**TESTIMONY OF MICHAEL COMSTOCK,**

**ACTING DIRECTOR FOR THE CITY OF MESA, ARIZONA GAS SYSTEM**

**ON BEHALF OF THE AMERICAN PUBLIC GAS ASSOCIATION**

**BEFORE THE HOUSE AGRICULTURE COMMITTEE**

**JULY 10, 2008**

Chairman Peterson, Ranking Member Goodlatte and Members of the
Committee, I appreciate this opportunity to testify before you today and
I thank the Committee for calling this hearing on the important subject
of trading in the over-the-counter (OTC) market. My name is name is
Michael Comstock and I am the Acting Director for the City of Mesa,
Arizona Gas System. I also serve as Vice-Chair of the Board of Directors
for the American Public Gas Association (APGA).

The City of Mesa provides natural gas, electric, water and wastewater
service to its residents. We have provided gas service to our customers
for over 90 years and we currently serve approximately 53,000 homes and
businesses throughout Mesa and portions of Pinal County. Strong growth
in the region has made Mesa one of the fastest-growing and respected
municipal gas utilities in the United States.

I testify today on behalf of the APGA. APGA is the national association
for publicly-owned natural gas distribution systems. There are
approximately 1,000 public

gas systems in 36 states and over 700 of these systems are APGA members.
Publicly-owned gas systems are not-for-profit, retail distribution
entities owned by, and accountable to, the citizens they serve. They
include municipal gas distribution systems, public utility districts,
county districts, and other public agencies that have natural gas
distribution facilities. Every member of the Committee, with the
exception of Congressman Walberg of Michigan, has public gas systems in
their state.

APGA's number one priority is the safe and reliable delivery of
affordable natural gas. To bring natural gas prices back to a long-term
affordable level, we ultimately need to increase the supply of natural
gas. However, equally critical is to restore public confidence in the
pricing of natural gas. This requires a level of transparency in natural
gas markets which assures consumers that market prices are a result of
fundamental supply and demand forces and not the result of manipulation,
other abusive market conduct or excessive speculation.

We, along with other consumer groups, have watched with alarm over the
last several years certain pricing anomalies in the markets for natural
gas. More recently, we have noted a run-up in the price of energy and
other physical commodities. APGA has strongly supported an increase in
the level of transparency with respect to trading activity in these
markets from that which currently exists. We believe that additional
steps are needed in order to restore our current lack of confidence in
the natural gas marketplace and to provide sufficient transparency to
enable the CFTC, and market users, to form a reasoned response to the
critically important questions that have been raised before this
Committee during the course of these hearings.

APGA believes that the increased regulatory, reporting and
self-regulatory provisions relating to the unregulated energy trading
platforms contained in legislation that reauthorizes the Commodity
Futures Trading Commission ("CFTC") is a critically important step in
addressing our concerns. Those provisions are contained in Title XIII of
the Farm Bill which has become law. We commend this Committee for its
work on the CFTC reauthorization bill. The market transparency language
that was included in the Farm Bill will help shed light on whether
market prices in significant price discovery energy contracts are
responding to legitimate forces of supply and demand or to other,
non-bona fide market forces. APGA believes that more can, and should, be
done to further increase transparency of trading in the energy markets.
Many of these steps would likely also be useful in better understanding
the current pricing trends in the markets for other physical commodities
as well.

APGA believes that these additional steps, a number of which the CFTC
has undertaken through administrative action, have the potential either
directly to address the concerns APGA has raised with respect to lack of
transparency in these markets, or to provide needed information so that
a consensus can be reached on the additional statutory or regulatory
steps, if any, that should be taken to responsibly and effectively
address the questions that have been raised regarding the potentially
adverse effects on these markets resulting from excessive speculative
trading.

Although the additional authorities which have been provided to the CFTC
under Title XIII of the 2008 Farm Bill will provide the CFTC with
significant additional tools to respond to the issues raised by this
hearing (at least with respect to the energy markets), we nevertheless
believe that it may be necessary for Congress to provide the CFTC with
additional statutory authorities. We are doubtful that the initial steps
taken by the reauthorization legislation are, or will be, sufficient to
fully respond to the concerns that we have raised regarding the need for
increased transparency. In this regard, we believe that additional
transparency measures with respect to transactions in the
Over-the-Counter markets are needed to enable the cop on the beat to
assemble a full picture of a trader's position and thereby understand a
large trader's potential impact on the market.

We further believe, that in light of the critical importance of this
issue to consumers, that this Committee should maintain active and
vigilant oversight of the CFTC's market surveillance and enforcement
efforts, that Congress should be prepared to take additional legislative
action to further improve transparency with respect to trading in energy
contracts and, should the case be made, to make additional amendments to
the Commodity Exchange Act, 7 U.S.C. §1 *et seq.* ("Act"), to make
changes in the administration of speculative position limits in order to
ensure the integrity of the energy markets.

*History of Regulation Under the Commodity Exchange Act*

Systemized trading in contracts for the future delivery of agricultural
commodities developed in the United States in the mid to late 1800s from
an economic need for risk shifting. Glaring abuses were attendant with
the advantages of trading, these included price manipulations, market
corners and extreme and sudden price fluctuations on the organized
exchanges. These abuses stirred repeated demands for legislative action
to prohibit or comprehensively regulate futures trading. Although the
first regulation of the grain futures markets dates from the 1920's,[^1]
the Commodity Exchange Act of 1936[^2] was the first statute to
comprehensively regulate the futures markets.

Section 3 of the Act as it existed before to the 2000 amendments
explained the statute's purpose in relevant part as follows:

> Transactions in commodities involving the sale thereof for future
> delivery as commonly conducted on boards of trade and known as
> "futures" are affected with a national public interest. Such futures
> transactions are carried on in large volume by the public generally
> and by persons engaged in the business of buying and selling
> commodities and the products and byproducts thereof. . . . The prices
> involved in such transactions are generally quoted and disseminated
> through the United States and in foreign countries as a basis for
> determining the prices to the producer and the consumer. . . .The
> transactions and prices of commodities on such boards of trade are
> susceptible to excessive speculation and can be manipulated,
> controlled, cornered or squeezed, to the detriment of the producer or
> the consumer. . . .

Section 4a(a) of the Act echoes the Congressional finding of former
section 3, providing that, "Excessive speculation in any commodity under
contracts of sale of such commodity for future delivery made on or
subject to the rules of contract markets . . . 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." 7 U.S.C. §6a.

The CFTC in 1981 adopted a rule requiring all futures exchanges to
impose speculative position limits for all commodities that were not
subject to a Federal speculative position limit.[^3] In so doing, the
Commission explained the danger that unchecked speculative positions can
pose to the markets, saying:

> It appears that the capacity of any contract market to absorb the
> establishment and liquidation of large speculative positions in an
> orderly manner is related to the relative size of such positions,
> i.e., the capacity of the market is not unlimited. Recent events in
> the silver market would support a finding that the capacity of a
> liquid futures market to absorb large speculative positions is not
> unlimited, notwithstanding mitigating characteristics of the
> underlying cash market.

"Establishment of Speculative Position Limits," 46 *Fed Reg.* 50938,
509040 (October 16, 1981).

The CFTC's conclusion in 1981 was that the ability of liquid markets to
absorb excessively large speculative positions without suffering from
artificial upward pressure on prices is not unlimited, and based on that
reasoning, required exchanges to adopt speculative position limits for
all contracts. That question, whether liquid markets have the ability to
absorb excessively large speculative positions without suffering from
artificial upward price pressure is the same question that is before
this Committee today.

*Speculators' Effect on the Natural Gas Market*

As hedgers that use both the regulated futures markets and the OTC
energy markets, we value the role of speculators in the markets. We also
value the different needs served by the regulated futures markets and
the more tailored OTC markets. As hedgers, we depend upon liquid and
deep markets in which to lay off our risk. Speculators are the grease
that provides liquidity and depth to the markets.

However, speculative trading strategies may not always have a benign
effect on the markets. For example, the recent blow-up of Amaranth
Advisors LLC and the impact it had upon prices exemplifies the impact
that speculative trading interests can have on natural gas supply
contracts for local distribution companies ("LDCs"). Amaranth Advisors
LLC was a hedge fund based in Greenwich, Connecticut, with over \$9.2
billion under management. Although Amaranth classified itself as a
diversified multi-strategy fund, the majority of its market exposure and
risk was held by a single Amaranth trader in the OTC derivatives market
for natural gas.

Amaranth reportedly accumulated excessively large long positions and
complex spread strategies far into the future. Amaranth's speculative
trading wagered that the relative relationship in the price of natural
gas between summer and winter months would change as a result of
shortages which might develop in the future and a limited amount of
storage capacity. Because natural gas cannot be readily transported
about the globe to offset local shortages, the way for example oil can
be, the market for natural gas is particularly susceptible to localized
supply and demand imbalances. Amaranth's strategy was reportedly based
upon a presumption that hurricanes during the summer of 2006 would make
natural gas more expensive in 2007, similar to the impact that
hurricanes Katrina and Rita had had on prices the previous year. As
reported in the press, Amaranth held open positions to buy or sell tens
of billions of dollars of natural gas.

As the hurricane season proceeded with very little activity, the price
of natural gas declined, and Amaranth lost approximately \$6 billion,
most of it during a single week in September 2006. The unwinding of
these excessively large positions and that of another previously failed
\$430 million hedge fund---MotherRock--- further contributed to the
extreme volatility in the price of natural gas. The Report by the Senate
Permanent Committee on Investigations affirmed that "Amaranth's massive
trading distorted natural gas prices and increased price
volatility."[^4]

Many natural gas distributors locked-in prices prior to the period
Amaranth collapsed at prices that were elevated due to the accumulation
of Amaranth's positions. They did so because of their hedging procedures
which require that they hedge part of their winter natural gas in the
spring and summer. Accordingly, even though natural gas prices were high
at that time, it would have been irresponsible (and contrary to their
hedging policies) to not hedge a portion of their winter gas in the hope
that prices would eventually drop. Thus, the elevated prices which were
a result of the excess speculation in the market by Amaranth and others
had a significant impact on the price these APGA members, and ultimately
their customers, paid for natural gas. The lack of transparency with
respect to this trading activity, much of which took place in the OTC
markets, and the extreme price swings surrounding the collapse of
Amaranth have caused bona fide hedgers to become reluctant to
participate in the markets for fear of locking-in prices that may be
artificial.

Recently, additional concerns have been raised with respect to the size
of positions related to, and the role of, passively managed long-only
index funds. In this instance, the concern is not whether the positions
are being taken in order to intentionally drive the price higher, but
rather whether the unintended effect of the cumulative size of these
positions has been to push market prices higher than the fundamental
supply and demand situation would justify.

The additional concern has been raised that recent increased amounts of
speculative investment in the futures markets generally have resulted in
excessively large speculative positions being taken that due merely to
their size, and not based on any intent of the traders, are putting
upward pressure on prices. The argument made is that these additional
inflows of speculative capital are creating greater demand then the
market can absorb, thereby increasing buy-side pressure which results in
advancing prices.

Some have responded to these concerns by reasoning that new futures
contracts are capable of being created without the limitation of having
to have the commodity physically available for delivery. This explains
why, although the open-interest of futures markets can exceed the size
of the deliverable supply of the physical commodity underlying the
contract, the price of the contract could nevertheless reflect the
forces of supply and demand.

APGA commends this Committee for its focus on the possible impact
speculative investment has on the price of natural gas and other energy
commodities and for asking these tough questions. With energy prices at
their current high levels, consumers should not be forced to pay a
"speculative premium." However, APGA is not in a position to determine
which of the above two views is correct. More significantly and
profoundly disturbing, because of limitations with respect to
transparency of trading in these markets, the data and facts are
unavailable that would enable market observers, including both the
regulators and the public, to make a reasoned judgment about this issue.

As we noted above, as hedgers we rely on speculative traders to provide
liquidity and depth to the markets. Thus, we do not wish to see steps
taken that would discourage speculators from participating in these
markets using *bona fide* trading strategies. But more importantly,
APGA's members rely upon the prices generated by the futures to
accurately reflect the true value of natural gas. Accordingly, APGA
would support additional regulatory controls, such as stronger
speculative position limits, if a reasoned judgment can be made based on
currently available, or additional forthcoming market data and facts,
that such controls are necessary to address the unintended consequences
arising from certain speculative trading strategies or to reign in
excessively large speculative positions. To the extent that speculative
investment may be increasing the price of natural gas or causing pricing
aberrations, we strongly encourage Congress to take quick action to
expand market transparency in order to be able to responsibly address
this issue and protect consumers from additional cost burdens.

*The Markets in Natural Gas Contracts*

The market for natural gas financial contracts is composed of a number
of segments. Contracts for the future delivery of natural gas are traded
on NYMEX, a designated contract market regulated by the CFTC. Contracts
for natural gas are also traded in the OTC markets. OTC contracts may be
traded on multi-lateral electronic trading facilities which are exempt
from regulation as exchanges, such as the Intercontinental Exchange
("ICE"). ICE also operates an electronic trading platform for trading
non-cleared (bi-lateral) OTC contracts. They may also be traded in
direct, bi-lateral transactions between counterparties, through voice
brokers or on electronic platforms. OTC contracts may be settled
financially or through physical delivery. Financially-settled OTC
contracts often are settled based upon NYMEX settlement prices and
physically delivered OTC contracts may draw upon the same deliverable
supplies as NYMEX contracts, thus linking the various financial natural
gas market segments economically.

Increasingly, the price of natural gas in many supply contracts between
suppliers and local distribution companies, including APGA members, is
determined based upon monthly price indexes closely tied to the monthly
settlement of the NYMEX futures contract. Accordingly, the futures
market serves as the centralized price discovery mechanism used in
pricing these natural gas supply contracts.

Generally, futures markets are recognized as providing an efficient and
transparent means for discovering commodity prices.[^5] However, any
failure of the futures price to reflect fundamental supply and demand
conditions results in prices for natural gas that are distorted and
which do not reflect its true value. [^6] This has a direct affect on
consumers all over the U.S., who as a result of such price distortions,
will not pay a price for the natural gas that reflects bona fide demand
and supply conditions. If the futures price is manipulated or distorted,
then the price consumers pay for the fuel needed to heat their homes and
cook their meals will be similarly manipulated or distorted.

Today, the CFTC has effective oversight of futures exchanges, and the
CFTC and the exchanges provide a significant level of transparency. And
under the provisions of the Title XIII of the Farm Bill, the CFTC has
been given additional regulatory authority with respect to significant
price discovery contracts traded on exempt commercial markets, such as
ICE. This is indeed a major step toward greater market transparency.
However, even with this additional level of transparency, a large part
of the market remains opaque to regulatory scrutiny. The OTC markets
lack such price transparency. This lack of transparency in a very large
and rapidly growing segment of the natural gas market leaves open the
potential for a participant to engage in manipulative or other abusive
trading strategies with little risk of early detection; and for problems
of potential market congestion to go undetected by the CFTC until after
the damage has been done to the market.

Equally significant, even where the trading is not intended to be
abusive, the lack of transparency for the over-all energy markets leaves
regulators unable to answer questions regarding speculators' possible
impacts on the market. For example, do we know who the largest traders
are in the over-all market, looking at regulated futures contracts,
significant price discovery contracts and bi-lateral OTC transactions?
Without being able to see a large trader's entire position, it is
possible that the effect of a large OTC trader on the regulated markets
is masked, particularly when that trader is counterparty to a number of
swaps dealers that in turn take positions in the futures market to hedge
these OTC exposures as their own.

*Regulatory Oversight*

NYMEX, as a designated contract market, is subject to oversight by the
CFTC. The primary tool used by the CFTC to detect and deter possible
manipulative activity in the regulated futures markets is its large
trader reporting system. Using that regulatory framework, the CFTC
collects information regarding the positions of large traders who buy,
sell or clear natural gas contracts on NYMEX. The CFTC in turn makes
available to the public aggregate information concerning the size of the
market, the number of reportable positions, the composition of traders
(commercial/non-commercial) and their concentration in the market,
including the percentage of the total positions held by each category of
trader (commercial/non-commercial).

The CFTC also relies on the information from its large trader reporting
system in its surveillance of the NYMEX market. In conducting
surveillance of the NYMEX natural gas market, the CFTC considers whether
the size of positions held by the largest contract purchasers are
greater than deliverable supplies not already owned by the trader, the
likelihood of long traders demanding delivery, the extent to which
contract sellers are able to make delivery, whether the futures price is
reflective of the cash market value of the commodity and whether the
relationship between the expiring future and the next delivery month is
reflective of the underlying supply and demand conditions in the cash
market.[^7]

Title XIII of the Farm Bill, recently empowered the CFTC to collect
large trader information with respect to "significant price discovery
contracts" traded on the ICE trading platform. However, there remain
significant gaps in transparency with respect to trading of OTC energy
contracts, including many forms of contracts traded on ICE. Despite the
links between prices for the NYMEX futures contract and the OTC markets
in natural gas contracts, this lack of transparency in a very large and
rapidly growing segment of the natural gas market leaves open the
potential for participants to engage in manipulative or other abusive
trading strategies with little risk of early detection and for problems
of potential market congestion to go undetected by the CFTC until after
the damage has been done to the market, ultimately costing the consumers
or producers of natural gas. More profoundly, it leaves the regulator
unable to assemble a true picture of the over-all size of a speculator's
position in a particular commodity.

*Greater Transparency Needed*

Our members, and the customers served by them, believe that although
Title XIII of the Farm Bill goes a long way to addressing the issue,
there is not yet an adequate level of market transparency under the
current system. This lack of transparency has led to a growing lack of
confidence in the natural gas marketplace. Although the CFTC operates a
large trader reporting system to enable it to conduct surveillance of
the futures markets, it cannot effectively monitor trading if it
receives information concerning positions taken in only one, or two,
segments of the total market. Without comprehensive large trader
position reporting, the government will remain handicapped in its
ability to detect and deter market misconduct or to understand the
ramifications for the market arising from unintended consequences
associated with excessive large positions or with certain speculative
strategies. If a large trader acting alone, or in concert with others,
amasses a position in excess of deliverable supplies and demands
delivery on its position and/or is in a position to control a high
percentage of the deliverable supplies, the potential for market
congestion and price manipulation exists. Similarly, we simply do not
have the information to analyze the over-all effect on the markets from
the current practices of speculative traders.

Over the last several years, APGA has pushed for a level of market
transparency in financial contracts in natural gas that would routinely,
and prospectively, permit the CFTC to assemble a complete picture of the
overall size and potential impact of a trader's position irrespective of
whether the positions are entered into on NYMEX, on an OTC multi-lateral
electronic trading facility which is exempt from regulation or through
bi-lateral OTC transactions, which can be conducted over the telephone,
through voice-brokers or via electronic platforms. APGA is optimistic
that the enhanced authorities provided to the CFTC in the provisions of
the CFTC reauthorization bill will help address the concerns that we
have raised, but recognizes that more needs to be done to address this
issue comprehensively.

*Additional Potential Enhancements in Transparency*

In supporting the CFTC reauthorization bill, we previously noted that
only a comprehensive large trader reporting system would enable the
CFTC, while a scheme is unfolding, to determine whether a trader, such
as Amaranth, is using the OTC natural gas markets to corner deliverable
supplies and manipulate the price in the futures market.[^8] A
comprehensive large trader reporting system would also enable the CFTC
to better detect and deter other types of market abuses, including for
example, a company making misleading statements to the public or
providing false price reporting information designed to advantage its
natural gas trading positions, or a company engaging in wash trading by
taking large offsetting positions with the intent to send misleading
signals of supply or demand to the market. Such activities are more
likely to be detected or deterred when the government is receiving
information with respect to a large trader's overall positions, and not
just those taken in the regulated futures market. It would also enable
the CFTC to better understand the overall size of speculative positions
in the market as well as the impact of certain speculative investor
practices or strategies on the future's markets ability to accurately
reflect fundamental supply and demand conditions.

Accordingly, APGA supports proposals to further increase and enhance
transparency in the energy markets, generally, and in the markets for
natural gas, specifically. APGA supports greater transparency with
respect to positions in natural gas financial contracts acquired through
bi-lateral transactions. Because bi-lateral trading can in fact be
conducted on an all-electronic venue, and can impact prices on the
exchanges even if conducted in a non-electronic environment, it is
APGA's position that transparency in the bi-lateral markets is critical
to ensure an appropriate level of consumer protection.

*Electronic Ti-lateral trading*

One example of the conduct of bi-lateral trading on an all-electronic
trading platform was \"Enron On-line.\" Enron, using its popular
electronic trading platform, offered to buy or sell contracts as the
universal counterparty to all other traders using this electronic
trading system. This one-to-many model constitutes a dealer\'s market
and is a form of bi-lateral trading. This stands in contrast to a
many-to-many model which is recognized as a multi-lateral trading venue.
This understanding is reflected in section 1a(33) of the Commodity
Exchange Act, which defines \"Trading Facility\" as a \"group of persons
that . . . provides a physical or electronic facility or system in which
multiple participants have the ability to execute or trade agreements,
contracts or transactions by accepting bids and offers made by other
participants that are open to multiple participants in the facility or
system.\" On the Enron On-line trading platform, only one
participant\--Enron\--had the ability to accept bids and offers of the
multiple participants\--its customers\-- on the trading platform.

Section1a(3) continues by providing that, \"the term \'trading
facility\' does not include (i) a person or group of persons solely
because the person or group of persons constitutes, maintains, or
provides an electronic facility or system that enables participants to
negotiate the terms of and enter into bilateral transactions as a result
of communications exchanged by the parties and not from interaction of
multiple bids and multiple offers within a predetermined,
nondiscretionary automated trade matching and execution algorithm . . .
. \" This means that it is also possible to design an electronic
platform for bi-lateral trading whereby multiple parties display their
bids and offers which are open to acceptance by multiple parties, so
long as the consummation of the transaction is not made automatically by
a matching engine.

Both of these examples of bi-lateral electronic trading platforms might
very well qualify for exemption under the current language of sections
2(g) and 2(h)(1) of the Commodity Exchange Act. To the extent that these
examples of electronic bi-lateral trading platforms were considered by
traders to be a superior means of conducting bi-lateral trading over
voice brokerage or the telephonic call-around markets, or will not fall
within the significant price discovery contract requirements, their use
as a substitute for a more-regulated exempt commercial market under
section 2(h)(3) of the Act should not be readily discounted.

*Non-electronic Bi-lateral Trading*

Moreover, even if bi-lateral transactions are not effected on an
electronic trading platform, it is nonetheless possible for such direct
or voice-brokered trading to affect prices in the natural gas markets.
For example, a large hedge fund may trade bi-laterally with a number of
counterparty/dealers using standard ISDA documentation. By using
multiple counterparties over an extended period of time, it would be
possible for the hedge fund to establish very large positions with each
of the dealer/counterparties. Each dealer in turn would enter into
transactions on NYMEX to offset the risk arising from the bi-lateral
transactions into which it has entered with the hedge fund. In this way,
the hedge fund's total position would come to be reflected in the
futures market. Thus, a prolonged wave of buying by a hedge fund, even
through bi-lateral direct or voice-brokered OTC transactions, can be
translated into upward price pressure on the futures exchange.

As NYMEX settlement approaches, the hedge fund's bi-lateral purchases
with multiple dealer/counterparties would maintain or increase upward
pressure on prices. By spreading its trading through multiple
counterparties, the hedge fund's purchases would attract little
attention and escape detection by either NYMEX or the CFTC. In the
absence of routine large-trader reporting of bi-lateral transactions,
the CFTC will only see the various dealers' exchange positions and have
no way of tying them back to purchases by a single hedge fund.

Given that the various segments of the financial markets that price
natural gas are linked economically, it is critical to achieving market
transparency that traders holding large positions entered into through
bi-lateral transactions be included in any large-trader reporting
requirement. As explained above, by trading through multiple dealers, a
large hedge fund would be able to exert pressure on exchange prices
similar to the pressure that it could exert by holding those positions
directly. Only a large-trader reporting system that includes positions
entered into in the OTC bi-lateral markets would enable the CFTC to see
the entire picture and trace such positions back to a single source.

If large trader reporting requirements apply only to positions acquired
on multi-lateral electronic trading platforms, traders in order to avoid
those reporting requirements may very well move more transactions to
electronic bilateral markets or increase their direct bi-lateral
trading. This would certainly run counter to efforts by Congress to
increase transparency. APGA remains convinced that all segments of the
natural gas marketplace should be treated equally in terms of reporting
requirements. To do otherwise leaves open the possibility that dark
markets on which potential market abuses could go undetected would
persist and that our current lack of sufficient information to fully
understand the impact of large speculative traders and certain trading
strategies on the markets will continue, thereby continuing to place
consumers at risk.

*Better Categorizing of Positions and Administration of Hedge
Exemptions*

APGA also notes that it has advocated that the CFTC take additional
steps within its existing authorities to increase transparency,
particularly with respect to the categorization of trades as speculative
or not.[^9] The CFTC uses the information derived from its large trader
reporting system both for its internal analyses of the markets as well
as providing the public with certain aggregated information in its
weekly "Commitments of Traders Reports." For purposes of this report, it
classifies traders as "commercials" or "non-commercials." It is assumed
that commercial traders are hedging in the markets and that
non-commercials are speculators.

The CFTC in 2007 made certain enhancements to its Commitment of Traders
Reports by reporting separately the aggregate positions held by
long-only, passively managed investment funds. The CFTC recently
announced that it was extending this initiative to include information
relating to the crude oil markets. APGA is encouraged that the CFTC has
taken steps to expand these enhancements to their Commitment of Traders
Reports to include the crude oil contracts.[^10] APGA believes that it
is critical that this initiative include all physical commodities, and
in particular, all energy-related commodities. Enhanced transparency
with respect to large traders and the size, scope and composition of
their aggregate positions will improve our understanding of the dynamics
of the market at any particular time, potentially increasing hedger's
confidence in the markets' price discovery function.

The CFTC has also announced an initiative to examine the classification
of swaps dealers under the large trader reporting system. The example
discussed above of a speculative trader entering into a bi-lateral
transaction with a swaps dealer that then covers its position in the
regulated futures market illustrates why this reclassification
initiative is important to a full understanding of the impact of
speculators on the markets. Prior to the CFTC's initiative, positions
that were assumed for speculative purposes in the OTC markets apparently
could be reflected in the CFTC's futures market reporting system as the
positions of a "commercial." This happens because the swaps dealer may
be covering its exposure in the futures market arising from its OTC
position as counter-party to a bi-lateral OTC transaction. This was
classified as a 'hedge' of the OTC position by the 'commercial' swaps
dealer. However, the original OTC position may have been entered into
for speculative purposes, by a hedge fund, for example. Accordingly,
despite the economic linkage between the speculative OTC transaction and
the regulated market, prior to the CFTC's recent re-classification
initiative, speculative OTC positions have been reflected in the CFTC's
COT futures market reports as non-speculative, "commercial" positions.
Similarly, when a long-only index fund enters into a speculative OTC
position with a swaps dealer, the position of the swaps-dealer in the
futures market has been classified by the CFTC as the non-speculative
position of a "commercial."

Equally profound, speculative position limits do not apply to hedging
activity by commercials. Thus, positions that would be subject to a
speculative position limit if entered into directly on the regulated
exchange are not so limited if the speculator enters into the
transaction in the OTC market and the swaps dealer in turn covers its
ensuing risk in the regulated market. In this way a speculator can amass
a larger position indirectly than it could by trading directly on the
exchange. The CFTC has also granted a number of staff no-action letters
exempting from speculative position limits certain passively managed
long-only index funds that have price exposure from their obligation to
track a commodity index.[^11]

Part of the increased transparency that APGA has been seeking includes a
more nuanced approach to classification of positions so that the impact
of these OTC speculative positions on the regulated market can be better
understood. As noted above, the CFTC has recently undertaken several
initiatives to report more accurately the trading of index funds and to
better classify trading by swaps dealers. APGA believes that these are
important initiatives that will shed greater light and understanding on
the possible effects on the oil market arising from speculative traders
and from certain speculative trading strategies.

It may be, however, that additional statutory changes would be helpful
in ensuring that the CFTC has sufficient authority and direction to
deepen and make permanent these steps and to apply them with respect to
all physical commodities, including all energy-related products. APGA
believes that although the issues discussed at this hearing arise most
acutely in today's oil markets, the issues apply equally to all energy
markets, including in particular natural gas. The problems that are
being noted in relation to the oil markets have also been raised quite
recently with respect to the natural gas markets and have been noted in
respect to the market for propane. APGA believes that the problems that
have been noted by this Committee are broader than the oil markets and
that other energy markets, including natural gas, require continuing
rigorous oversight and close attention.

*CFTC Resources*

The CFTC plays a critical role in protecting consumers, and the market
as a whole, from fraud, manipulation and market distortion. It is
essential that the CFTC have the necessary resources to monitor markets
and protect consumers from attempts to manipulate the market. This is
critical given the additional oversight responsibilities the CFTC will
have through the market transparency language included in the Farm Bill
and the additional transparency requirements that APGA is proposing to
the Committee.

Over the last several years, trading volumes have doubled while CFTC
staffing levels have, on average, decreased. In fact, while we are
experiencing record trading volumes, employee levels at the CFTC are at
their lowest since the agency was created. APGA is concerned that if
funding for the CFTC is inadequate, so may be the level of protection.
American consumers expect more than this form of regulatory triage.

*Conclusion*

Our testimony today is not meant to imply that the CFTC has not been
vigilant in pursuing wrongdoers. Experience tells us that there is never
a shortage of individuals or interests who believe they can, and will
attempt to, affect the market or manipulate price movements to favor
their market position. The fact that the CFTC has assessed over \$300
million in penalties, and has assessed over \$2 billion overall in
government settlements relating to abuse of these markets affirms this.
These efforts to punish those that manipulate or abuse markets or to
address those that might innocently distort markets are important. But
it must be borne in mind that catching and punishing those that
manipulate markets after a manipulation has occurred is not an
indication that the system is working. To the contrary, by the time
these cases are discovered using the tools currently available to
government regulators, our members, and their customers, have already
suffered the consequences of those abuses in terms of higher natural gas
prices. Nor is it acceptable to be unable to make responsible public
policy decisions because of a lack of transparency in the markets.

Greater transparency with respect to traders' large positions, whether
entered into on a regulated exchange or in the OTC markets in natural
gas will provide the CFTC with the tools to answer that question and to
detect and deter potential manipulative or market distorting activity
before our members and their customers suffer harm.

This hearing has raised issues that are vital to APGA's members and
their customers. We do not yet have the tools in place to say with
confidence the extent to which the pricing mechanisms in the natural gas
market today are reflecting market fundamentals or the possible market
effects of various speculative trading strategies. However, we know that
the confidence that our members once had in the pricing integrity of the
markets has been badly shaken.

In order to protect consumers the CFTC must be able to (1) detect a
problem before harm has been done to the public through market
manipulation or price distortions; (2) protect the public interest; and
(3) ensure the price integrity of the markets. Accordingly, APGA and its
704 public gas system members applaud your continued oversight of the
CFTC's surveillance of the natural gas markets. We look forward to
working with the Committee to determine the further enhancements that
may be necessary to restore consumer confidence in the integrity of the
price discovery mechanism.

  

In addition to increasing market transparency, however, if we are to
bring natural gas prices back to an affordable level, it is equally
important that energy policy must ensure that supply is adequate to meet
demand. In addition to greater transparency in market pricing, this will
require that supply and demand for natural gas be unfettered by
regulation. Yet, current statutory and regulatory policies (1) prohibit
the assessment of offshore reserves, (2) restrict and limit access to
production in areas of known reserves; and (3) encourage the use of
natural gas for new electric generation.

It makes no sense to encourage greater use of natural gas on the one
hand while at the same time to impede the acquisition of data that could
point to areas of abundant new resources and to obstruct production in
areas with rich supplies. In light of these facts, is it a wonder that
speculators find these markets attractive?

Natural gas is a lifeblood of our economy and millions of consumers
depend on natural gas every day to meet their daily needs. It is
critical that the price those consumers are paying for natural gas comes
about through the operation of fair, orderly and transparent markets. It
is equally critical that regulatory policy support bringing demand and
supply into balance. Every winter, more than 65 million residential and
commercial homes and businesses are heated by natural gas. More than 20%
of our nation's electricity is generated by natural gas, and that
percentage will grow because America is unwilling to adopt 21st century
nuclear technology and other alternatives to replace coal for electric
generation. Increases in market transparency alone will not address this
problem.

[^1]: See, Grain Futures Act of 1922, Publ. L. No. 6-331, 42 Stat. 998
    (1922).

[^2]: Act of June 15, 1936, ch 545 §5, 49 Stat 1494.

[^3]: The Commission subsequently modified this requirement, permitting
    contract markets to impose "position accountability rules" in lieu
    of speculative position limits for certain contracts, including the
    energy contracts.

[^4]: *See "Excessive Speculation in the Natural Gas Market,"* Report of
    the U.S. Senate Permanent Subcommittee on Investigations (June 25,
    2007) ("PSI Report") at p. 119

[^5]: *See* the Congressional findings in Section 3 of the Commodity
    Exchange Act, 7 U.S.C. §1 et seq. ("Act"). Section 3 of the Act
    provides that, "The transactions that are subject to this Act are
    entered into regularly in interstate and international commerce and
    are affected with a national public interest by providing a means
    for . . . discovering prices, or disseminating pricing information
    through trading in liquid, fair and financially secure trading
    facilities." A further question with respect to whether other
    speculative strategies, or excessively large speculative positions
    is also distorting market prices by pushing prices higher than they
    otherwise would be.

[^6]: The effect of Amarath's trading resulted in such price
    distortions. *See generally PSI Report.* The PSI Report on page 3
    concluded that "Traders use the natural gas contract on NYMEX,
    called a futures contract, in the same way they use the natural gas
    contract on ICE, called a swap. . . . The data show that prices on
    one exchange affect the prices on the other."

[^7]: *See* letter to the Honorable Jeff Bingaman from the Honorable
    Reuben Jeffery III, dated February 22, 2007.

[^8]: *See e.g*. *U.S. Commodity Futures Trading Commission* v. *BP
    Products North America, Inc.*, Civil Action No. 06C 3503 (N.D. Ill.)
    filed June 28, 2006.

[^9]: For example, the CFTC recently amended its Rule 18.05 "special
    call" provision to make explicit that its special call authority to
    traders applies to OTC positions, including bi-lateral transactions
    and transactions executed on the unregulated electronic trading
    facilities where the trader has a reportable position on a
    designated contract market in the same commodity. This amendment
    made explicit authority that the CFTC has previously exercised under
    Rule 18.05 to require a trader with a reportable position on a
    regulated exchange, upon special call, to report related OTC
    positions.

[^10]: See, "*Recent Energy Initiatives*," CFTC Statement,
    http://cftc.gov/stellent/groups/public/@newsroom/documents/file/cftcenergyinitiatives061708.pdf

[^11]: *See* CFTC Letter 06-09 (April 19, 2006); CFTC Letter 06-19
    (September 6, 2006).