachs 
directing its traders to use the ICE platform rather than 
Nymex.'' 146
---------------------------------------------------------------------------
    \144\ Prior to the listing of a WTI contract on the ICE Futures 
exchange, ICE offered a WTI contract for trading on its OTC electronic 
exchange. In a recent interview, ICE Chairman and CEO Jeffrey Sprecher 
described how ICE's development of a successful OTC contract for WTI 
paved the way for the introduction of the WTI contract on ICE Futures:
    To the outside world, we launched WTI and it came out with a very 
high adoption rate. But the reality is ICE was working on that contract 
for a year and a half prior to its launch. One unique thing about ICE 
is that we can take a product and launch it as a bilateral OTC contract 
allowing the energy trading community to trade it. While they trade it 
we can work out many of the details, such as the size of the contract, 
delivery aspects, tick size and those things. Then we can add clearing 
to it and bring in more of the funds and speculators--if we get that 
going, then we can make it a futures contract. That's the process we 
went through with the WTI contract. It went from a bilateral swap to a 
cleared OTC contract to a futures contract.
      And we're bringing other contracts through that conveyor belt 
process. In the first half of this year, we're bringing clearing to 50 
bilateral contracts that we already offered.
    ICE: ``The market has spoken,'' Futures & Options Week, April 24, 
2006. As previously discussed, quantitative data on the WTI contract 
traded on the ICE OTC electronic exchange is not readily available. 
According to former Federal Reserve Chairman Greenspan's recent 
testimony, during this period hedge funds and other institutional 
investors conducted a substantial amount of trading in crude oil in 
this market.
    \145\ CFTC data provided to the Subcommittee.
    \146\ Market Forces: Big Oil increases market reach, Energy 
Compass, March 24, 2006.
---------------------------------------------------------------------------
    ICE Futures has further expanded its reach into the U.S. 
energy commodities market. In addition to trading WTI crude oil 
futures on its London exchange, in April 2006, ICE Futures 
began trading futures in U.S. gasoline and home heating oil.

C. Implications for Oversight of U.S. Commodity Markets

    The trading of U.S. energy commodities on the ICE Futures 
exchange in London from terminals within the United States 
permits traders within the United States to trade U.S. energy 
commodities without any U.S. oversight or regulation. This type 
of unregulated trading of a U.S. commodity from within the 
United States undermines the very purpose of the Commodity 
Exchange Act and the central mission of the CFTC--to prevent 
manipulation or excessive speculation of commodity prices ``to 
the detriment of the producer or the consumer and the persons 
handling commodities.'' Without information about the trading 
of U.S. energy commodities, the CFTC cannot undertake, let 
alone accomplish, its mission.
    Furthermore, the trading of U.S. energy commodities on 
foreign or unregulated OTC exchanges without any reporting to 
the CFTC undermines the reporting system for commodities traded 
on CFTC-regulated exchanges. With respect to traders that trade 
on both exchanges, the CFTC will be provided only partial data 
regarding the extent of their trades, thereby affecting the 
accuracy of the data to the CFTC.
    For example, a trader wishing to disguise its position on 
the regulated market, or give the regulated market a false 
impression of its trading, could buy and sell an identical 
number of futures in different months; this would then be 
reported to the CFTC as a spread position. That same trader 
then could offset one of those positions, say, for example, the 
short position, on the unregulated exchange. In this example, 
the trader would have a net long position, but it would appear 
to the CFTC and the public, through the Commitment of Traders 
Report, as a spread position. Hence, both the CFTC and the 
public would have an inaccurate view of the composition of the 
market. Only the trader would know the correct position. It is 
not difficult to imagine other schemes to distort the CFTC's 
market data.
    For the CFTC to be able to carry out its fundamental 
mission to protect the integrity of the U.S. commodity futures 
markets, all U.S. traders of U.S. energy futures or futures-
like contracts must keep records and report large trades to the 
CFTC, regardless of where the trade takes place--on the NYMEX, 
an electronic exchange, or a foreign exchange. To continue the 
present situation, in which the CFTC does not police two of 
three major markets trading U.S. energy futures, is to turn a 
blind eye to an increasingly large segment of these markets, 
thereby impairing the ability to detect, prevent, and prosecute 
market manipulation and fraud. The United States needs to put 
the cop back on the beat in all of these key energy markets.


 
                                APPENDIX

                              ----------                              


MEASURING THE INCREASE IN SPECULATIVE TRADING

A. CFTC Commitment of Traders Report

    One of the few direct, quantitative measures of the 
increased trading activity by speculative money managers in 
energy futures trading is provided by the Commodity Futures 
Trading Commission (CFTC) weekly report on futures trading 
activity. The CFTC publishes, on a weekly basis, a ``Commitment 
of Traders'' (COT) Report, providing, for each commodity traded 
on a U.S. futures exchange, statistical information regarding 
the extent and nature of trading in that commodity in the 
previous week. Oil industry consultant and analyst Matthew R. 
Simmons characterizes the COT Report as, ``In the Land of the 
Blind, it is the `One-Eyed King.' '' 147 The report 
``tells who the players are,'' provides a ``snapshot of Tuesday 
market close,'' and can ``spot some long-term trends (after the 
fact).'' 148
---------------------------------------------------------------------------
    \147\ Matthew R. Simmons, Oil Prices, Volatility and Speculation, 
Presentation at the IEA/NYMEX Conference, New York, New York, November 
23, 2004.
    \148\ Id.
---------------------------------------------------------------------------
    For trades conducted on the regulated futures markets, the 
CFTC regulations require clearing houses and brokers to report, 
on a daily basis, futures positions on their books for traders 
that hold positions exceeding certain levels established by the 
CFTC (``reportable positions''). Traders holding futures 
positions are also required to file a report with the CFTC 
describing the nature of their business; the CFTC uses this 
data to classify each trader as ``commercial'' or ``non-
commercial.'' Commercial traders are those entities that use 
the commodity as part of their business, and hence use the 
futures markets for hedging; non-commercial traders are all 
other traders. The non-commercial category includes commodity 
pools, pension funds, hedge funds, and other types of managed 
money funds. Generally, non-commercial traders do not use the 
commodity in their normal course of business or purchase 
futures to hedge their exposure to changes in the price of 
those commodities; they are instead engaged in market 
speculation to profit from price changes.149
---------------------------------------------------------------------------
    \149\ In some cases, a hedge fund or other type of managed money 
fund may purchase futures for portfolio diversification to limit the 
fund's financial exposure to energy prices fluctuations.
---------------------------------------------------------------------------
    The COT Report provides, for each commodity: the total 
amount of open interest in that commodity, meaning the total of 
all futures and option contracts entered into and not yet 
offset by another transaction or delivery of the 
commodity.150 The COT Report also provides the 
number of outstanding short and long positions held by 
commercial and non-commercial traders, respectively; and the 
number of ``spreading'' positions held by non-commercial 
traders. Spreading includes each trader's reported long and 
short positions in the same commodity, to the extent they are 
balanced.151 The report also identifies the number 
of long and short non-reportable positions, which is derived 
from the total open interest and the data on the reportable 
positions. Generally, reportable positions represent from 70-90 
percent of the particular market.152 The COT Report 
also provides data on the percentage of open interest and 
various other positions held by the largest four and largest 
eight traders. This data provides a gauge on how much of the 
market is dominated by the largest traders.
---------------------------------------------------------------------------
    \150\ The CFTC defines ``open interest'' as ``the total of all 
futures and/or option contracts entered into and not yet offset by a 
transaction, by delivery, by exercise, etc.'' Open interest held or 
controlled by a trader is referred to as that trader's position. For 
the CFTC's Commitment of Traders Futures and Options Combined Report, 
the open interest in options is calculated by mathematically computing 
the futures-equivalent of the unexercised option contracts. CFTC 
Backgrounder, The Commitment of Traders Report, at CFTC website, at 
http://www.cftc.gov/opa/backgrouder/opacot596.htm.
    \151\ For example, a trader might purchase a contract in the near-
future, and, at the same time, sell a longer-term futures contract. 
This would be reported to the CFTC as a spread position. If the trader 
purchased two long futures contracts, and sold one short contract, it 
would be reported as one spread contract and one long contract.
    \152\ Haigh, Hranaiova and Overdahl, at pp. 3-4.
---------------------------------------------------------------------------

B. Increased Speculative Trading on the NYMEX

    The increase in trading in oil and natural gas futures and 
options by money managers and speculators is seen clearly in 
the trends in the CFTC trader data over the past several years. 
Figure A-1 shows the increasing amount of open interest in 
crude oil and natural gas contracts traded on the NYMEX since 
1998. 

[GRAPHIC] [TIFF OMITTED] T8640.007

   Figure A-1. The open interest in both crude oil and natural gas 
contracts has doubled since 2004. Data source: CFTC COT data.

    A breakdown of the crude oil and natural gas open interest 
by the various types of positions tracked by the CFTC shows how 
there has been a shift in the composition of trading on the 
NYMEX over the past couple of years. As Figure A-2 demonstrates 
for crude oil contracts, and Figure A-3 demonstrates for 
natural gas contracts, in the past few years there has been a 
significant increase in the amount of open interest held by 
non-commercial traders. In both markets, there has been a large 
increase in the amount of spreading--i.e. holding of both long 
and short positions that do not offset each other--by non-
commercial traders. In short, the amount of speculative trading 
in crude oil and natural contracts has increased significantly 
in the past 2 years. 

[GRAPHIC] [TIFF OMITTED] T8640.008

   Figure A-2. The amount of speculative trading in crude oil contracts 
has increased significantly in the past 2 years, as evidenced by the 
increase in the number of non-commercial spread positions. Data source: 
CFTC. 

[GRAPHIC] [TIFF OMITTED] T8640.009

   Figure A-3. The amount of speculative trading in natural gas 
contracts has increased significantly in the past 2 years, as evidenced 
by the increase in the number of non-commercial spread positions. Data 
source: CFTC.

    Table A-1 presents similar information in tabular format. 
Additionally, Table A-1 shows the increase in the number of 
non-commercial traders over this same period. Although the 
number of commercial traders holding short and long positions 
has not varied by more than about 20 percent during this 
period, the number of non-commercial traders holding spread 
positions has quadrupled, so that there are now more non-
commercial traders than commercial traders. 

[GRAPHIC] [TIFF OMITTED] T8640.011

   Table A-1. CFTC data shows a significant increase in the number of 
non-commercial traders and the percentage of open interest held by non-
commercial traders in the past few years. Data source: CFTC.

    Figure A-4 shows how the influx of investment into longer-
term futures has raised the prices of futures contracts above 
the price of the nearer-term futures contracts (``contango''). 
The relative increase in the price of longer-term futures 
contracts has provided a financial incentive for oil companies 
and refiners to purchase additional oil and put it into 
inventory.

[GRAPHIC] [TIFF OMITTED] T8640.010

   Figure A-4. In recent years longer-term futures prices have 
increased to levels higher than nearer-term futures contracts, 
providing a financial incentive to purchase and store oil. For years 
1999-2002, the dates reflect the forward curve as of December 1 of that 
year. For other years, the dates reflect the foward curve as of 
December 2, 2003, December 2, 2004, December 6, 2005, and April 1, 
2006. Data source: NYMEX.

C. Increased Speculative Trading on ICE

    Because there are no reporting requirements for OTC 
trading, there are no publicly available quantitative measures 
of the extent of speculative trading in the OTC markets. 
Industry participants are not required to file large trader 
reports and the CFTC does not have any data to compile 
Commitment of Trader Reports. What little information has been 
publicly disclosed, however, indicates there has been a 
substantial growth in speculative activity on the ICE OTC 
market.
    ICE financial statistics show a tripling in the amount of 
OTC commission fees it has received from a level of 
approximately $8 million in the fourth quarter of 2004 to 
approximately $24 million in the first quarter of 
2006.153 ICE reported an increase in the number of 
cleared Henry Hub natural gas contracts from 4,512,000 in 2003 
to 15,887,000 in 2004 and then to 42,760,000 in 
2005.154 In the first 3 months of 2006, ICE reported 
a trading volume of 44,906 million North American natural gas 
contracts as compared to a trading volume of 23,838 million gas 
contracts for the first 3 months of 2003.155
---------------------------------------------------------------------------
    \153\ ICE Form 10-Q, at p. 22.
    \154\ ICE Form 10-K, at p. 73.
    \155\ ICE Form 10-Q, at p. 22 (each contract representing one 
million BTUs).
---------------------------------------------------------------------------
    The ICE financial statistics indicate that a large part of 
this growth can be attributed to increased trading by hedge 
funds, managed money, and individual speculators. Table A-2 
provides the most recent breakdown provided by ICE of the 
composition of ICE participants.

                                                    Table A-2
                                              ICE OTC Participants
----------------------------------------------------------------------------------------------------------------
                                                                                    Year ended December 31,
            OTC Participants Trading  (as % of total commissions)            -----------------------------------
                                                                                 2003        2004        2005
----------------------------------------------------------------------------------------------------------------
Commercial companies (including merchant energy)                                    64.1        56.5        48.8
----------------------------------------------------------------------------------------------------------------
Banks and financial institutions                                                    31.3        22.4        20.5
----------------------------------------------------------------------------------------------------------------
Hedge funds, locals and proprietary trading shops \156\                              4.6        21.1        30.7
\156\ The term ``local'' refers to an individual who commits his or her own
 capital for speculative trading on an electronic exchange. A ``proprietary
 trader'' is a professional trader hired by a firm to trade that firm's
 money. See, e.g., Jim Kharouf, Prop Shops and Trading Schools Raise the
 Bar, Stocks, Futures & Options Magazine, January 2004.
----------------------------------------------------------------------------------------------------------------

      Table A-2. Hedge funds and other speculators have 
significantly increased their use of OTC electronic markets. 
Data source: ICE Form 10-K, at p. 73.
     

                                 
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