Sewing the Energy Loopholes Shut in Wall St and Congress
- From: "leonard78sp@xxxxxxxxx" <leonard78sp@xxxxxxxxx>
- Date: Mon, 2 Jun 2008 10:20:56 -0700 (PDT)
It seems like Congress intends to issue
price controls and rationing
Sewing the Energy Loopholes Shut
NYTimes Dealbook
With gasoline prices bubbling up toward a once-unthinkable $5 a
gallon, lawmakers in Washington are running franticly to do something
- anything - to halt the steep rise in the price of oil.
Congressional leaders are focusing their attention on speculation in
the energy markets by index funds, investment banks and hedge funds,
which they believe are behind the recent spike in the oil price. They
say that Wall Street has been exploiting many “loopholes” created in
the past few years by legislation aimed at liberalizing the futures
markets. They argue that this has basically turned the commodity
market into a virtual casino where the American consumer always loses.
If successful, the new limits on trading could shut down a profit
center that many on Wall Street have come to depend on. But some
traders argue that it could just shift the profit-making machine from
exchanges and hedge funds to the investment banks and prime brokers,
as the laws would force trading underground. But if it kills
investors’ appetite for commodity investing, Wall Street could lose
big.
Lots of Loopholes
Lawmakers apparently love to label things “loopholes.” There is the
Enron loophole, the London loophole, the “swap loophole” and many
others, which they argue have helped fuel the rise in speculation in
commodities. After years of criticism, two — the Enron and London
loopholes — were shut this month.
The Enron loophole was named after the infamous Texas energy giant.
Back in 2000, the company along with many Wall Street banks lobbied to
loosen federal oversight on the over-the-counter energy market. The
move, some lawmakers say, allowed traders to make big bets on the over-
the-counter market, which was then used to manipulate the visible
futures market. Sen. Carl Levin of Michigan had been lobbying to close
the Enron loophole for ages and finally got his wish when he slipped
legislation into the farm bill.
The London loophole, which allowed traders to do business on the
IntercontinentalExchange in London, out of sight of United States
regulators, was shut Thursday. This provision kept trading data of
United States energy contracts in London from being reported to the
United States energy trading regulator, the Commodities Futures
Trading Commission. Now British regulators have agreed to hand over
daily trading data for all United States oil contracts traded in
London via the ICE. The Commodities Futures Trading Commission will
also get daily alerts if any trader exceeds the speculation limits
that apply to oil contracts traded in New York.
So what will this do to halt the rise in oil prices? Several traders
told DealBook that it will actually do very little. It will be a
preventive measure to halt any one trader from building up positions
on one exchange to influence the other exchange. Aides to lawmakers
acknowledged that this will do little to halt the rise in oil prices,
but it is a stop-gap measure that will put “traders on notice” that
they are now being watched.
Going further
Closing the loopholes appears to be the first step in Washington’s
effort to curb speculation. But some politicians want to go a lot
further — prompting some hedge funds and commodities exchanges to cry
foul.
Harry Reid, the Senate majority leader, has cobbled suggestions from
various Democrats and stuffed them into a bill called the Consumer-
First Energy Act of 2008. One part of the act targets “market
speculators” and aims to reduce their ability to gamble on the energy
markets by upping the amount of margin - or collateral - they put up
with the exchanges to make bets.
The exchanges currently require market players to put up just enough
money to cover a one-day movement in the value of a commodity
contract, which works out to around 5 to 7 percent of the commodity’s
value. That contrasts to the government mandated minimum of 50 percent
for stocks, which was set after the Great Depression.
The legislation to increase margins is being championed by Senator
Byron Dorgan of North Dakota. “There is an orgy of speculation in the
oil futures market,” Mr. Dorgan said in a statement last week.
“Speculators are using money they don’t have to control oil they’ll
never use. This may help the speculators’ profits, but it hurts
American drivers and our economy because it keeps oil prices
artificially high.”
The legislation would require the C.F.T.C. to “substantially” increase
the margin requirement on energy futures. But the C.F.T.C. currently
does not have the right to set margin limits on futures exchanges, so
it is unclear how they could raise them without being granted new,
sweeping powers.
Either way, the change would be a massive blow to the two big
commodities exchanges that trade energy futures, the New York
Mercantile Exchange, or Nymex, in New York and ICE in London. Both
have made buckets of money in the past few years from the explosion in
energy trading. By forcing hedge funds and other market speculators to
put up more money to trade on the exchange, they will be less likely
to bet on the price of oil, because they won’t be able to lever up by
massive amounts.
Not so fast, an energy trader at a major hedge fund told DealBook,
asking not to be named. This trader said that the increase in margins
will not kill speculation, but rather the exchanges’ business. The
Wall Street banks will actually become the big winner, he believes, as
they will get a massive uptick in business from speculators, who will
use the banks’ prime brokerage units to lend them money to make
leveraged bets.
The trader went on to say that when a large fund wants to bet big on a
stock, it can put down a far smaller margin than the government-
mandated 50 percent by going through a prime broker. The prime broker
will put up the rest of the funds to the exchange and charge the hedge
fund a fat fee.
But banks may not be willing to lend money out in massive quantities
to cover leveraged commodity bets. New risk controls being put in
place across the sector after the subprime debacle could limit prime
brokerages from extending too much credit to hedge funds and other
speculators.
Wall Street banks’ internal trading units, which have made a great
deal of money trading energy, will also be limited from making the
large bets that they have become accustomed to. This could cancel out
any benefits the banks would receive from the increased prime broker
business.
All the major investment banks trade energy products, but it is
difficult to ascertain exactly how much they make — most bury the
results in their financial statements. Citigroup is one that doesn’t.
It made $686 million last year from its commodities trading principal
operations. (The firm says comprises mostly results from Phibro, which
trades “crude oil, refined oil products, natural gas, and other
commodities.”)
Other investment banks like Morgan Stanley and Goldman Sachs are said
to be even bigger players. With the investment banks still reeling
from the subprime mortgage mess, any loss in income at this point
could be catastrophic.
What’s ahead
Last week, the Senate Homeland Security and Government Affairs
Committee, chaired by Sen. Joseph I. Lieberman of Connecticut, held an
inquiry to look into how institutional investors like public pension
funds have been adding to the oil price explosion.
These “passive investors” have been throwing money at commodity
indexes like the S&P-GSCI, sending itsky high. Michael Masters, a
hedge fund manager, told the Senate panel (PDF) that investment in
indexes based on commodity futures has risen from $13 billion five
years ago to $260 billion today. About $40 billion alone was added to
the market in the past quarter.
Mr. Masters went on to explain the effects:
When an institutional investor decides to allocate 2% to
commodities futures, for example, they come to the market with a set
amount of money. They are not concerned with the price per unit; they
will buy as many futures contracts as they need, at whatever price is
necessary, until all of their money has been ‘put to work.’ Their
insensitivity to price multiplies their impact on commodity markets.
Since institutional investors are long-only funds, any investment they
make in commodities will be for a higher price. This explosion in the
amount of money going into the market has surely had an effect on
price; still, as one trader pointed out to DealBook, it is only half
the market value of Exxon Mobil.
But the billions that institutional investors have poured into these
index funds managed by Wall Street banks could disappear. Mr.
Lieberman is in the “early early” stages of creating a bill that would
bar institutional investors in investing in commodities, a person
close to the senator told DealBook. The bill would seek to amend the
ERISA Act, making investments by institutional investors in the
commodities market taxable.
Pension funds like Calpers, the massive California public employees
fund, have diverted increasingly more of their capital into the
commodity space as other markets have done poorly amid the credit
crunch. Calpers invested $450 million in commodities last year, its
first foray into that space. In a board meeting in February, the
pension fund agreed to invest .05 to 3 percent of its $240 billion
fund in commodities by 2010.
If institutional investors, like Calpers, are forced to divest its
commodity positions, the market could go into a tailspin, crushing the
positions of many of the banks that hold long positions. One of the
investment banks’ more profitable businesses these days could be
turned on its head.
The bull run in commodities has been influenced by many factors, but
Congress believes that Wall Street bears the blame for a large part of
it. With gasoline prices on the rise and the election looming, they
appear to have full power to not only close the oil casino, but burn
it to the ground.
.
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