Paris, 12 August 009 

The increased volatility in oil prices over recent years has been blamed in part for the financial meltdown and general economic downturn. Speculative activity has been seen as a key reason behind unpredictable prices for consumers and the unstable investment environment for oil producers and international oil companies, and this has prompted a response by regulators and politicians: IEA

President Obama’s tenure began with promises to tighten financial regulation. The aim is now to establish government oversight for the over-the‐ counter (OTC) derivatives market and set position limits for commodity traders. The legislation, if enacted, would amend the Commodity Exchange Act, and nullify the controversial Commodity Futures Modernization Act of 2000, which, arguably, created the so‐called ‘Enron loophole’ in futures markets. The enthusiasm for regulation is no less elsewhere in the world. Calls for a more structured dialogue between producers and consumers to establish ‘a reasonable price range’ are coming from some G8 leaders and OPEC representatives alike. Current regulatory sentiment is said to show a willingness to err on the side of too much regulation rather than too little. Many market participants fear that there is a danger politicians will enact measures which ‘over‐regulate’, bringing in restrictions possibly harmful to the functioning of the market.

The US regulator the Commodity Futures Trading Commission (CFTC) is tasked with ensuring markets that are transparent and free from fraud, manipulation and other abuses. However, studies performed by the CFTC itself, the UK’s Financial Services Authority (FSA) and the International Monetary Fund (IMF) have so far been unable to prove any systematic connection between ‘financialisation’ of commodities – financial flows into commodity markets – and price volatility. Despite convergence in recent months between moves in the NYMEX WTI price and the movements of non commercials net positions in NYMEX WTI futures, over a longer time span, the correlation is not significant, nor is the relationship between total open interest of non commercials and the oil price.

More data gathering and further investigation of the linkages between OTC trading, index trading and price formation in oil markets has been recommended. The CFTC is expected to shortly release a new review re‐examining the role of speculation in driving prices. The US Federal Trade Commission (FTC) will also tighten anti price‐manipulation legislation, and has said it would fine traders and companies up to $1 million a day if they manipulate oil markets.

In recent weeks the CFTC held hearings to receive views on the proposed regulatory changes from various stake‐holders. The concept of position limits for energy commodities trading does appear to have been accepted by exchanges and traders, although it remains to be seen how broad or deep they may be. The fears from the energy industry have been that a great deal of liquidity could be lost from the US market, possibly increasing volatility instead of reducing it. Hedging is used to manage risk and to ensure project financing. Energy companies worry that the emphasis on standardised OTC contracts will drive up hedging costs, tie up much‐needed cash and eliminate the traditional practice of pledging assets in collateral.

However, proponents counter that, through careful regulatory design, it should be possible to authorise the use of non‐cash collateral to satisfy margin requirements and allow for the continued use of customised contracts, if a contract is not sufficiently standardised to be cleared or if one party does not qualify as a major market participant. CFTC Chairman Gary Gensler has made the, not universally accepted, point that position limits could aid liquidity by making participation less concentrated and more diversified.

For its part, the UK FSA held a private meeting on Wednesday 29th July with around 30 oil industry participants in London to discuss market transparency and regulation. No statement was issued from the meeting, but the FSA is thought to be much more reluctant to set position limits. Energy markets in the US and the UK are inextricably linked through lookalike contracts and arbitrage. They have an information sharing agreement and claim to work under equivalent regulatory conditions. Concerns have been expressed that a lack of uniformity in regulatory extent and coverage could merely see trade migrate.

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International Energy Agency