February 3, 2009

**U.S. House Committee on Agriculture**

**Protecting Families From Another Energy Price Shock: Restoring
Transparency and Regulation to Futures Markets To Keep The Speculators
Honest**

**Tyson Slocum, Director**

**Public Citizen's Energy Program**

Thank you, Mr. Chairman and members of Committee on Agriculture for the
opportunity to testify on the issue of energy futures regulation. My
name is Tyson Slocum and I am Director of Public Citizen's Energy
Program. Public Citizen is a 38-year old public interest organization
with over 100,000 members nationwide. We represent the needs of
households by promoting affordable, reliable and clean energy.

The extraordinary volatility in energy prices, particularly crude
oil---which soared from \$27/barrel in September 2003 to a high of
\$147/barrel in July 2008 before plummeting to its current price of
\$40/barrel---wreaked havoc with the economy while making speculators
rich. The spectacular 75% decline in oil prices in just five months
cannot be explained purely by supply and demand; rather, a speculative
bubble burst, triggered by the Wall Street financial crisis. Strapped of
their credit that had been fueling their highly leveraged trading
operations, the credit crisis ended the speculators' ability to continue
driving up prices far beyond the supply demand fundamentals. This
speculation was made possible by legislative and regulatory actions that
deregulated these energy futures markets. Although energy prices are no
longer at record highs, it must be assumed that it is a matter of when,
not if, a return to high prices will occur. Absent reregulation of the
energy futures markets, aggressive government efforts to restore
liquidity and unfreeze the credit markets will give new life to the Wall
Street financial speculators, ushering a return to an energy commodity
speculative bubble.

Restoring transparency to futures markets is all the more urgent given
the wave of consolidation that has occurred among the financial firms
that were leading the speculative frenzy. Several major energy trading
firms merged their operations in response the credit crisis:

-   In 2007, ABN Amro was purchased by the Dutch national government,
    the Royal Bank of Scotland and Spain's Banco Santander.

-   In April 2008, JP Morgan Chase acquired Bear Stearns and its trading
    operations.

-   In September 2008, Bank of America acquired Merrill Lynch

-   In October 2008, Wells Fargo and Wachovia agreed to merge

-   Électricité de France arranged to purchase all of Lehman Bros.
    energy trading operations in October 2008.

-   Wells Fargo agreed to buy Wachovia in October 2008.

-   In January 2009, UBS sold its energy trading operations to Barclays.

Congress can take two broad actions to provide relief: providing
incentives to households to give them better access to alternatives to
our dependence on oil, and restoring transparency to the futures markets
where energy prices are set. The former option is of course an effective
long-term investment, as providing incentives to help families afford
the purchase of super fuel efficient hybrid or alternative fuel
vehicles, solar panel installation, energy efficient improvements to the
home and greater access to mass transit would all empower households to
avoid the brunt of high energy prices.

The second option---restoring transparency to the futures markets where
energy prices are actually set---is equally important. Stronger
regulations over energy trading markets would reduce the level of
speculation and limit the ability of commodity traders to engage in
anti-competitive behavior that is contributing the record high prices
Americans face. And as Congress considers market-based climate change
legislation that would create a pollution futures trading market, the
priority of establishing strong regulatory oversight over all energy-
and pollution-related futures trading is the only way to effectively
combat climate change, in order to ensure price transparency.

Of course, supply and demand played a role in the recent rise and
decline in oil prices. Gasoline demand in America is down, with
Americans driving 112 *billion* less miles from November 2007 to
November 2008,[^1] and global demand---even in emerging economies like
China, India and oil exporting nations in the Middle East---has
slackened in response to the global economic downturn, thereby
offsetting the fact that mature, productive and easily-accessible oil
fields are in decline. Claims of Saudi spare capacity are questioned due
to the Kingdom's refusal to allow independent verification of the
country's oil reserve claims. Simply put, oil is a finite resource with
which the world - until recently - has embarked on unprecedented
increased demand.

But there is no question that speculators and unregulated energy traders
have pushed prices beyond the supply-demand fundamentals and into an era
of a speculative bubble in oil markets. While some speculation plays a
legitimate function for hedging and providing liquidity to the market,
the exponential rise in market participants who have no physical
delivery commitments has skyrocketed, from 37 percent of the open
interest on the NYMEX West Texas Intermediate (WTI) contract in January
2000 to 71 percent in April 2008.[^2]

Rather than demonize speculation generally, the goal is to address
problems associated with recent Congressional and regulatory actions
that deregulated energy trading markets that has opened the door to
these harmful levels of speculation. Removing regulations has opened the
door too wide for speculators and powerful financial interests to engage
in anti-competitive or harmful speculative behavior that results in
prices being higher than they would otherwise be. When oil was at
\$145/barrel, many estimated that at least \$30 of that price was pure
speculation, unrelated to supply and demand.

While the Commodity Futures Trading Commission (CFTC) and Congress have
taken recent small steps in the right direction, more must be done to
protect consumers. While the CFTC has been disparaged by consumer
advocates as being too deferential to energy traders, it has responded
to recent criticism by ordering the United Kingdom to set limits on
speculative trading of WTI contracts, proposing stronger disclosure for
index traders and swap dealers, spearheading an interagency task force
to more closely monitor energy markets and strengthening disclosure
requirements in its amended Dubai Mercantile Exchange no-action letter.
But these actions are hardly enough to rein in the harmful levels of
speculation and anti-competitive behavior that are causing energy prices
to rise. A new CFTC chairman presents important opportunities for the
agency to take a more assertive role in policing these markets.

Recent Congressional action, too, has been beneficial to consumers, but
the legislation has not gone nearly far enough. Title XIII of H.R. 6124
(the "Farm Bill") that became law in June 2008, closed some elements of
the so-called "Enron Loophole," which provided broad exemptions from
oversight for electronic exchanges like ICE. But the Farm Bill only
provides limited protections from market manipulation, as it allows the
CFTC, "at its discretion,\" to decide on a contract-by-contract basis
that an individual energy contract should be regulated only if the CFTC
can prove that the contract will "serve a significant price discovery
function" in order to stop anti-competitive behavior.

In December 2007, H.R. 6 was signed into law. Sections 811 through 815
of that act

empower the Federal Trade Commission to develop rules to crack down on
petroleum

market manipulation.[^3] If these rules are promulgated effectively,
this could prove to be

an important first step in addressing certain anti-competitive practices
in the industry.

Public Citizen recommends four broad reforms to rein in speculators and
help ensure that energy traders do not engage in anti-competitive
behavior:

-   Subject Over-the Counter (OTC) trading to the same transparency and
    regulatory requirements to which regulated exchanges, such as NYMEX,
    must adhere, including the submission of Large Trader Reports which
    disclose key information of a trader's activities. Requiring
    investment banks, hedge funds and other market participants to
    provide more information to the government will provide regulators
    and policymakers with the data necessary to quickly determine the
    exact cause of price swings.

-   Raise margin requirements so market participants will have to put up
    more of their own capital in order to trade energy contracts, and
    impose aggregate position limits on non-commercial trading to reduce
    speculation. Currently, margin requirements are too low, which
    encourages speculators to more easily enter the market by borrowing,
    or leveraging, against their positions. And aggregated limits over
    all markets---not just select ones---would preclude an energy trader
    from dipping their hands in multiple futures market cookie jars with
    the intent to speculate.

-   Require foreign-based exchanges that trade U.S. energy products to
    be subjected to full U.S. regulatory oversight.

-   Impose legally-binding firewalls to limit energy traders from
    speculating on information gleaned from the company's energy
    infrastructure affiliates or other such insider information, while
    at the same time allowing legitimate hedging operations***.***
    Congress must authorize the FTC and DOJ to place greater emphasis on
    evaluating anti-competitive practices that arise out of the nexus
    between control over hard assets like energy infrastructure and a
    firm's energy trading operations.

Legislation introduced by U.S. Representative Collin C. Peterson, "The
Derivatives Markets Transparency and Accountability Act of 2009,"[^4]
does a great job addressing most of Public Citizen's recommendations.
There are two areas, however, upon which the legislation could be
improved. First, the bill should immediately subject OTC markets to the
same regulatory oversight to which regulated exchanges like NYMEX must
adhere. Second, the legislation should impose aggregate speculation
limits over all markets to limit the ability of traders to engage in
harmful speculation.

**Energy Trading Abuses Require Stronger Oversight**

***Background***

Two regulatory lapses are enabling anti-competitive practices in energy
trading markets where prices of energy are set. First, oil companies,
investment banks and hedge funds are exploiting recently deregulated
energy trading markets to manipulate energy prices. Second, energy
traders are speculating on information gleaned from their own company's
energy infrastructure affiliates, a type of legal "insider trading."
These regulatory loopholes were born of inappropriate contacts between
public officials and powerful energy companies and have resulted in more
volatile and higher prices for consumers.

Contrary to some public opinion, oil prices are not set by the
Organization of Petroleum Exporting Countries (OPEC); rather, they are
determined by the actions of energy traders in markets. Historically,
most crude oil has been purchased through either fixed-term contracts or
on the "spot" market. There have been long-standing futures markets for
crude oil, led by the New York Mercantile Exchange and London's
International Petroleum Exchange (which was acquired in 2001 by an
Atlanta-based unregulated electronic exchange, ICE). NYMEX is a floor
exchange regulated by the U.S Commodity Futures Trading Commission
(CFTC). The futures market has historically served to hedge risks
against price volatility and for price discovery. Only a tiny fraction
of futures trades result in the physical delivery of crude oil.

The CFTC enforces the Commodity Exchange Act, which gives the Commission
authority to investigate and prosecute market manipulation.[^5] But
after a series of deregulation moves by the CFTC and Congress, the
futures markets have been increasingly driven by the unregulated
over-the-counter (OTC) market over the last few years. These OTC and
electronic markets (like ICE) have been serving more as pure speculative
markets, rather than traditional volatility hedging or price discovery.
And, importantly, this new speculative activity is occurring outside the
regulatory jurisdiction of the CFTC.

Energy trading markets were deregulated in two steps. First, in response
to a petition by nine energy and financial companies, led by Enron[^6],
on November 16, 1992, then-CFTC Chairwoman Wendy Gramm supported a rule
change---later known as Rule 35---exempting certain energy trading
contracts from the requirement that they be traded on a regulated
exchange like NYMEX, thereby allowing companies like Enron and Goldman
Sachs to begin trading energy futures between themselves outside
regulated exchanges. Importantly, the new rule also exempted energy
contracts from the anti-fraud provisions of the Commodity Exchange
Act.[^7] At the same time, Gramm initiated a proposed order granting a
similar exemption to large commercial participants in various energy
contracts that was later approved in April 2003.[^8]

Enron had close ties to Wendy Gramm's husband, then-Texas Senator Phil
Gramm. Of the nine companies writing letters of support for the rule
change, Enron made by far the largest contributions to Phil Gramm's
campaign fund at that time, giving \$34,100.[^9]

Wendy Gramm's decision was controversial. Then- chairman of a House
Agriculture subcommittee with jurisdiction over the CFTC, Rep. Glen
English, protested that Wendy Gramm's action prevented the CFTC from
intervening in basic energy futures contracts disputes, even in cases of
fraud, noting that that "in my 18 years in Congress \[Gramm's motion to
deregulate\] is the most irresponsible decision I have come across."
Sheila Bair, the CFTC commissioner casting the lone dissenting vote,
argued that deregulation of energy futures contracts "sets a dangerous
precedent."[^10] A U.S. General Accounting Office report issued a year
later urged Congress to increase regulatory oversight over derivative
contracts,[^11] and a congressional inquiry found that CFTC staff
analysts and economists believed Gramm's hasty move prevented adequate
policy review.[^12]

Five weeks after pushing through the "Enron loophole," Wendy Gramm was
asked by Kenneth Lay to serve on Enron's Board of Directors. When asked
to comment about Gramm's nearly immediate retention by Enron, Lay called
it "convoluted" to question the propriety of naming her to the
board.[^13]

Congress followed Wendy Gramm's lead in deregulating energy trading
*contracts* and moved to deregulate energy trading *exchanges* by
exempting electronic exchanges, like those quickly set up by Enron, from
regulatory oversight (as opposed to a traditional trading floor like
NYMEX that remained regulated). Congress took this action during
last-minute legislative maneuvering on behalf of Enron by former Texas
GOP Senator Phil Gramm in the lame-duck Congress two days after the
Supreme Court ruled in *Bush v Gore*, buried in 712 pages of unrelated
legislation.[^14] As Public Citizen pointed out back in 2001,[^15] this
law deregulated OTC derivatives energy trading by "exempting" them from
the Commodity Exchange Act, removing anti-fraud and anti-manipulation
regulation over these derivatives markets and exempting "electronic"
exchanges from CFTC regulatory oversight.

This deregulation law was passed against the explicit recommendations of
a multi-agency review of derivatives markets. The November 1999 release
of a report by the President's Working Group on Financial Markets---a
multi-agency policy group with permanent standing composed at the time
of Lawrence Summers, Secretary of the Treasury; Alan Greenspan, Chairman
of the Federal Reserve; Arthur Levitt, Chairman of the Securities and
Exchange Commission; and William Rainer, Chairman of the
CFTC---concluded that energy trading must not be deregulated. The Group
reasoned that "due to the characteristics of markets for nonfinancial
commodities with finite supplies ... the Working Group is unanimously
recommending that the \[regulatory\] exclusion not be extended to
agreements involving such commodities."[^16] In its 1999 lobbying
disclosure form, Enron indicated that the "President's Working Group"
was among its lobbying targets.[^17]

As a result of the Commodity Futures Modernization Act, trading in
lightly-regulated exchanges like NYMEX is declining as more capital
flees to the unregulated OTC markets and electronic exchanges such as
those run by the IntercontinentalExchange (ICE). Trading on the ICE has
skyrocketed, with the 138 million contracts traded in 2007 representing
a 230 percent increase from 2005.[^18] This explosion in unregulated and
under regulated trading volume means that more trading is done behind
closed doors out of reach of federal regulators, increasing the chances
of oil companies and financial firms to engage in anti-competitive
practices. The founding members of ICE include Goldman Sachs, BP, Shell
and TotalfinaElf. In November 2005, ICE became a publicly traded
corporation.

***The Players***

Goldman Sachs' trading unit, J. Aron, is one of the largest and most
powerful energy traders in the United States, and commodities trading
represents a significant source of revenue for the company. Goldman
Sachs' most recent 10-k filed with the U.S. Securities and Exchange
Commission show that Fixed Income, Currency and Commodities (which
includes energy trading) generated 17 percent of Goldman's \$22 billion
in revenue for 2008.[^19] That share, however, masks the role that
energy trading plays in Goldman's revenue as the company lumps
underperforming activities such as securitized mortgage debt, thereby
dragging down revenues for the entire segment. Indeed, Goldman touted
the performance of its commodity trading activities in 2008, noting that
it "produced particularly strong results and net revenues were higher
compared with 2007."

In 2005, Goldman Sachs and Morgan Stanley---the two companies are widely
regarded as the largest energy traders in America---each reportedly
earned about \$1.5 billion in net revenue from energy trading. One of
Goldman's star energy traders, John Bertuzzi, made as much as \$20
million in 2005.[^20]

In the summer of 2006, Goldman Sachs, which at the time operated the
largest commodity index, GSCI, announced it was radically changing the
index's weighting of gasoline futures, selling about \$6 billion worth.
As a direct result of this weighting change, Goldman Sachs unilaterally
caused gasoline futures prices to fall nearly 10 percent.[^21]

Morgan Stanley held \$18.7 billion in assets in commodity forwards,
options and swaps at November 30, 2008. As the company noted in its
annual report: "Fiscal 2008 results reflected . . . record revenues from
commodities . . . . . . Commodity revenues increased 62%, primarily due
to higher revenues from oil liquids and electricity and natural gas
products."

A deregulation action by the Federal Reserve in 2003---at the request of
Citigroup and UBS---allows commercial banks to engage in energy
commodity trading.[^22] Since then commercial banks have become big
players in the speculation market. The total value of commodity
derivative contracts held by the Citigroup's Phibro trading division
increased 384 percent from 2004 through 2008, rising from \$44.4 billion
to \$214.5 billion.[^23] Bank of America held \$58.6 billion worth of
commodity derivatives contracts as of September 2008.[^24] Merrill
Lynch, which BoA acquired in September 2008, experienced "strong net
revenues for the \[third\] quarter \[2008\] generated from our . . .
commodities businesses."[^25]

Just a year after Enron's collapse, the Commodity Futures Trading
Commission finalized rules allowing hedge funds to engage in energy
trading without registering with the CFTC, opening the door to firms
like Citadel and D.E. Shaw.[^26]

***The Consequences of Deregulation***

A recent bipartisan U.S. Senate investigation summed up the negative
impacts on oil prices with this shift towards unregulated energy trading
speculation:

> *Over the last few years, large financial institutions, hedge funds,
> pension funds, and other investment funds have been pouring billions
> of dollars into the energy commodity markets---perhaps as much as \$60
> billion in the [regulated]{.underline} U.S. oil futures market
> alone...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...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...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...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...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 oversights. 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.* [^27]

Thanks to the Commodity Futures Modernization Act, participants in these
newly-deregulated energy trading markets are not required to file
so-called Large Trader Reports, the records of all trades that NYMEX
traders are required to report to the CFTC, along with daily price and
volume information. These Large Trader Reports, together with the price
and volume data, are the primary tools of the CFTC's regulatory regime:
"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."[^28] So the deregulation of OTC
markets, by allowing traders to escape such basic information reporting,
leave federal regulators with no tools to routinely determine whether
market manipulation is occurring in energy trading markets.

One result of the lack of transparency is the fact that even some
traders don't know what's going on. A recent article described how:

> *Oil markets were rocked by a massive, almost instant surge in
> after-hours electronic trading one day last month, when prices for
> closely watched futures contracts jumped 8%...this spike stands out
> because it was unclear at the time what drove it. Two weeks later, it
> is still unclear. What is clear is that a rapid shift in the bulk of
> crude trading from the raucous trading floor of the New York
> Mercantile Exchange to anonymous computer screens is making it harder
> to nail down the cause of price moves...The initial jump "triggered
> more orders already set into the system, and with prices rising,
> people thought somebody must know something," Tom Bentz, an analyst
> and broker at BNP Paribas Futures in New York who was watching the
> screen at the time, said the day after the spike. "The more prices
> rose, the more it seemed somebody knew something."*[^29]

Oil companies, investment banks and hedge funds are exploiting the lack
of government oversight to price-gouge consumers and make billions of
dollars in profits. These energy traders boast how they're price-gouging
Americans, as a recent *Dow Jones* article makes clear: energy "traders
who profited enormously on the supply crunch following Hurricane Katrina
cashed out of the market ahead of the long weekend. 'There are traders
who made so much money this week, they won't have to punch another
ticket for the rest of this year,' said Addison Armstrong, manager of
exchange-traded markets for TFS Energy Futures."[^30]

The ability of federal regulators to investigate market manipulation
allegations even on the lightly-regulated exchanges like NYMEX is
difficult, let alone the unregulated OTC market. For example, as of
August 2006, the Department of Justice is still investigating
allegations of gasoline futures manipulation that occurred *on a single
day in 2002*.[^31] If it takes the DOJ four years to investigate a
single day's worth of market manipulation, clearly energy traders intent
on price-gouging the public don't have much to fear.

That said, there have been some settlements for manipulation by large
oil companies. In January 2006, the CFTC issued a civil penalty against
Shell Oil for "non-competitive transactions" in U.S. crude oil futures
markets.[^32] In March 2005, a Shell subsidiary agreed to pay \$4
million to settle allegations it provided false information during a
federal investigation into market manipulation.[^33] In August 2004, a
Shell Oil subsidiary agreed to pay \$7.8 million to settle allegations
of energy market manipulation.[^34] In July 2004, Shell agreed to pay
\$30 million to settle allegations it manipulated natural gas
prices.[^35] In October 2007, BP agreed to pay \$303 million to settle
allegations the company manipulated the propane market.[^36] In
September 2003, BP agreed to pay NYMEX \$2.5 million to settle
allegations the company engaged in improper crude oil trading, and in
July 2003, BP agreed to pay \$3 million to settle allegations it
manipulated energy markets.[^37]

In August 2007, Oil giant BP admitted in a filing to the Securities and
Exchange Commission that "The US Commodity Futures Trading Commission
and the US Department of Justice are currently investigating various
aspects of BP's commodity trading activities, including crude oil
trading and storage activities, in the US since 1999, and have made
various formal and informal requests for information."[^38]

In August 2007, Marathon Oil agreed to pay \$1 million to settle
allegations the company manipulated the price of West Texas Intermediate
crude oil.[^39]

There is near-unanimous agreement among industry analysts that
speculation is driving up oil and natural gas prices. Representative of
these analyses is a May 2006 Citigroup report on the monthly average
value of speculative positions in American commodity markets, which
found that the value of speculative positions in oil and natural gas
stood at \$60 billion, forcing Citigroup to conclude that "we believe
the hike in speculative positions has been a key driver for the latest
surge in commodity prices."[^40]

Natural gas markets are also victimized by these unregulated trading
markets. Public Citizen has testified before Congress on this
issue,[^41] and a March 2006 report by four state attorneys general
concludes that "natural gas commodity markets have exhibited erratic
behavior and a massive increase in trading that contributes to both
volatility and the upward trend in prices."[^42]

The Industrial Energy Consumers of America wrote a January 2005 letter
to the Securities and Exchange Commission "alarmed at the significant
increase in unregulated hedge funds trading on the NYMEX and OTC
natural-gas markets."[^43] In November 2004 the group wrote Congress,
asking them to "increase energy market oversight by the Commodity
Futures Trading Commission."[^44]

While most industry analysts agree that the rise in speculation is
fueling higher prices, there is one notable outlier: the federal
government. In a widely dismissed report, the CFTC recently concluded
that there was "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 prices
changes...in the crude oil market."[^45]

The CFTC study (and similar one performed by NYMEX) is flawed for
numerous reasons, including the fact that the role of hedge funds and
other speculators on long-term trading was *not* included in the
analysis. The *New York Times* reported that "many traders have scoffed
at the studies, saying that they focused only on certain months, missing
price run-ups."[^46]

**Latest Trading Trick: Energy Infrastructure Affiliate Abuses**

Energy traders like Goldman Sachs are investing and acquiring energy
infrastructure assets because controlling pipelines and storage
facilities affords their energy trading affiliates an "insider's peek"
into the physical movements of energy products unavailable to other
energy traders. Armed with this non-public data, a company like Goldman
Sachs most certainly will open lines of communication between the
affiliates operating pipelines and the affiliates making large bets on
energy futures markets. Without strong firewalls prohibiting such
communications, consumers would be susceptible to price-gouging by
energy trading affiliates.

For example, In January 2007, Highbridge Capital Management , a hedge
fund controlled by JP Morgan Chase, bought a stake in an energy unit of
Louis Dreyfus Group to expand its oil and natural gas trading. Glenn
Dubin, co-founder of Highbridge, said that owning physical energy assets
like pipelines and storage facilities was crucial to investing in the
business: "That gives you a very important information advantage.
You\'re not just screen-trading financial products."[^47]

Indeed, such an "information advantage" played a key role in allowing
BP's energy traders to manipulate the entire U.S. propane market. In
October 2007, the company paid \$303 million to settle allegations that
the company's energy trading affiliate used the company's huge control
over transportation and storage to allow the energy trading affiliate to
exploit information about energy moving through BP's infrastructure to
manipulate the market.

BP's energy trading division, North America Gas & Power (NAGP), was
actively communicating with the company's Natural Gas Liquids Business
Unit (NGLBU), which handled the physical production, pipeline
transportation and retail sales of propane. A powerpoint exhibit to the
civil complaint against BP details how the two divisions coordinated
their manipulation strategy, which includes "assurance that \[the\]
trading team has access to all information and optionality within \[all
of BP\]...that can be used to increase chance of success \[of market
manipulation\]... Implement weekly meetings with Marketing & Logistics
to review trading positions and share opportunities."[^48]

And in August 2007, BP acknowledged that the federal government was
investigating similar gaming techniques in the crude oil markets.

BP is not alone. A Morgan Stanley energy trader, Olav Refvik, "a key
part of one of the most profitable energy-trading operations in the
world...helped the bank dominate the heating oil market by locking up
New Jersey storage tank farms adjacent to New York Harbor."[^49] As of
November 2008, Morgan Stanley committed \$452 million to lease petroleum
storage facilities for 2009. As the company notes: "In connection with
its commodities business, the Company enters into operating leases for
both crude oil and refined products storage and for vessel charters.
These operating leases are integral parts of the Company's commodities
risk management business."[^50] In 2003, Morgan Stanley teamed up with
Apache Corp to buy 26 oil and gas fields from Shell for \$500 million,
of which Morgan Stanley put up \$300 million in exchange for a portion
of the production over the next four years, which it used to supplement
its energy trading desk.[^51] Again, control over physical
infrastructure assets plays a key role in helping energy traders game
the market.

The *Wall Street Journal* suggested that the bankruptcy of a single
firm, SemGroup, served as the initital trigger of crude oil's price
collapse this summer. The company operated 1,200 miles of oil pipliens
and held 15 million barrels of crude storage capacity, but was
misleading regulators and its own investors on the extent of its heding
practices. Data suggests that SemGroup was taking out positions far in
excess of its physical delivery commitments, becoming a pure speculator.
When its bets turned sour, the company was forced to declare
bankruptcy.[^52]

This shows that the energy traders were actively engaging the physical
infrastructure affiliates in an effort to glean information helpful for
market manipulation strategies. And it is important to note that BP's
market manipulation strategy was extremely aggressive and blatant, and
regulators were tipped off to it by an internal whistleblower. A more
subtle manipulation effort could easily evade detection by federal
regulators, making it all the more important to establish firewalls
between energy assets affiliates and energy trading affiliates to
prevent any undue communication between the units.

Financial firms like hedge funds and investment banks that normally
wouldn't bother purchasing low-profit investments like oil and gasoline
storage have been snapping up ownership and/or leasing rights to these
facilities mainly for the wealth of information that controlling energy
infrastructure assets provides to help one's energy traders manipulate
trading markets. The *Wall Street Journal* reported that financial
speculators were snapping up leasing rights in Cushing, Ok.[^53]

In August 2006, Goldman Sachs, AIG and Carlyle/Riverstone announced the
\$22 billion acquisition of Kinder Morgan, Inc., which controls 43,000
miles of crude oil, refined products and natural gas pipelines, in
addition to 150 storage terminals.

Prior to this huge purchase, Goldman Sachs had already assembled a long
list of oil and gas investments. In 2005, Goldman Sachs and private
equity firm Kelso & Co. bought a 112,000 barrels/day oil refinery in
Kansas operated by CVR Energy, and entered into an oil supply agreement
with J. Aron, Goldman's energy trading subsidiary. Goldman's Scott L.
Lebovitz & Kenneth A. Pontarelli and Kelso's George E. Matelich &
Stanley de J. Osborne all serve on CVR Energy's Board of Directors.

In May 2004, Goldman spent \$413 million to acquire royalty rights to
more than 1,600 natural gas wells in Pennsylvania, West Virginia, Texas,
Oklahoma and offshore Louisiana from Dominion Resources. Goldman Sachs
owns a six percent stake in the 375-mile Iroquois natural gas pipeline,
which runs from Northern New York through Connecticut to Long Island. In
December 2005, Goldman and Carlyle/Riverstone together are investing
\$500 million in Cobalt International Energy, a new oil exploration firm
run by former Unocal executives.

**Conclusion**

This era of high energy prices isn't a simple case of supply and demand,
as the evidence suggests that weak or non-existent regulatory oversight
of energy trading markets provides opportunity for energy companies and
financial institutions to price-gouge Americans. Forcing consumers
suffering from inelastic demand to continue to pay high prices---in part
fueled by uncompetitive actions---not only hurts consumers economically,
but environmentally as well, as the oil companies and energy traders
enjoying record profits are not investing those earnings into
sustainable energy or alternatives to our addiction to oil. Reforms to
strengthen regulatory oversight over America's energy trading markets
are needed to restore true competition to America's oil and gas markets.

***Solutions***

-   Re-regulate energy trading markets by subjecting OTC
    exchanges---including foreign-based exchanges trading U.S. energy
    products---to full compliance under the Commodity Exchange Act and
    mandate that all OTC energy trades adhere to the CFTC's Large Trader
    reporting requirements. In addition, regulations must be
    strengthened over existing lightly-regulated exchanges like NYMEX.

-   Impose legally-binding firewalls to limit energy traders from
    speculating on information gleaned from the company's energy
    infrastructure affiliates or other such insider information, while
    at the same time allowing legitimate hedging operations***.***
    Congress must authorize the FTC and DOJ to place greater emphasis on
    evaluating anti-competitive practices that arise out of the nexus
    between control over hard assets like energy infrastructure and a
    firm's energy trading operations. Incorporating energy trading
    operations into anti-trust analysis must become standard practice
    for federal regulatory and enforcement agencies to force more
    divestiture of assets in order to protect consumers from abuses.

-   Raise margin requirements so market participants will have to put up
    more of their own capital in order to trade energy contracts, and
    impose aggregate position limits on non-commercial trading to reduce
    speculation. Currently, margin requirements are too low, which
    encourages speculators to more easily enter the market by borrowing,
    or leveraging, against their positions. And aggregated limits over
    all markets - not just select ones - would preclude an energy trader
    from dipping their hands in multiple futures market cookie jars with
    the intent to speculate.

[^1]: www.fhwa.dot.gov/ohim/tvtw/tvtpage.htm

[^2]: http://energycommerce.house.gov/Investigations/EnergySpeculationBinder_062308/15.pdf

[^3]: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=110_cong_public_laws&docid=f:publ140.110.pdf

[^4]: http://agriculture.house.gov/inside/Legislation/111/PETEMN_001_xml.pdf

[^5]: 7 USC §§ 9, 13b and 13(a)(2).

[^6]: The other eight companies were: BP, Coastal Corp (now El Paso
    Corp.) Conoco and Phillips (now ConocoPhillips), Goldman Sachs' J.
    Aron & Co, Koch Industries, Mobil (now ExxonMobil) and Phibro Energy
    (now a subsidiary of CitiGroup).

[^7]: 17 CFR Ch. 1, available at
    www.access.gpo.gov/nara/cfr/waisidx_06/17cfr35_06.html

[^8]: "Exemption for Certain Contracts Involving Energy Products," 58
    Fed. Reg. 6250 (1993).

[^9]: Charles Lewis, "The Buying of the President 1996," pg 153. The
    Center for Public Integrity.

[^10]: "Derivatives Trading Forward-Contract Fraud Exemption May be
    Reversed," *Inside FERC's Gas Market Report*, May 7, 1993.

[^11]: "Financial Derivatives: Actions Needed to Protect the Financial
    System," GGD-94-133, May 18, 1994, available at
    http://archive.gao.gov/t2pbat3/151647.pdf

[^12]: Brent Walth and Jim Barnett, "A Web of Influence," *Portland
    Oregonian*, December 8, 1996.

[^13]: Jerry Knight, "Energy Firm Finds Ally, Director, in CFTC
    Ex-Chief," *Washington Post*, April 17, 1993.

[^14]: HR 5660, an amendment to H.R.4577, which became Appendix E of
    P.L.106-554 available
    athttp://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=106_cong_public_laws&docid=f:publ554.106.pdf

[^15]: *Blind Faith: How Deregulation and Enron's Influence Over
    Government Looted Billions from Americans*, available at
    www.citizen.org/documents/Blind_Faith.pdf

[^16]: "Over-the-Counter Derivatives Markets and the Commodity Exchange
    Act," *Report of The President's Working Group on Financial
    Markets*, pg. 16. www.ustreas.gov/press/releases/docs/otcact.pdf

[^17]: Senate Office of Public Records Lobbying Disclosure Database,
    available at
    [http://sopr.senate.gov/cgi-win/opr_gifviewer.exe?/1999/01/000/309/000309331\|30](http://sopr.senate.gov/cgi-win/opr_gifviewer.exe?/1999/01/000/309/000309331|30),
    page 7.

[^18]: Available at www.theice.com/exchange_volumes_2005.jhtml

[^19]: http://idea.sec.gov/Archives/edgar/data/886982/000095012309001278/y74032e10vk.htm

[^20]: <http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_senate_committee_prints&docid=f:28640.pdf>,
    pages 24 and 26.

[^21]: Heather Timmons, "Change in Goldman Index Played Role in Gasoline
    Price Drop," *The New York Times*, September 30, 2006.

[^22]: Regulation Y; Docket No. R-1146,
    www.federalreserve.gov/boarddocs/press/bcreg/2003/20030630/attachment.pdf

[^23]: http://idea.sec.gov/Archives/edgar/data/831001/000104746908011506/a2188770z10-q.htm

[^24]: http://idea.sec.gov/Archives/edgar/data/70858/000119312508228086/d10q.htm

[^25]: http://idea.sec.gov/Archives/edgar/data/65100/000095012308014369/y72170e10vq.htm

[^26]: 17 CFR Part 4, RIN 3038-AB97, "Additional Registration and Other
    Regulatory Relief for Commodity Pool Operators and Commodity Trading
    Advisors," final rule issued August 1, 2003.

[^27]:
    > *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 of the U.S. Senate,
    > June 27, 2006, available
    > athttp://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_senate_committee_prints&docid=f:28640.pdf

[^28]: Letter from Reuben Jeffrey III, Chairman, CFTC, to Michigan
    Governor Jennifer Granholm, August 22, 2005.

[^29]:
    > Matt Chambers, "Rise in Electronic Trading Adds Uncertainty to
    > Oil," *The Wall Street Journal*, April 10, 2007.

[^30]: Leah McGrath Goodman, "Oil Futures, Gasoline In NY End Sharply
    Lower," September 2, 2005.

[^31]: John R. Wilke, Ann Davis and Chip Cummins, "BP Woes Deepen with
    New Probe," *The Wall Street Journal*, August 29, 2006.

[^32]: "U.S. Commodity Futures Trading Commission Assesses Penalties of
    \$300,000 Against Shell-Related Companies and Trader in Settling
    Charges of Prearranging Crude Oil Trades" available at
    www.cftc.gov/newsroom/enforcementpressreleases/2006/pr5150-06.html

[^33]: "Commission Accepts Settlement Resolving Investigation Of Coral
    Energy Resources," available at
    www.ferc.gov/news/news-releases/2005/2005-1/03-03-05.asp

[^34]: "Order Approving Contested Settlement," available at
    www.ferc.gov/whats-new/comm-meet/072804/E-60.pdf

[^35]: "Coral Energy Pays \$30 Million to Settle U.S. Commodity Futures
    Trading Commission Charges of Attempted Manipulation and False
    Reporting," available at www.cftc.gov/opa/enf04/opa4964-04.htm

[^36]: www.cftc.gov/newsroom/enforcementpressreleases/2007/pr5405-07.html

[^37]: "Order Approving Stipulation and Consent Agreement," 104 FERC ¶
    61,089, available at
    http://elibrary.ferc.gov/idmws/common/opennat.asp?fileID=10414789

[^38]: www.sec.gov/Archives/edgar/data/313807/000115697307001223/u53342-6k.htm

[^39]: www.cftc.gov/newsroom/enforcementpressreleases/2007/pr5366-07.html

[^40]: *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 of the U.S. Senate, June
    27, 2006, available at
    http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_senate_committee_prints&docid=f:28640.pdf

[^41]: "The Need for Stronger Regulation of U.S. Natural Gas Markets,"
    available at www.citizen.org/documents/Natural%20Gas%20Testimony.pdf

[^42]: *The Role of Supply, Demand and Financial Commodity Markets in
    the Natural Gas Price Spiral*, available at
    www.ago.mo.gov/pdf/NaturalGasReport.pdf

[^43]: www.ieca-us.com/downloads/natgas/SECletter013105.doc

[^44]: www.ieca-us.com/downloads/natgas/111704LettertoCongr%23AAC2.doc

[^45]: Michael S. Haigh, Jana Hranaiova and James A. Overdahl, "Price
    Dynamics, Price Discovery and Large Futures Trader Interactions in
    the Energy Complex," available at
    www.cftc.gov/files/opa/press05/opacftc-managed-money-trader-study.pdf

[^46]: Alexei Barrionuevo and Simon Romero, "Energy Trading, Without a
    Certain 'E'," January 15, 2006.

[^47]: Saijel Kishan and Jenny Strasburg, "Highbridge Capital Buys Stake
    in Louis Dreyfus Unit," Bloomberg, January 8, 2007,
    www.bloomberg.com/apps/news?pid=20601014&sid=aBnQy1botdFo

[^48]: www.cftc.gov/files/enf/06orders/opa-bp-lessons-learned.pdf

[^49]: [[http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_senate_committee_prints&docid=f:28640.pdf]{.underline}](http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_senate_committee_prints&docid=f:28640.pdf),
    page 26.

[^50]: http://idea.sec.gov/Archives/edgar/data/895421/000119312509013429/d10k.htm

[^51]: Paul Merolli, "Two Morgan Stanley M&A deals show bullish stance
    on gas," Natural Gas Week, Volume 19; Issue 28, July 14, 2003.

[^52]: Brian Baskin, \"SemGroup Loses Bets on Oil; Hedging Tactics
    Coincide With Ebb In Price of Crude,\" July 24, 2008, Page C14

[^53]: Ann Davis, "Where Has All The Oil Gone?" October 6, 2007, Page
    A1.