Futures Markets: Approach for Examining Oversight of Energy
Futures (04-MAY-06, GAO-06-742T).
Record high crude oil and natural gas prices have generated
significant concerns by the public and members of Congress that
the high and relatively volatile prices may be the result of
factors other than market forces. Several members of the House
and the Senate have expressed concerns over the upward trending
prices and factors that may be causing the perceived increases in
volatility of several energy commodities, including crude oil,
gasoline, natural gas, and heating oil. As a result, we initiated
this study under the authority of the Comptroller General. This
testimony focuses on our ongoing study of (1) changes in energy
futures markets and volatility since 2000 and (2) CFTC
surveillance and enforcement activities in the oversight of
energy futures trading.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-06-742T
ACCNO: A53340
TITLE: Futures Markets: Approach for Examining Oversight of
Energy Futures
DATE: 05/04/2006
SUBJECT: Commodity futures
Commodity marketing
Energy marketing
Financial futures
Fraud
Fuel prices
Independent regulatory commissions
Prices and pricing
Risk management
Government agency oversight
******************************************************************
** This file contains an ASCII representation of the text of a **
** GAO Product. **
** **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced. Tables are included, but **
** may not resemble those in the printed version. **
** **
** Please see the PDF (Portable Document Format) file, when **
** available, for a complete electronic file of the printed **
** document's contents. **
** **
******************************************************************
GAO-06-742T
* Background
* Changes in Energy Futures Markets and Volatility Since 2000
* CFTC Provides Oversight Through Surveillance and Enforcement
* Contact and Acknowledgements
* GAO's Mission
* Obtaining Copies of GAO Reports and Testimony
* Order by Mail or Phone
* To Report Fraud, Waste, and Abuse in Federal Programs
* Congressional Relations
* Public Affairs
Testimony
Before the Committee on Energy and Commerce, House of Representatives
United States Government Accountability Office
GAO
For Release on Delivery Expected at 10:00 a.m. EDT
Thursday, May 4, 2006
FUTURES MARKETS
Approach for Examining Oversight of Energy Futures
Statement of Orice M. Williams, Director Financial Markets and Community
Investment
GAO-06-742T
Mr. Chairman and Members of the Committee:
I am pleased to be here today to discuss the design of our ongoing study
of the Commodity Futures Trading Commission's (CFTC) oversight of futures
trading in energy commodities. As you are aware, record high crude oil and
natural gas prices have generated significant concerns by the public and
members of Congress that the high and relatively volatile prices may be
the result of factors other than market forces. Several members of the
House and the Senate have expressed concerns over the upward trending
prices and factors that may be causing the perceived increases in
volatility of several energy commodities, including crude oil, gasoline,
natural gas, and heating oil. As a result, we initiated this study under
the authority of the Comptroller General. My remarks today focus on our
ongoing study of (1) changes in energy futures markets and volatility
since 2000 and (2) CFTC surveillance and enforcement activities in the
oversight of energy futures trading.
This ongoing work will leverage results of our previous reviews of the
financial and physical energy markets, and trading data from the CFTC and
the New York Mercantile Exchange (NYMEX).1 It will also be based on
discussions and reviews of available information from officials and staff
from several federal agencies, refiners, vertically integrated oil
companies, associations representing end users of natural gas, investment
banks, and hedge funds, as well as market analysts and academics. We will
also be reviewing relevant CFTC enforcement cases and CFTC Inspector
General reports and incorporating their results in our work.
In summary:
Our ongoing study explores how energy futures markets and market
participants with different investment objectives affect futures and
commodity prices in a complex and rapidly evolving marketplace. Some of
these participants include producers and refiners, who use futures
contracts2 as a key tool to manage risk they face due to changes in
prices. Since 2000, there has also been an increase in the number of new
participants, such as hedge funds and investment banks. Our ongoing study
will evaluate what market studies and other market data indicate as to
whether energy futures prices have become more volatile. Specifically, we
are looking at different ways of measuring volatility and reviewing recent
studies on volatility by NYMEX, CFTC, Consumer Federation of America, and
others. We are also using NYMEX trading data to document trends in
volatility.
1See U.S. GAO, Energy Markets: Factors Contributing to Higher Gasoline
Prices, GAO-06-412T (Washington, D.C.: February 1, 2006); U.S. GAO, Motor
Fuels: Understanding the Factors That Influence the Retail Price of
Gasoline, GAO-05-525SP (Washington, D.C.: May 2005).
Our ongoing study also explores how CFTC's market surveillance program is
used to monitor and detect market abuses in the trading of energy futures.
We are also determining what fraudulent, manipulative, and abusive
practices have been identified by CFTC and others in the trading of energy
futures and how CFTC is positioned to protect market users from these
practices. CFTC's surveillance program is one tool used to oversee the
integrity of the futures market. CFTC uses its large trader reporting
system and other sources such as relevant self-regulatory organizations
(SRO) and other federal agencies to monitor for attempted manipulation in
the futures markets. In cases of suspected fraud, manipulation or abuse,
CFTC will undertake enforcement actions. As part of this study, we are
looking at CFTC's authority and its resources to protect market users.
Background
Futures contracts are traded on regulated exchanges and are settled daily
based on their current value in the marketplace. The key players in
futures markets are hedgers, speculators, and brokers. Hedgers use futures
to shift the risk of a price change onto other market participants such as
speculators. Speculators may assume the price risk that hedgers try to
avoid in the hope of making a profit. Although speculators usually have no
commercial interest in the commodities they trade, the desire to make a
profit motivates them to collect market information regarding the supply
and demand of commodities to anticipate the potential impact of this
information on prices. Finally, there are brokers, who make the trade.
2Futures are one type of derivatives contract. The market value of a
derivatives contract is derived from a reference rate, index, or the value
of an underlying asset, including stocks, bonds, commodities, interest
rates, foreign currency exchange rates, and indexes that reflect the
collective value of underlying financial products. The regulation of
derivatives generally varies depending on whether they are traded on
exchanges (exchange-traded) or traded over-the-counter (OTC) and on the
nature of the underlying asset, reference rate, or index. Futures obligate
the holder to buy or sell a specific amount or value of an underlying
asset, reference rate, or index at a specified price on a specified future
date and are often traded on exchanges.
Oversight of the futures market is the responsibility of CFTC, which was
created in 1974 as an independent agency responsible for encouraging
competitiveness and efficiency in futures markets, ensuring their
integrity, protecting market participants against manipulation, abusive
trading practices, and fraud, and ensuring the financial integrity of the
clearing process.3 Through its oversight, especially its surveillance and
enforcement programs, CFTC is responsible for enabling the futures markets
to provide a means for determining the price of commodities-price
discovery-and for offsetting price risk faced by market participants.
Oversight is also provided by NYMEX, an SRO, that is itself regulated by
the CFTC.
In the U.S. futures regulatory structure, SROs-the futures exchanges and
the National Futures Association-provide industry oversight. Futures SROs,
such as NYMEX, are responsible for establishing and enforcing rules
governing member conduct and trading; providing for the prevention of
market manipulation, including monitoring trading activity; ensuring that
futures industry professionals meet qualifications; and examining members
for financial strength and other regulatory purposes. Their operations are
funded by the futures industry through transaction fees and other charges.
CFTC oversees the SROs to ensure that each has an effective
self-regulatory program.
Changes in Energy Futures Markets and Volatility Since 2000
Since 2000, there has been an increase in the number of market
participants in the energy futures markets, such as hedge funds and
investment banks, raising questions about the impact they have had on the
market overall and volatility in particular. Futures contracts are also
seen as a key tool that producers and refiners use to manage the risks
they face due to changes in prices. Our work is designed to describe how
energy futures markets and market participants with different investment
objectives influence energy prices. To address this, we will provide an
overview of the energy futures markets and the role played by various
market participants. Further, we will discuss how the markets function to
provide price discovery, liquidity, and risk management. We will also
address markets other than NYMEX, such as the over-the-counter (OTC)
market, and how these markets differ from NYMEX. Finally, we will explore
NYMEX's role in providing price discovery for energy commodities and
futures prices and their link to spot or cash prices.
3According to CFTC, clearing is the procedure through which the clearing
organization becomes the buyer to each seller of a futures contract or
other derivative, and the seller to each buyer for clearing members.
As part of our work, we are also reviewing what market studies by CFTC,
NYMEX and others have found to affect volatility. Specifically, we are
determining how volatility is defined and identifying factors that impact
volatility. We will also address whether available evidence suggests that
new market participants are a factor causing volatility. In answering this
question we will analyze both CFTC and NYMEX trading data and studies that
have addressed the causes of volatility in the futures markets.
CFTC Provides Oversight Through Surveillance and Enforcement Activities of
Energy Futures Trading
CFTC provides oversight through surveillance and enforcement of energy
futures trading and our ongoing work involves assessing how CFTC's market
surveillance program is used to monitor and detect market abuses in the
trading of energy futures. To address these issues we are evaluating both
CFTC and NYMEX surveillance programs, with a focus on how CFTC uses its
large trader reporting system data as part of its surveillance. This work
will describe how CFTC commissioners are kept informed of surveillance and
other market concerns. We will also describe how both CFTC and NYMEX
surveillance programs provide oversight and how NYMEX monitors positions
against specific limits to detect attempted abuses. This work will also
document efforts of other agencies, including the Department of Justice,
the Federal Trade Commission, and the Federal Energy Regulatory Commission
in providing oversight to energy market activities.
We are also focusing on what fraudulent, manipulative, and abusive
practices have been identified by CFTC and others in the trading of energy
futures. We will provide information on the enforcement programs of CFTC
and NYMEX, including the results of recent enforcement actions taken by
CFTC and NYMEX and the settlements reached involving these enforcement
actions. We are also addressing the extent to which CFTC uses internal and
external sources in developing enforcement cases. This includes discussing
NYMEX's enforcement activities and how NYMEX coordinates these activities
with CFTC.
Finally, we are exploring how CFTC is positioned to protect market users
and the public from actual and potential abuses in the trading of energy
futures. Areas we are focusing on include changes in CFTC's regulatory
approach since the Commodity Futures Modernization Act of 2000 and staff
resources available to accomplish its mission including the allocation of
staff. Our current timeframe from completing this work is September 2006.
Mr. Chairman, this completes my prepared statement. I would be pleased to
answer any questions that you or Members of the Committee may have.
Contact and Acknowledgements
For further information about this testimony, please contact Orice
Williams on (202) 512-8678 or [email protected] . Contact points for our
Offices of Congressional Relations and Public Affairs may be found on the
last page of this statement. Individuals making key contributions to this
testimony include John Wanska (Assistant Director), Kevin Averyt, and John
Forrester.
(250299)
This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
work may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this material
separately.
GAO's Mission
The Government Accountability Office, the audit, evaluation and
investigative arm of Congress, exists to support Congress in meeting its
constitutional responsibilities and to help improve the performance and
accountability of the federal government for the American people. GAO
examines the use of public funds; evaluates federal programs and policies;
and provides analyses, recommendations, and other assistance to help
Congress make informed oversight, policy, and funding decisions. GAO's
commitment to good government is reflected in its core values of
accountability, integrity, and reliability.
Obtaining Copies of GAO Reports and Testimony
The fastest and easiest way to obtain copies of GAO documents at no cost
is through GAO's Web site ( www.gao.gov ). Each weekday, GAO posts newly
released reports, testimony, and correspondence on its Web site. To have
GAO e-mail you a list of newly posted products every afternoon, go to
www.gao.gov and select "Subscribe to Updates."
Order by Mail or Phone
The first copy of each printed report is free. Additional copies are $2
each. A check or money order should be made out to the Superintendent of
Documents. GAO also accepts VISA and Mastercard. Orders for 100 or more
copies mailed to a single address are discounted 25 percent. Orders should
be sent to:
U.S. Government Accountability Office 441 G Street NW, Room LM Washington,
D.C. 20548
To order by Phone: Voice: (202) 512-6000 TDD: (202) 512-2537 Fax: (202)
512-6061
To Report Fraud, Waste, and Abuse in Federal Programs
Contact:
Web site: www.gao.gov/fraudnet/fraudnet.htm E-mail: [email protected]
Automated answering system: (800) 424-5454 or (202) 512-7470
Congressional Relations
Gloria Jarmon, Managing Director, [email protected] (202) 512-4400 U.S.
Government Accountability Office, 441 G Street NW, Room 7125 Washington,
D.C. 20548
Public Affairs
Paul Anderson, Managing Director, [email protected] (202) 512-4800 U.S.
Government Accountability Office, 441 G Street NW, Room 7149 Washington,
D.C. 20548
*** End of document. ***